Tuesday, 6 December 2011

Economists vs the Market

A friend sent through to me a Reuters survey from 18 February this year with 24 market economists outlining their forecasts for the cash rate for December.

None thought that interest rates would be cut from the 4.75% level prevailing at the time and a couple thought that the RBA would hike the cash rate to 5.75%. The best forecast was from BNP Paribas (their European heritage influencing their thinking?) who thought the RBA would be on hold for the year. Everyone else had a hike or two or three or four by December.

The reason I point this out is not to bag out these forecasters for their rotten forecasts – it is a tough gig. I am not sure how I would have responded to this survey. But it shows yet again how hairy forecasts for even less than a year can be, and how unfolding events can change the game.

A similar survey of market economists from June wasn’t much better – no one saw cuts, even though the extent of the rate hiking cycle had been scaled back. This was about the time when the market, as it turns out correctly, starting pricing in aggressive interest rate cuts much to the scorn of many in the market (yes Adam).

It would be very interesting to see some self-reflection from those in the market about their forecasts at the start of the year. Treasury and the RBA do this when they update their forecasts. My guess is that market economists paid little or no attention to the massive fiscal policy tightening, even though it was obvious at the time.

Another mistake, I reckon, was that the market economists focused on China as an engine of growth and did not look at the whole global economy which was starting to fall in a heap early in 2011. Locally, I reckon too much attention was paid to the boom in mining and business investment and they ignored the free-fall in credit growth, falling house prices and stalling job creation as temporary or desirable trends. The floods in Queensland didn’t help with data interpretation but it was clear that growth was cooling in the early part of 2011 under the weight of tight monetary policy, tight fiscal policy and the booming Australian dollar.

Now it seems that almost everyone is calling for more interest rate cuts. Some of those forecasting 3 or 4 rate hikes earlier this year are now calling for 2 further cuts early in the new year. In framing these views, I hope they look more at government demand, focus more on credit growth, look at leading indicators for the labour market and the global economy as a whole and not just China. It is also to be hoped, as Ross Gittins pointed out yesterday, they look at issues objectively and not with a political bias that clouds their judgment.


  1. Hi Stephen,

    I think a recent Freakonomics podcast ('The Folly of Prediction', link: http://www.freakonomics.com/2011/09/14/new-freakonomics-radio-podcast-the-folly-of-prediction/ ) may have some valid points about the different incentives facing market economist forecasters and those who are revealing their preferences in the market.

    Indeed, a market economist forecaster's job is often to get the company's brand name into the newscycle; thus, the risk of going against the grain of Groupthink and being wrong (even if the probability of being correct is high) is riskier to their reputation/the brand than going along with the Groupthink and being one of a bunch of forecasters who got it wrong. There's a touch of that in this post: http://www.macrobusiness.com.au/2011/07/bill-evans-backflips/

    However, I do suspect that the focus on China and lack-of-focus on other areas, as you suggest, was also a factor.


  2. (PS. I probably shouldn't have said 'revealing of preferences' as that would have been more appropriate for discussing consumer behaviour; the implied "putting their money where their mouth is" holds though)