On the usefulness of macroeconomic forecasts as inputs to forecasting models

A forecasting model for y_t based on its relationship to exogenous variables (e.g. x?_t) must use x?_t, the forecast of x?_t. An example is given where commercially available x?_t's are sufficiently inaccurate that a univariate model for y_t appears preferable. For a variety of types of models inclusion of an exogenous variable x?_t is shown to worsen the y_t forecasts whenever x?_t must itself be forecast by x?_t and MSE (x?_t) > Var (x?_t). Tests with forecasts from a variety of sources indicate that, with a few notable exceptions, MSE (x?_t) > Var (x?_t) is common for macroeconomic forecasts more than a quarter or two ahead. Thus, either:

• (a) available medium range forecasts for many macroeconomic variables (e.g. the GNP growth rate) are not an improvement over the sample mean (so that such variables are not useful explanatory variables in forecasting models), and/or
• (b) the suboptimization involved in directly replacing x?_t by x?_t is a luxury that we cannot afford.