Whenever I see a forecast for economic growth, exchange or interest rates, or sales growth, I’m always reminded of the quote attributed to Danish physicist Neils Bohr that “prediction is very difficult, especially about the future”.
His contemporary, Werner Heisenberg’s uncertainty principle says you can’t measure both the position and momentum of a particle with any precision – the more accurate you are about one, the less you are about the other – because, there is a certain element of fuzziness necessitating a probabilistic guesstimate of where things are.
These two ideas neatly encapsulate the problem with economic, market, and business forecasts. They are nowhere near as precise as the forecasters pretend.
And yet forecast economists, strategists, businesses, treasurers, and central bankers must, if only to keep external stakeholders happy in the artifice that there is some sort of faux-precision around the decision-making process.
I mention all this as background to the forecasts in the RBA’s quarterly Statement on Monetary Policy.
What those forecasts – and their implied precision – don’t show is the degree of uncertainty around the RBA’s central tendency these forecasts represent.
The RBA says in the SoMP that “the forecasts are based on a range of assumptions about the evolution of some variables, such as the exchange rate and the cash rate, and judgements about how developments in one part of the economy will affect others. One way of demonstrating the uncertainty surrounding the central forecasts is to present confidence intervals based on historical forecast errors”.
They then offer charts of GDP growth, inflation, and unemployment which highlight the 70% range and the 90% range around their central tendency for these metrics.
Where is all the uncertainty coming from you might ask.
The RBA said:
A key source of uncertainty for the forecasts continues to be the outlook for growth in the Chinese economy and its implications for commodity prices, Australia’s exports and the terms of trade. Higher commodity prices, particularly for oil, are likely to contribute to global inflationary pressures, which could affect the path of monetary policies over the forecast period. This, in turn, could affect financial market prices, particularly exchange rates, which are assumed to be constant in the forecasts.
As has been the case for some time, geopolitical risks and global financial stability risks could also affect global growth and financial market prices, should they materialise.
Domestically, there is considerable uncertainty about the momentum in the labour market, the extent to which household income and consumption growth will pick up over the next few years and the outlook for the housing market. All these sources of domestic uncertainty present risks to the outlook for activity and inflation.
Yet for all that uncertainty, which is probably the only thing predictable and persistent through the years, the RBA has managed to steer the Australian economy to 25 years without a recession.
So next time you here someone declare they’re smarter than the RBA, or that the RBA is wrong, just ask to see the track record of their predictions.
Here’s the charts of the certainty bands.
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