Reserve Bank forecasting review provided 'comprehensive health check'
Australian Financial Review Apr 6 2016 at 6:43 PM
Jacob Greber
The Reserve Bank of Australia has established a new full-system modelling unit to capture a broader range of potential shocks to the economy following an external review of how the bank forecasts.
Assistant governor Christopher Kent, who heads the economics department, confirmed the results of the review – first revealed last year – in a speech in Hobart on Wednesday, saying it had provided a "comprehensive health check."
Conducted by Adrian Pagan, a former Reserve Bank board member, and David Wilcox, head of research and statistics at the US Federal Reserve, the review suggested several improvements, including testing predictive models to ensure they recognised the massive structural changes of the past decade, particularly those caused by the resources boom.
The review urged the Reserve Bank to change the way it presented forecasts and the extent to which forecasters should publish judgments about the likelihood of risks to the outlook coming to pass; as well as a call to shift staff and resources from studying Asian economies and local business liaison, towards more modelling.
Dr Kent said the Reserve Bank had already acted on several of the proposals, which were presented to the bank more than a year ago after Mr Pagan and Mr WIlcox spent two weeks with staff during one of the regular economic forecasting rounds that culminate in the quarterly Statement on Monetary Policy.
Changes to that document, which is closely watched by markets and interest-rate forecasters, include the introduction of so-called confidence intervals around key forecasts for GDP growth, inflation and the jobless rate.
The quarterly statement now includes a "more comprehensive explanation of the uncertainties around our forecasts, including more information about the channels through which risks could affect the economy," Dr Kent said in this speech.
RECOMMENDATION ADOPTED
Another recommendation; that the bank publish assumptions around the future path of official interest rates, has also been put in place. Since the start of 2015, the forecasts are conditioned by an assumption that the cash rate moves broadly in line with the path implied by financial market pricing.
Dr Kent said he has created a new macroeconomic modelling section within the economic analysis department that will generate model-based analysis to complement existing forecasting systems, rather than replace them.
"Our forecasts will still be generated by a range of analysts and will feature a degree of judgement, rather than be mechanical, model-based forecasts."
Dr Kent rejected the review's recommendation that staff monitoring overseas economies and liaising with businesses be reassigned, particularly to modelling.
"This reflected our assessment that the benefits of monitoring overseas economies and conducting domestic economic liaison go well beyond the direct contribution to our quarterly forecasting process," he said.
For example, he said during the mining investment boom, talks with mining companies provided "timely and accurate" information about construction projects that wasn't available elsewhere.
"Moreover, because a commodity price boom of this magnitude had not been experienced before, models estimated using historical data would have had difficulty anticipating the extent of the response of mining investment."
Dr Kent said the review was not commissioned out of any "concerns about our recent forecasting experience or because we felt that our existing procedures were fundamentally flawed.
"But it was time for a careful health check of our approach."