Effect of globalisation on the supply side

Comments on Stephen Grenville “Why forecasting has broken down”, 10/01/2013, http://www.businessspectator.com.au/bs.nsf/Article/Global-economy-fiscal-policy-forecasting-models-ec-pd20130108-3R4MS?OpenDocument

I think the reasons why those international forecasters consistently got their forecasts wrong you mentioned are correct ones, though there might be more than those.

I think there might be a different effect of globalisation on the aggregate demand and supply of an economy.

The conventional frameworks for macroeconomics may suffer from lacking a closer look at the effect of globalisation on the supply side in the context of a serious supply side shock in the wake of the GFC and the ensuing various other related government debts and fiscal problems.

Let's say various macro policies do have an effect on increasing the aggregate demand of an economy, but that may not necessarily restore the domestic supply side when international supply can substitute domestic supply due to their advantages in being unaffected by the supply side forces that exist in the more advanced economies such as the US and EU.

This increased effect of globalisation and trade substitution on the side supply may suggest that the full recovery of the advanced economies to their normal growths may take longer time even though the macroeconomic policy particularly the monetary policy is much more accommodating now as compared to the 1930s.

Unless the governments can come up with new ways to restore the domestic supply side of an economy, the road to recovery will be long and hard for those economies.

Greater strategic framework needed

Comments on Peter McDonald “Demand for workers will outstrip fear about resources”, 10/05/2010, http://www.theaustralian.com.au/news/opinion/demand-for-workers-will-outstrip-fear-about-resources/story-e6frg6zo-1225864239240

With all respect, it seems that Peter McDonald, director of the Australian Demographic and Social Research Institute at the Australian National University, is using nothing more than only partial arguments to support his points. And that is a pity and regrettable in terms of informing the debate and the public.

People know that it is notoriously difficult to forecast the economy, the resource sector particularly when it is driven by overseas demand and labour demand due to the resource sector. In that case the advantages of forecast of labour demand for certainty for population and immigration planning purpose would certainly be overwhelmed by the uncertainty created by any forecasts, no matter how credible and reasonable one might consider they are.

So, the argument for immigration planning based on forecast of resources sector growth is nice in name only and naive and impractical.

However, that does not mean immigration cannot be part of the solution to any labour shortage. Everyone knows that we can vary immigration intake very easily, that is to either increase or decrease as the domestic demand changes.

So the latter solution is much better than what McDonald argues.

The lesson from this is that many studies, while well intended, may fall far short than what are needed to be reliable and credible, because of their narrow focuses, or the limitations of their authors, if not greater strategic framework is considered.

How good are official economic modelling and forecasts in Australia are?

I came to this article in the Australian Financial Review on 11 March 2010. It is interesting timing and very timely indeed.

The article in in the Features section and on page 61, with a full page and some interesting pictures, featuring the forecasts by RBA and Treasury amd four key people: RBA assistant govenor Phil Love, Treasury head Ken Henry, Director of Outlook Economics Peter Downes and ANU professor Warwick Mckibbin.

Peter Downes says "there's a lot of problems in the forecasting area. We are tlaking about faorecasting errors that statistically should occur only every thousand years."

Warwick Mckibbin says "they didn't have a model that looked at how things added up in the end."

There is digital deition available online from AFR, but it requires charges vis membership subscription. But if you querry by the article name, it should come up for login.

Miserable Swan that cannot fly, nor swim in economic fields

Comments on Wayne Swan “Rollback is part of the plan”, 10/09/2009, http://www.theaustralian.news.com.au/story/0,25197,26050760-5017272,00.html

The Treasurer seems never to be able to grow up to a normal person, but unfortunately he is in charge of what he cannot manage nor understand, that is the economy and budget.

To just using one point in his little article, he said the stimulus has been designed to withdraw automatically. Let's assume what he said was correct with the original design for the moment. But the economy has already proved that the Treasury forecast was out of order with what has been happening, so why the original design based on that earlier forecast is still correct? Isn't it a common sense that when things are different from one's assumptions, then one needs to change the strategies according to the new reality as opposed to sticking with the original plan?

