On Monday (January 7, 2012) – The culpability lies elsewhere … always! – I wrote about the unacceptably large forecasting errors from the IMF derived from models that informed their input into bailout packages etc, which in turn set the fiscal austerity agenda and as resulted in millions becoming unemployed. I was interviewed about this today by the ABC National Radio program – the World Today – and told the journalist that if errors of this size occurred in medicine, the practitioner would be jailed for professional negligence. A summarised transcript from the World Today programme is available here – Eurozone jobless rate hits record high. A few snippets from a 10 minute interview! I did another interview today about a paper that came out recently from the RBA, which largely admitted its forecasting record was inferior to what we might have gained from assuming a random walk (unemployment) or simple historical averages (real GDP growth). You have to see this incompetence not in terms of some technical boffins waxing lyrical in a research paper about a range of technical measures of their errors but rather, in terms of the damage that the policy that has been informed by these errors. Today we received more evidence of that damage in the form of the ABS publication – Job Vacancies, Australia (November 2011). The evidence is clear. Our economy is faltering because policy settings have been wrong. They have been wrong because the policy setting paradigm is wrong and this has led to the use of models which deliver predictions that cannot be sustained given the underlying dynamics of the monetary system that this ideology chooses to ignore.
In November 2012, the RBA published a research paper – Estimates of Uncertainty around the RBA’s Forecasts – which also cast doubt
The Data used for the paper is very interesting and saves one having to track all the RBA forecasting publications and put together the shifting forecasting horizons.
In that paper, the RBA authors admit that
The confidence intervals … strike many observers as wide, particularly for GDP growth. In other words, our estimates of uncertainty are surprisingly high.
The RBA also say that their forecast intervals (standard errors) are very wide:
For example, the 90 per cent confidence interval for GDP growth in the year ended 2013:Q4 extends from 0.9 per cent to 5.7 per cent. That is, although the central forecast is for growth to be moderate, it could easily turn out to be very strong, or quite weak. Similarly, while little change in the unemployment rate is expected, a large increase or decrease is possible. Although the most likely outcome for headline inflation is within the RBA’s target range, it could easily be well outside. In comparison, we can be somewhat more confident about underlying inflation, which is likely to remain moderately close to the target range.
Which raises the question as to the veracity of the underlying model being used to generate these forecasts. It also means that such forecasts are virtually useless for policy making purposes. There is no reason, on statistical grounds (at the 10 per cent level of significance), to choose between a 0.9 per cent GDP growth rate and a 5.7 per cent growth rate. In statistical terms, these interval bounds are not qualitatively better or worse than the point estimate.
I don’t want this blog to be interpreted as an exclusive RBA bashing exercise. There is an extensive literature that shows that the Bank of England, the Federal Reserve Bank, OECD and of-course the IMF, all offer (systematically) poor economic forecasts.
In relation to real GDP growth, the RBA forecasts are inferior to a simple “historic (since 1959) mean” over a 12-month horizon and breaks even over the second year.
This led the authors to say:
… the low explanatory power of macroeconomic forecasts is a striking result, with important implications. For example, it affects how much weight should be placed upon forecasts of GDP in determining macroeconomic policy.
In relation to the unemployment rate, the alternative they test against is a random walk – that is, that the best estimate next period is this period’s actual value. All variation is thus stochastic and by definition unpredictable. The result is that the RBA forecasts are inferior to the random walk.
Even in relation to the “key” RBA variable, the inflation rate, and especially the forward-looking rate, which the whole premise of inflation targetting is based on, the RBA admits that:
… but – consistent with successful inflation targeting – at longer horizons deviations in underlying inflation from the RBA’s target seem to be unpredictable. Uncertainty about the forecasts for GDP growth and (beyond the immediate horizon) changes in unemployment is about the same as the variation in these variables. In other words, forecasts for these variables lack explanatory power.
The following graph shows the RBA real GDP growth forecasts and the actual result for quarterly data from February 2008, which was the low-point unemployment rate quarter of the last economic cycle.
The blue arrowed line represents when the RBA started to tighten interest rates again. The Target rate was increased by 0.25 percentage points in October 2009, November 2009, December 2009, March 2010, April 2010, May 2010, then a break, and another rise in November 2010.
The recovery in real GDP growth in early 2009 which was sustained through 2010 was largely due to the massive fiscal policy stimulus that the Federal government introduced in late 2008.
The RBA fell prey to its own rhetoric about the strength of the rebound in commodity prices and the size of the minerals boom that was restored after the first period of the crisis, largely because the Chinese government kept their growth cycle going by using fiscal policy to inject increased spending on domestic activity as its export markets contracted (due to the decline in World trade in 2008-09).
