The author has been described by News Ltd as an "iconoclast", "Svengali", a pollie's "economist muse", and "pungently accurate". Fairfax says he is a "Renaissance man" and "one of Australia’s most respected analysts." Stephen Koukoulas concludes that he is "85% right", and "would make a great Opposition leader." Terry McCrann claims the author thinks "‘nuance’ is a trendy village in the south of France", but can be "scintillating" when he thinks "clearly". The ACTU reckons he’s "an enigma wrapped in a Bloomberg terminal, wrapped in some apparently well-honed abs."

Tuesday, October 2, 2012

RBA cuts on its forecasts. But what does Glenn Stevens say about forecasts?

As I had indicated was possible in the AFR on 7 September, and many other commentators--notably Alan Mitchell, David Bassanese, Peter Martin, David Uren, and Terry McCrann--all similarly stated during the month, the RBA was more likely than not to cut in October. While not agreeing with this decision, I reiterated the probability in the AFR on Monday. Other commentators, like McCrann, argued it was an "almost certain" outcome. These were very confident calls from folks who have been head-faked by the RBA in the past. As some less fickle economists noted, there was nothing data-wise to change forecasters' views between September and October. In fact, much of the data, including the GDP, jobless and house price numbers, were pretty solid (to argue they are otherwise you have to be selective in your interpretation and ignore the headline GDP, jobless, and house price outcomes). The shift in some market forecasts that did occur was  precipitated, I very strongly suspect, by the loud consensus in the fourth estate.  You can quibble about ABS data, but they have been telling a similar story. The RBA made this explicit today, for the avoidance of any disputes: "growth has been running close to trend." As has been the case for the last one and a half years, according to the latest version of the National Accounts. So the RBA cut today, and in May and June, and in November and December, on the basis of its forecasts of future growth, unemployment, inflation, and the output gap. There will be a lot of ex post facto rationalisation about how the RBA is right to cut. But this noise cannot conceal the fact the RBA is cutting on the basis of its forecasts. So here are some very recent remarks Glenn Stevens has made on forecasting, and the importance of "now-casting", which I have emphasised in recent commentary (for a friend who I know will read this, you can trace the now-casting lineage from Stevens to here):

Glenn Stevens (August 2012): As I said earlier, forecasting is an extremely imprecise art. There is not a great deal of science in it. It has ever been thus...Some of the difficulty is—and I probably will not get this comprehensively complete off the top of my head—the future is inherently difficult to predict anyway. The recent past has actually been difficult to predict—that is, the data that we have for what has been happening. Inevitably, even the best data is measured with a margin of error. It gets revised, and so the jumping-off point into the future that you think you have today actually you find is a little bit somewhere else subsequently. That would be true to say partly why the very near-term growth forecasts are a bit higher. That would be right, I think Chris, that the recent history got revised up a bit from what we had been told earlier. That is a difficulty. We know that the future will have shocks. A shock by definition is an unforecasted event. We spend time thinking about what they might be, but there will always be things that come along that you could not predict and, even if you could predict they might occur, not when. It is often hard to have a good sense of how they work...So those things—acute uncertainty: the forecasters always want to say there is more than the usual degree of additional uncertainty; that is sort of a forecasting cliche. But it probably is true at times like this. That is what I would say. Chris, do you want to add anything? 

Dr Christopher Kent (August 2012): I would agree with you there. The shocks that are before us—we cannot ever know what they are. A critical part, though—and of late—has been knowing where we are coming from. The point is that it is just very hard to pin down the state of the economy in real time; it takes time for data to come through and be processed accurately and compiled together...

Glenn Stevens (November 2011): Experience over the inflation targeting era (since 1993) suggests that the probability of the CPI outcome being within half a percentage point of the central forecast [eg, between 2-3%] is roughly two in five at either a one year or a two year horizon.