Mr Swan, you need to get some common sense, not to mention the skills to manage the nation's budget and the economy.

Besides, the nation’s top economic advisors need to get real as well and provide good economic and budgetary advice to the government of the day. It is their advice that has also contributed to Mr Swan’s confused mind.

This time the IMF has better insight and foresight than Aussie Treasury

Comments on Michael Stutchbury “IMF sees problems here even after global crisis passes”, 10/08/2009, http://www.theaustralian.news.com.au/story/0,25197,25906807-5017771,00.html

While the IMF has got its forecast wrong many times as any other economic forecasters did in the past, its assessment of this time seems more reasonable than the Treasury's used in the may budget. The destruction to the Australia's capacity may not be very big, but to the main OECD countries are very large indeed. This is one reason why the media term growth cannot be as those in previous recoveries from recession.

Another main reason is the inevitable adjustment to rebalance internationally, especially in the US and China in particular to their economic structures and savings and consumptions. That adjustment process of the main international economies on top of the damage to productive capacities by the great recession will see a slower world growth. That in turn will mean a slower growth for the Australian economy, both in the recovery phase and thereafter.

The Treasury needs to have another very careful examination of its assumptions used in its economic forecast. The structural parameters have changed and one cannot simply extrapolate the past experience without taking into account the new international situation.

Rupert Murdoch on economic forecast

This my comments on （参加就奖）中国是否即将面临高通胀？【辩论帖】, 22/07/2009, http://www.pinggu.org/bbs/thread-483033-1-1.html. The context is:

在2009年7月至2010年6月，这1年期间我国CPI会达到多少高度？是否会出现恶性通胀？（10%及以上）因此对各方面的影响？（小企业、房价、官方利率等）希望大家以事实和数据为依据，理性探讨辩论通胀的可能性。
正方立场：在1年之内，我国的CPI预计会达到6%以上。反方立场：在1年之内，我国的CPI最高不会超过6%（6%是极限）。

Is it scientific to say one way or another, or to support or against the argument?

News Corporation Chairman, Mr Rupert Murdoch said not long ago: "Economists just make the weatherman looks better."

Inflation, as economic growth, is endogenous and affected by so many variables, including government policies and responses by other market agents. They are difficult to forecast, because they can change as other things including policies change.

To say one way or another is not meaningful and is not different to betting. It does not make any sense, although so many people are interested in doing it. There is no science in it.

Exchange rate and Treasury forecast

Comments on the report “Treasury chief says rise in $A could hurt exports”, 3/06/2009, http://www.businessspectator.com.au/bs.nsf/Article/Rise-in-Aussie-dollar-could-hurt-exports---Treasur-SN5EQ?OpenDocument

This is an example why Treasury forecast of above trend growth the economy used to underpin the Rudd/Swan budget 2009 was problematic and too optimistic.

They assumed Australia will benefit from China's growth, but at the same time did not make plausible assumption about the impact of China's growth on the $A. The remarkable feature of this is that it has not been long since that forecast for the $A to shoot up.

Yes, currency will fluctuate all the time, but there are some important underlying factors that should be taken into account when forecasting the Australian economy.

It was not the best course for Treasury to take to be optimistic without carefully considering the important and likely downsides. More importantly, the Treasury forecast suffered another serious drawback of the issue that was the Locus’ critique, as I argued elsewhere earlier.

Understanding economic modelling and forecasting - be realistic about it

Comments on Lenore Taylor “Job forecasting a model for success”, 16/06/2009, http://www.theaustralian.news.com.au/story/0,25197,25642571-5017906,00.html

Economic model of forecasting of one type or another is no more than assumptions used in it. Most models are long run general equilibrium model. How many jobs will be lost or gained largely depends on the assumptions of wage flexibility.

In the short run, most modellers assume some sort of wage rigidity, so any perturbations like the ETS will cause job losses. In the long run, wage growth will be slower to resume full employment or near full employment. One does not need to be a modeller to know the results of ETS without renewable energies.

