Escalation management: Forecasting the effects of inflation on building projects

Following a review of the development and use of indices which purport to measure the effects of inflation upon the building industry, the paper focuses upon the problem of forecasting. Errors in published forecasts of building cost indices and tender price indices are noted and various possibilities for achieving more accurate forecasts are evaluated. The evaluations demonstrate that stochastic time series forecasting is a useful approach. A probabilistic project cash flow model for NED02 work categories was produced and combined with stochastic time series forecasts of the NEDO category indices to yield project escalation forecasts of measured variability. Although high forecasts of escalation resulted, these forecasts were of lower error than other forecasts derived from published information. Sensitivity analyses were used to consider variability and error sources in the forecasts, showing the primary variable to be the indices. It is concluded that forecasts of projects' escalation based upon stochastic time series techniques offer considerable advantages to the construction industry and its clients.