Buyer beware when even RBA thinks its forecasts are rubbery
Glenn Dyer and Bernard Keane|
Nov 13, 2012 12:34PM |EMAIL|PRINT
When even the Reserve Bank thinks its forecasts should be handled with care, private forecasters owe their users an explanation, write Glenn Dyer and Bernard Keane.
Caveat emptor is usually applied to buying cars, food and other products and services. It should apply to economic forecasting as well. Surprisingly the Reserve Bank thinks it should and should especially apply to its own forecasts.
Four times a year the central bank releases its Statement of Monetary Policy. They examine the conduct of monetary policy, the way the economy is travelling and forecast future levels of inflation and economic growth. The final SMP for the year was released last Friday and gained considerable publicity for a lowering of economic growth forecasts for 2013 and 2014, and a raising of the bank’s forecasts for inflation. Newspapers, radio and TV all picked up on these changed forecasts.
There was no discussion of how this was the fourth attempt at forecasting inflation and growth this year where there had been a change made in response to changes in the domestic and international economies. In other words, the latest forecasts were as “rubbery” (to use Phillip Lynch’s famous phrase) as those that came before, but no one quoting them recognised that.
Yesterday another paper from the RBA itself provided a timely warning that we should wary of forecasts. Without saying so, the warning is directed at the media and business economists: its forecasts aren’t dodgy, but they shouldn’t be taken as gospel. Or to quote the study paper:
“We find that RBA forecasts have substantial explanatory power for inflation over the first forecast year. However, like many other forecasters, the RBA forecasts explain very little of the variations in GDP growth, medium-term changes in unemployment, or the medium-term deviations of underlying inflation from the target …
“Uncertainty about RBA forecasts is similar to that about private sector forecasts. More precisely, RBA forecasts of inflation have been marginally more accurate than the average of private sector forecasts, while RBA forecasts of GDP growth have been less accurate. However, the differences are not large.”
Moreover, it warns against assuming shorter-term forecasts are better than medium-term forecasts:
“Uncertainty about some key variables does not increase with the forecast horizon. We know about as much about economic growth in the current quarter as we do about growth two years ahead.
“In contrast to the approach of some foreign central banks, the RBA has responded to this uncertainty by placing relatively less emphasis on forecasts and more on analysis of current economic developments in its leading publications. In the SMP, forecasts of select variables are presented in a table using ranges beyond the near-term horizon to avoid an impression of excessive precision.”
Just how accurate has the RBA been?
“For example, 70% of the RBA’s forecasts for underlying inflation one year ahead have been within half a percentage point of actual outcomes. If future forecast errors are similar to those in the past, then there is a 70% probability of actual underlying inflation falling within half a percentage point of the current forecast.”
“Forecasting economic activity is more difficult. As has been found for many forecasters overseas, the RBA’s forecasts of GDP growth lack explanatory power … Forecasts of the unemployment rate outperform a random walk only for a few quarters ahead.”
If caveat emptor is good enough for the RBA, then it should be good enough for private sector forecasters. And it should particularly apply to forecasters who are engaged, or who have allowed themselves to be used, in what appears to be a partisan campaign.
Recently, as part of Michael Stutchbury’s ongoing campaign against the government at The Australian Financial Review, we had another forecast its now-favoured forecaster, small-time Canberra outfit Macroeconomics, claiming the government would be racking up structural deficits of over $120 billion. Macroeconomics, remember, was badly out in its MYEFO revenue estimates, but that’s forgotten about in the perpetual present of the world of forecasting, where your track record is irrelevant as long as your numbers contradict those of a designated political opponent.
So here’s a challenge for everyone engaged in economic forecasting, whether you’re a bank that bases actual investment decisions on them, self-promoting Canberra consultants or partisan economists: next time you offer your latest set of forecasts, give us a table of how your last half-dozen forecasts for growth, inflation, employment and tax revenue have fared against reality.
But we’d be surprised if that happened. Caveat emptor indeed.