With renewable energies, more opportunities are generated to employ more labour. That is for sure, but it says little about the underlying welfare situation. Further, how many jobs will be created will depend on the quantity of those assumed renewable energies and the labour intensity of each of them.

The point is that whether it is short term job losses, or job absorption by renewable, they all depend on assumptions used. And those assumptions are based on the current labour intensities and the assumed future labour intensities. In the long term, there is no job impact, because people/labour will adjust to any future situations.

In some sense, it is meaningless to talk about job losses or gains of one sector or at one time, under one particular scenario. There are always other balancing factors working to offset that. One needs to be realistic about modelling and results from modelling.

Once one understands how models work and how modellers work, it is not too difficult to understand their results. Nevertheless, having models is much better than having no models, and that is why modellers or forecasters are the beneficiaries of any debates involving economic consequences, such as employment and welfare.

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!

A critique of Treasury economic forecast for the budget

Treasury forecast that the Australian economy will grow above trend at 4.5% for a number of years following this recession. This has been used in the federal 2009 budget documents. It is said that this is based on past experiences, re those ones in the early 1990s and the early 1980s. The media and many commentators said it was optimistic, much more so than both the IMF and RBA forecasts.

While it is not uncommon to use past experiences in economic forecasts, one must realise its inherent danger if used mechanically. The famous Lucas critique should serve as a sobering reminder. Lucas pointed out that it is naïve to try to predict the effects of a change in economic policy entirely on the basis of relationships observed in historical data, especially highly aggregated historical data. This undoubtedly applies to the Treasury forecasts.

My critique of the Treasury forecast is that it has conveniently ignored the most likely implications of the great recession we are still having now. One implication of this recession is that there will be a much greater international effort to address the huge international imbalances in savings, consumption and investment.

A manifesto of the imbalances is the low or negative savings by the US and its huge debts. It is likely that the US has to increase savings to fund its domestic investment and government deficits. The contribution of consumption to the economy is likely to fall significantly to boost savings. This is likely to cause the US economy to grow more slowly than the case in the 1990s or in the early this century. When the world biggest economy does this, the world economy is likely to be dragged to slow somewhat. What this means is that the world economy is likely to experience a period of slower growth.

The financial crisis has caused great damages to the international banking and financing system. It needs to be repaired. Many banks and financial institutions need to deleverage and/or increase own capitals. This means the costs of capital will increase above those prevailing prior to the crisis. Higher capital costs will reduce investment and slow economic growth.

Besides the damages to banks and financial institutions, this great recession has also caused enormous damages to some non-banking companies. Some examples of big ones include GM and Chrysler that are facing a real possibility of bankcruptcy. These sorts of business failures destroy social wealth and reduce productive capacities/capital. They decrease demand through the wealth effects and reduce supply, further compounding the effects of international rebalancing of savings and consumption.

China is expected to continue grow rapidly and that is likely to benefit Australia. But even China will be affected by the expected international rebalancing. A slower US economy will limit China’s exports to the US. As a result, the Chinese economy is also likely to experience growth below its trend growth prior to the crisis.

All these point to a period of slower world growth ahead. It is against this background that I say the Treasury has probably got it wrong in its forecast by assuming above trend growth for Australia after this recession, especially for a lengthy period. It appears that it has not made the plausible assumptions on world economic growth. As a result, it has failed to take into account the changed structure of the world growth and its impact on important parameters such as world growth in its model, a point not too dissimilar to that of the Lucas critique.

It is worth noting that the government and Treasury have recently changed the conventional practice of assuming trend growth for the outer years in government budget documents. It is said that this is to make the forecast more accurately reflect the likely future course. On this account, they have either conveniently ignored the Lucas critique, or made a seriously bad judgement in the modelling process, under the understandably very strong pressure of preparing the budget.