As the Federal government started to withdraw its stimulus and begin its obsessive (now-failed) pursuit of a budget surplus the RBA was tightening monetary policy and it was clear that real GDP growth was starting to falter again, notwithstanding the massive investment that was occurring in the mining sector. The external sector was not delivering the bounty that the spin doctors were predicting and households were resuming pre-credit binge saving patterns.
The result is clear – real GDP started slowing and by early 2011 was heading south. Even at that time, the RBA was predicting strong growth. Over 2011 real GDP growth fell away sharply and despite some odd quarters (such as March 2012) when there was an investment spike, the trend downwards has continued. The RBA only started easing monetary policy again a year after its rise in November 2010.
For 12 months, it claimed the Target rate was appropriate, despite the on-going fiscal contraction and the faltering real GDP growth rate.
The other evidence available – construction activity, demand for credit and the labour market information – all pointed in the same direction. Unfortunately, the RBA ignored the underlying message and took far too long to realise that the so-called once-in-a-hundred-years mining boom was not going to deliver anything like the growth that was predicted.
That boom, was relatively strong, but the other countervailing spending contractions (mainly fiscal policy) were nullifying influences.
In the Mid-Year Economic and Fiscal Outlook 2012-13, which was published in October 2012, the Government re-affirmed its economic logic:
Returning to surplus provides ongoing scope for monetary policy to respond to economic developments and underpins confidence in Australia’s public finances at a time of global economic uncertainty.
The Treasurer’s claims that the government’s surplus promise has allowed the RBA to cut rates is a strange argument. The Government’s strategy (combined with our excessively high interest rates) has been to deliberately create unemployment in the non-mining regions so that the idle resources could then service the mining boom.
Not only will the required migration patterns fail to occur but non-government spending is not strong enough to support trend growth – mining investment boom notwithstanding. Many large employing sectors are declining due to a combination of an appreciated currency (exacerbated by high interest rates) and the withdrawal of the fiscal stimulus.
On Page 35 of the MYEFO we read:
The Government’s fiscal consolidation should continue to provide scope for monetary policy to be eased, if appropriate, without generating price and wage pressures. This recognises that in normal circumstances, monetary policy should play the primary role in managing demand to keep the economy growing at close to capacity, consistent with the medium-term inflation target. The impact of the fiscal consolidation in 2012-13 should be more than offset by growth in private demand, with the aggregate economy growing around trend.
The Treasurer has repeated this mantra endlessly over the last three years. The reliance on monetary policy as the principle counter-stabilising policy tool is a world-wide obsession, which stems from the now discredited mainstream view that fiscal multipliers are low if not negative and inflation-first policy approaches are best because any unemployment that results is temporary and incidental.
The mainstream of my profession actually convinced policy makers that fiscal policy was both dangerous and ineffective. The danger related to when they wanted to run the inflation bogey, while the latter was when anyone suggested the government use budget deficits to tackle the persistently high unemployment.
What a pack of fools! Both the economists who ran that line and the rest of us (the Royal “us”) for believing them. The last three years has demonstrated categorically that fiscal policy is the main game in the policy kit and monetary policy despite all the gymnastics from central banks is incapable of restoring solid growth without spending support being provided by fiscal policy.
The mainstream obsession about the primacy of monetary policy should be discarded. The enduring economic crisis has demonstrated that. Even the IMF has been forced to admit that fiscal multipliers are now well over 1 meaning the cuts to net public spending are not offset by greater gains in private spending.
The fiscal contraction expansion myth is exposed well and truly by these admissions. The superiority of monetary policy is also being exposed by the poor performance of the central bank forecasting models.
Further, monetary policy changes have uncertain impacts on aggregate demand, which make them unreliable vehicles to influence spending growth. They cannot target regions, sectors or demographic cohorts, other than punishing (or rewarding) debtors and rewarding (punishing) creditors and fixed income recipients. These distributional impacts are unclear in net terms.
The RBA paper makes it clear that the central bank is aware that its growth forecasts were wrong and it is now trying to backfill the damage that the resulting high interest rates, combined with the Treasurer’s policy stance, are causing.
That is, of-course, a far cry from the way the Treasurer constructs the events.
As an historical note, it is not the first time the RBA has caused major damage with its faulty policy settings. In the late 1980s, the RBA held rates at ridiculously high levels (up to 19 per cent) for far too long given the circumstances. It was obvious that such high rates would generate a downturn, especially as the Federal Government was also waxing lyrical about the budget surpluses it had achieved, not realising that this was draining demand too quickly.
