In making the overall assessment of current and future economic performance in individual countries, a number of key variables and how they interact must be examined, broadly along the following lines:
- Domestic expenditures. Projections of private consumption and saving rates typically take into account real disposable income, household wealth, changes in the rate of inflation, monetary and financial conditions, and leading indicators of consumer confidence and retail sales. Business fixed investment is mainly assessed in relation to non-financial (sales, output and capacity utilisation) and financial (cash flow, monetary conditions and interest rates) variables. Business sentiment and survey information is also taken into account. Projections for residential construction typically take account of demographic trends, housing stocks, real income and financial conditions, but also draw on cyclical indicators for the construction sector. Projections of stockbuilding are usually made with reference to relevant stock-output and stock-sales ratios in relation to normal trends.
- Employment, wages and prices. Employment and other labour market trends are generally assessed on the basis of actual and projected activity. Important additional considerations relate to productivity trends, capacity constraints and costs. Unemployment rate projections are derived from employment and labour supply projections, with the latter assessed on the basis of demographic trends and participation rate assumptions. Wage and earnings assessments take into account a number of key factors, such as the pattern of current wage settlements data as a leading indicator. Unemployment, labour market conditions, productivity and the terms of trade also influence the overall projection for real wages and real compensation per employee. The assessment of domestic prices and inflation trends depends on unit costs, the strength of demand reflected by output gaps and foreign prices.
- Output gaps. The output gap is measured as the difference between actual and estimated potential GDP, in volume terms and in per cent of potential GDP. Output gaps are difficult to estimate and subject to substantial margins of error given that potential output and structural unemployment rates are generally unobservable variables. This generally follows a production function approach, taking into account the capital stock, changes in labour supply, factor productivities and underlying “non-accelerating inflation rates of unemployment” (NAIRU).
- Foreign trade and balance of payments. In making the forecasts, particular attention is paid to consistency at domestic and world levels, and to ensure that key accounting identities and relationships are observed, notably with respect to international trade and the balance of payments. Within this framework, projections for aggregated import volumes of goods and services typically take account of domestic activity (weighted expenditures) and relative price competitiveness, giving additional weight however to current and past trend developments in import penetration. Aggregate goods and services export volume projections are generally linked to developments in export weighted markets, competitiveness positions and trend export performance. Projections for export prices take account of domestic labour costs and import prices, as well as competitors’ export prices, while import prices are derived as weighted averages of foreign and domestic prices.
Investment income receipts and payments are set to reflect returns on stocks of external assets and liabilities, while international transfer debits and credit are exogenous, subject to consistency checks across countries. An important feature of the trade and balance of payments exercise is the need to ensure consistency across countries and regions and iterative procedures for maintaining balance at the world level. A global equation linking world trade growth to world GDP growth is also used in checking the consistency of the world trade trajectory for given world activity.