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Paradox of Treasury economic forecast for budget 2009

The Treasury forecast of economic growth over the next 10 years or so has been the source of considerable controversies. Most economists familiar with economic forecast have questioned the assumption of above trend growth for six or so consecutive years or would do so if they were asked about this issue. The government, especially the PM and the Treasurer have been busily defend the forecast and say they are conservative forecast. Having listened to government ministers’ spins, people are left wondering what a “normal”, as compared to conservative, forecast would look like and how high the assumed growth rates would be. Treasury head, Ken Henry also came out to the defence of his department’s forecast.

There are reasons for both sides to argue why they think they are correct. But which side can or will win the debate remains to be seen. It seems that it is a paradox when one tries to understand the Treasury forecast.

The first paradoxical aspect regards Treasury’s forecasts during the booming years prior to the recession. Treasury had often been criticised for consistently underestimate government revenue in the years prior to the current recession and the turn of government fortune in revenue collections. Some cynics have said that may have been deliberately done so that the government did not know they would have more money available to spend and most possibly to spend unwisely. On the other hand, many others have said that it purely reflected that Treasury forecasters had not adopted “rational expectations” and only were used to adaptive expectations, so they move a little according to the changes shown in the previous year but were consistently left behind the trend at that time.

The second paradoxical aspect is related to whether Treasury is conservative. Treasury is generally a conservative body with many conservative and cool heads. In this regard, it has been seen by some as a bunch of dull economists who lack imagination and creativity. They would follow conventions whenever possible. The facts shown in the last paragraph regarding its forecast records in that period also seemingly support that notion of conservatism. But the current forecast used in the government 2009 budget looks nothing but conservative and conventional. The conventional method for making growth assumptions was changed. The assumed growth rates are above the normally assumed trend growth rate. It is paradoxical or astonishing to many.

The third paradoxical aspect concerns the consideration of the likely future external environment. One would think that Treasury has been very experienced in economic forecasting and has considerable expertise in analysing the likely that vital environment, given the pivotal role of that external environment to Australia exports and growth. They would carefully consider the most of the important factors such as the features of this great recession and its implications for world economic growth in the near to media future growth, the likely and imminent international adjustments in savings and consumption in world’s largest economies, the likely course of China’s growth in its demand for minerals. But Henry’s speech or at least the reported part did not appear to support the belief that Treasury had done so in preparing its economic forecast for the next decade, a fairly long time for budgetary forecast. No wonder people would feel perplexed or bewildered.

There may be other aspects to this paradox. People have to wonder whether these are just coincidences or they really smell bad. But anyone who thinks this paradox can be resolved any time soon will run the risk of being seriously naïve.

If Treasury's advices supported the government's two cash handouts in the last six months or so, they would have considered the famous paradox of thrift in those deliberations. Those would certainly preceded this Treasury forecast paradox!

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