As we go into an election year, the Reserve Bank of Australia has given all of us a reality check on both the outlook for the Australian economy and its confidence in forecasting it.
For the first time ever, the central bank has started qualifying its forecasts for gross domestic product growth and inflation for the coming year, assigning them levels of confidence (Ross Gittins has a good explanation of its this morning). As a result, the RBA seems to be hedging its views about the economy’s outlook more than it has done for several years. It is a message to those who use its forecasts, or construct estimates of their own, that at best they will be approximate. The central bank knows the economy has weakened and could weaken further, but by how much and in which sectors remains unclear.
To make the new stance clear, the bank included a special explanation at the end of the section on the economic outlook for Australia in its first statement on monetary policy for 2013, which showed it had more confidence about the immediate outlook for inflation than economic growth. It seems this will be a regular part of the bank’s forecasting (four are issued every year in the statement of monetary policy).
The new-found conservatism about its forecasts could see the bank’s estimates less precise than those from Treasury in the budget and the pre-election economic and fiscal outlook update we’ll get in August, both of which will be treated as economic goals in themselves rather than as tools in the pursuit of economic goals. And, in turn, it should be a heads up not to take the private sector forecasts too seriously. It’s something to remember next time bank and economists and consultants (Chris Richardson anyone?) produce their own forecasts, which are duly treated as tablets brought down from the mountain by headline-hungry journalists and commentators, especially at the national dailies. Maybe it’s time for the private sector to start its own “structural adjustment” process to accommodate the RBA’s new, more honest way of estimating growth and inflation.
The bank reminded readers that a research paper issued last November that looked at the RBA’s forecasts from 1993 to 2011 found the forecasts for inflation were on the whole OK, but not for GDP growth. “Our estimates suggest that uncertainty about forecasts is high. We find that the RBA’s forecasts have substantial explanatory power for the inflation rate but not for GDP growth,” the paper concluded.
And that finding seems very evident in the monetary policy statement, especially the section on forecasts where the central bank goes out of its way to highlight the difficulties.
“… high levels of uncertainty have also been found in other countries, for other macroeconomic variables and for both private and public sector forecasts. One implication of this uncertainty is that there is limited value in discussing precise point estimates of the forecasts. Accordingly, the forecasts are rounded in the short term and presented as ranges further out.”
While telling us to be more cautious about using its forecasts, the change in the RBA’s approach could also be due to the added uncertainty about parts of the economy at the moment, particularly about the key challenge of what will take the place of the mining investment boom as it peaks. The bank underlined that feeling in the summary of risks for the economy listed at the end of the outlook where the “uncertainty” was an ongoing theme:
“… the absence of any clear indications of a pick-up in non-mining investment means that the outlook remains quite uncertain …”
“… although the lack of improvement in the demand for new detached houses to date raises questions about the breadth and strength of the recovery …”
“… while information received since the November statement still suggests that the peak in the mining investment boom is near, considerable uncertainty remains about the exact profile for spending.”
“There is also considerable uncertainty surrounding the outlook for public spending …”
That uncertainty would help explain the 0.25% trim to its 2013 growth forecast since its last statement in November, although growth for the year to December is estimated in the range of 2-3%, which is still solid. Its consumer price index forecast is also weaker by 0.25%, due to the weaker than expected economic growth and slower wages growth.
Like the post-board meeting statement from Glenn Stevens last week, the tone of the monetary policy statement left the market with the idea that the RBA could resume cutting interest rates next month or in April. The statements saw the dollar fall under $US1.03 to a series of three month lows, before it recovered that level in late trading on Friday night to end around $US1.0319.
The bank seems a bit stumped as to where the economy is heading at the moment — it knows inflation is mild, that there is still some strength in the labour market, but the expected pick up in housing activity hasn’t happened as yet despite repeated rate cuts. Retail sales remain flat and government spending is being cut, even though the federal government has abandoned the return to surplus pledge for the federal budget.
Perhaps that is why the final two sentences of the statement overview grabbed all the attention:
”The current inflation outlook would afford scope to ease policy further, should that be necessary to support demand. The board will adjust the cash rate as appropriate to foster sustainable growth and low inflation.”
That makes explicit the view that RBA sees room to cut rates if a weakening economy needs another hit from monetary policy, regardless of whether the forecasts are accurate or uncertain and suggesting a different story. In the end, economic management is all about judgment, not just forecasts which are only tools meant to help decision makers.