Recession hit in 1991, and the Treasurer then claimed it was “the recession we had to have” – which was a disgrace for a Labor Party Treasurer to say knowing it would drive hundreds of thousands of workers out of a job. The government refused to ease fiscal policy and the RBA refused to relax monetary policy sufficiently and by the middle of 1991, Australia was in the midst of the worst economic downturn since the Great Depression.
The lengthy recession was totally policy-induced by both incompetent (ideologically-obsessed) policy positions adopted by the RBA and the Federal Treasury.
The ABS Job Vacancies data shows (seasonally-adjusted):
- Total job vacancies in November 2012 decreased by 6.9 per cent from the August-quarter 2012.
- The number of job vacancies in the private sector decreased by 6.9 per cent from the August-quarter 2012.
- The number of job vacancies in the public sector decreased by 7.5 per cent from the August-quarter 2012.
Even the celebrated boom in the mining sector is tapering with a decline of 20 per cent in vacancies reported in the year to November 2012. Over the 12 months to November 2012, public sector vacancies fell by a staggering 29.7 per cent, reflecting the harsh (and totally unnecessary) fiscal austerity that is being imposed on the government sector.
While we are continually being told that there are more than enough jobs to go around and that harsh cuts to income support payments are because the government would rather people take jobs, the reality is that the number of unemployed to each job vacancy is on the rise again.
In February 2008, the low-point unemployment rate month of the last growth cycle, there were 2.58 unemployed persons (39 vacancies for every 100 unemployed). In November 2012, the UV ratio was at 3.87 (or only 25 vacancies per 100 persons unemployed).
The following graph uses today’s vacancies data to show you what has been happening to labour demand and labour supply in Australia since February 2008.
Labour Supply is computed by taking the current working age population and using the participation rate at February 2008 (66 per cent). This eliminates the cyclical swings in the participation rate (it is now down to 65 per cent) and thus implicitly adds the “hidden unemployed” back into the labour force.
Labour demand is the sum of total employment and total job vacancies. I have not tried to standardise this for hours (thus taking into account the significant rise in underemployment). The reality is that in full-time equivalent units the graph (the gap between labour supply and demand) would be much worse than it is without that correction.
Both series are indexed at 100 as at February 2008. So you know that the growth in labour supply has been stronger over this period than labour demand and the divergence, which closed during the period that the government was running its fiscal stimulus, is now rising again.
So we can say this is the best outlook – and that is pretty dismal indeed.
For further information and discussion of how to interpret vacancies data please read the blog – Labour market deregulation will not reduce unemployment.
The economy is clearly not producing enough jobs. In that context, the policy environment should be expansionary. The opposite is the case in Australia. That amounts to a policy failure.
The Treasurer’s claim that monetary policy has to do the hard policy yards is comical given the RBA’s admissions that it cannot forecast better than a random walk.
It is time to shift the policy focus back onto fiscal policy which we know has more direct impacts (the multipliers are well above one) on spending and employment.
And I have even mentioned that the ABS also published its latest – Retail Sales, Australia – data today, which showed that retail turnover in November was -0.1 per cent down on the previous month.
The question is when will it become obvious to the general public that mainstream economists are not in some elevated species with deep insight into how the economy operates. In the main, it is a profession that is unproductive – its main outputs are regularly demonstrated to be faulty. At some point, the return policy at the store will lose credibility and the company will go broke.
It cannot come quickly enough for those who are damaged by the professional incompetence and negligence.
By the way, I thought I would turn out an anthropologist study music and culture. I became an economist at the start of the neo-liberal era because unemployment was sky-rocketing and the policy makers began to blame victims rather than see it as a systemic failure of the macroeconomy. That was my motivation.
Which means I cannot finish with noting that Eurostat published the November 2012 labour force estimates yesterday (January 8, 2013) – Euro area unemployment rate at 11.8% – which reported that the Eurozone unemployment rate is now at 11.8 per cent (another record) and rising.
The unemployment rate in Spain rose to 26.6 per cent; Greece was (as at September) at 26 per cent but it will be higher now and the rest of it. Youth (under 25) unemployment in Spain is now at 56.5 per cent and rising.
It is nothing short of a total disaster and then we read that – The euro crisis is over, declares Barroso – and I wonder when the people en masse will take to the streets and expel these indecent elitist leaders.
Pretty depressing eh!
That is enough for today!
(c) Copyright 2013 Bill Mitchell. All Rights Reserved.