Economic and Business Forecasting: Analyzing and Interpreting Econometric Results

CHAPTER 9

The 10 Commandments of Applied Time Series Forecasting for Business and Economics

One of the most important elements of today's decision-making world, in both the public and the private sectors, is the forecasting of macroeconomic and financial variables. For instance, the key driver of borrowing costs is short-term interest rates. The Federal Reserve Board's federal funds target rate, the primary short-term interest rate, has been around 0 to 0.25 percent for more than four years (December 2008 to the time of this writing, July 2013). Decision makers thus ask: How much longer will the Fed leave rates low? Although several factors influence the Fed's decisions on rates, the two main economic factors are inflation and unemployment.¹ The Fed may begin to raise the federal funds target rate if (a) inflation expectations for the next one and two years continuously stay above its inflation target of 2 percent and/or (b) the unemployment rate falls below 6.5 percent.² Accurate forecasts of inflation and unemployment can help a decision maker predict the likelihood of a rate hike by the Fed.

During the past few decades, econometric model-based forecasting has become very popular in the private and the public decision-making process. In this chapter, we present 10 commandments of applied time series forecasting that an analyst should learn. These commandments, in our opinion, help produce accurate forecasts. The commandments are:

1. Know What You Are Forecasting
2. Understand the ...