Economic realities Predictions explored in 2 investment pages
The clouds part and predicts . . . that the forecasters will get it wrong.
Get set for a drop in house prices. Expect to see a weaker New Zealand dollar by the end of the year. Higher inflation may be just around the corner.
You don’t have to look far to be swamped with predictions about the outlook for the economy.
But now economists have issued a new warning to the average borrower or investor: Don’t put too much stock in what the experts say is going to happen.
Data shows that forecasters’ predictions can sometimes be wildly off the mark.
Economist Shamubeel Eaqub pointed to Reserve Bank predictions for the 90-day bank bill, which have been consistently incorrect over the past 10 years. They did not foresee the big drop in interest rates in 2009 and predicted a recovery that did not happen until many years later.
A new set of predictions will be made with this week’s official cash rate announcement and monetary policy statement.
Eaqub said there was no one that could be relied on to get it right when it came to forecasting.
‘‘This is why the experts who pretend to know what the future holds are losing their respect and credibility. The future is unknowable.’’
Research by the Wall St Journal showed that in 2015, United States forecasters were wrong about the price of a barrel of oil, the country’s gross domestic product, the rise in house prices and the rate of inflation. On average, they expected crude oil to be US$63 a barrel in December last year. In fact, it was about US$38.
Tim Hazledine, a professor of economics at the University of Auckland business school, said forecasters could never achieve high levels of accuracy. ‘‘There is no sound basis for forecasting unless you are a genuine mindreader,’’ he said.
People would respond to predictions and forecasts by changing their behaviour, which would then alter what happened.
He said economists had missed many of the big economic shocks of the past century, including the rapid rise of inflation in the 1970s and the global financial crisis.
‘‘In 2007 people were talking smugly about the ‘great moderation’ with low inflation and unemployment back around 4 per cent in New Zealand. Things seemed pretty good . . . then the global financial crisis hit.’’
ASB economist Jane Turner has done work on forecast accuracy and said it was generally accepted that no one forecaster would outperform others over time. ‘‘You’d consider you’re doing fairly well if your performance is in line with average forecast error.’’
Gareth Kiernan, of Infometrics, said one forecaster might be right on one occasion, and then not the next.
He recommended retail investors and borrowers read a number of forecasts and take general themes, rather than following one in detail.
‘‘Go with the average, that’s the least inaccurate,’’ he said. ‘‘Part of the trouble with economic forecasts is there tends ot be an element of mean reversion.
‘‘What’s the historical norm – you assume things return to that. The difficulty is if there is a big shift, it takes a while for forecasters to be confident that things have changed.
‘‘Sometimes you get to the point where you think the world has changed fundamentally and then as soon as you say that, you realise, oh no it hasn’t.’’
Turner said investors and borrowers should consider ‘‘the path of least regret’’.
‘‘If we’re wrong on the upside how would that leave you and how would you feel about that, and if we’re wrong on the downside, how would that leave you and how would you feel about that?’’ she said.
‘‘How would you spread your risk in that circumstance? Borrowing or investing always comes with an element of risk because you can’t know the future with absolute certainty. We do the best we can.’’
In a recent speech, Reserve Bank assistant governor John McDermott said reviews of its forecasts helped to update the bank’s understanding of economic relationships, evaluate risks to the current outlook and identify areas where accuracy could be improved.
‘‘The bank will always make forecast errors, reflecting the uncertainties in assessing the current state of the economy and its outlook,’’ he said.
‘‘For example, the vast majority of forecasters were unlikely to have been able to accurately predict the sharp decline in oil and export commodity prices that occurred over 2014 and 2015 – one factor that has led to current low inflation.
‘‘To say the potential for forecast errors is large is an understatement.’’
But he said forecasting was important because monetary policy would influence activity, including wage- and price-setting behaviour, with a lag.
‘‘Second, it is the outlook for the economy that matters for the economic behaviour of firms and households today,’’ he said.
‘‘Therefore, we need an understanding of the likely direction of the economy over the next few years, to guide our monetary policy strategy to achieve price stability.’’
McDermott said the bank’s recent forecasts had performed well compared to other forecasts available in the market.
Reserve Bank analysis shows it was the most accurate forecaster in the market for inflation when looking a year ahead. All forecasters performed more poorly on the exchange rate.