The Difficulty of Economic Forecasting

At a recent investor conference we attended, the Chief Economist at Westpac, Bill Evans, reviewed his forecasts made at the same conference held a year earlier in 2018 which we copy below.

As can be seen Evans’ forecasts were wildly inaccurate; mis-predicting the cash rate by 0.75%, the yield on the Australian Government 10 year bond by close to 2%, the Australian 3 year swap rate by 1.5%, the AUD currency by 4c (or around a 6% error) and the Fed Funds rate by 1%.  Evans even failed to get the directional movement of any of these variables correct except for the currency. Despite these results, Evans subsequently received much praise for his forecasts because although he was “wrong” he was far less “wrong” than most other economists! 

In September 2018, the RBA was communicating its intention to increase the cash rate, not reduce it. While Evans says he and his team assessed the data in 2018 as suggesting future weakness in the Australian economy, Westpac was reluctant to forecast a drop in the cash rate in contradiction to the clear messages from the RBA.  Westpac therefore opted for a “no change” forecast because it predicted the economic data would not provide any justification for the RBA raising the cash rate and therefore it believed the RBA would be forced to continue holding the cash rate steady. Many other economists either placed a greater emphasis on the RBA’s statements or estimated the path of the Australian economy differently resulting in forecasts projecting the cash rate would rise.

The overall lesson from Evans’ speech is that economic forecasting is incredibly difficult and unless one is of the opinion the RBA is willing to tell lies on an outright basis; deliberately deceiving the public as to its intentions (which we are not and we don’t think Westpac and Bill Evans hold this view either), then the RBA also failed to accurately forecast the direction of the Australian economy correctly either.  When the RBA concluded its 2018 projections no longer applied in 2019 as GDP growth began to fall, wage and consumer inflation remained subdued and business and consumer confidence started to falter as the housing market declined, the RBA decided to reduce interest rates starting in June 2019.

The inherent difficulty of economic forecasting generally leads Amicus to be conservative in its recommendations as to be otherwise would involve a high degree of speculation and risk placing big bets on economic outcomes.  Please feel free to contact us if you would like to know more about our investment philosophies or would like to discuss our advisory services for prudent and conservative wholesale fixed interest investors.

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