Swan budget09 - my first impression

This is my first response to Swan Bedget09, focusing on a couple of issues: the economic forecast used in the 2009 budget and the so called structural budgetary problem. They are, one might say, related to Treasury. That is why people may not question Swan/Rudd much over those yet. There are three points to be discussed:

· The economic forecast for the years to come
· The structural budgetary issue during the late Howard/Costello government
· The same structural budgetary issue now It can be shown:

· The economic forecast for the years to come to underpin the budgetary recovery back to surplus is too optimistic to achieve

The forecast economic growth for Australia for the two or three or more out years in the budget is 4.5% per year, above its trend growth. To start with, economic forecast is more an art than a science. Two years ago, probably virtually no forecasters in the whole world had foreseen the coming of the world great recession now we are having. The IMF in the past half years revised its forecast of the world economic growth outlook down 4 to 5 times. They are an indication of how unreliable economic forecast can be.

Against this background, any economic forecast can be questionable. However, the forecast used in the government's 2009 budget has caused particular eyebrows among not only many economists but also non-economists. One is also reminded that the government and the federal treasury also changed the traditional method and extended the more detailed forecast from normally two years to three, not long before the budget was made. It was said this change would make the forecast picture more accurate.

Let's look at some background information regarding the deficit. The Swan 2009 budget presents that the budget for the financial years 2008-09 and 2009-10 will be in deficit to the tune of $32.1 and $57.6 billion, the latter nearly 5% of GDP. This compares to last year's budget forecast of more than $20 billion surplus for 2008-09. Over the next few years, the government will accumulate a net debt of $188 billion. It is projected that the budget will return to surplus in 2015-16. It further assumes the debt to GSP ratio will be lowered to below 4 per cent.

There are likely two key problems with the economic forecast. One is that it has ignored the inevitable slow down of the world economy post recession, not so much caused by damages done by the recession, but more importantly by big structural changes in the largest international economies, such as the US, China. The US consumption share of its GDP will go down and the share in China will go up. These changes represent a new course for the world economy. It will be a new and uncharted water for the those economies as well as for other exports oriented economies for a period that will take at least those years shown in the budget. The paradigm shifts in international economies will lower growth in many countries for a number of years to come.

Two, while it is understandable though unusual to assume above trend growth, it is very unusually unusual and very hard to understand to assume that for a sustained period. They may argue that it is possible, but the possibility is very slim and highly unlikely.

Further, it is highly likely to be problematic by comparing this recession and the one in the 1990s. One needs to keep in mind that world growth in the 1990s after the (Australian) recession was higher than that in the 1980s. It occurred against the background of the end of the cold war following the collapse of the USSR, and the rise of the internet to boost technological changes and productivity.

Although the two appeared to have occurred together at the same time coincidentally, the combination of them produced extraordinary results in terms of world productivity and growth. The US and the West did not need for the first time in a few decades to spend as much in military and defence as they used to. The spread in the application of the internet technologies fuelled the growth of technology stocks which promoted the techonology bubble, which went burst and crashed at around 2000 or so. Another direct benefit of the reduced (to almost non-existent degree at one stage perhaps many had thought) security threat due to the end of the cold war was the more rapid transfusions of military technologies and productive capacities to civilian uses. Clearly productivity improvement in Australia in the 1990s was very impressive in that broad international context.

· The so called structural budgetary issue during the late Howard/Costello government is unlikely to be correct.

The Howard/Costello government managed its budget very successfully, although people may have a number of issues with the Howard government, such as the Tempo incident, the children overboard lies, the refusal to rectify the Kyoto protocol to reduce emissions, and to go to the Iraq war that has been proved to be based on false intelligence, and etc. It had paid down about $90 billion government debt inherited from its Labor predecessor. It set up a future fund. At the same time, it lowered taxes and returned taxpayers money.

Had it not lowered the taxes, it might have spent them. It is highly likely that would have been a greater waste if they were not spent prudently and productively. When government is awashed with cash, the efficiency of its spending is likely to be lower. So it is natural and the right thing to do to lower taxes to lift the burden to taxpayers and to let them to decide what they want to do with their wealth.

Few had forecast the coming of a great recession world wide and the end (I would say a temporary one) of the mining boom. It is not too difficult to understand that if one just considers the underlying economic forecast used in Swan's 2008 budget. It was one year after Howard/Costello last budget. It did not foresee the coming of the end of the mining boom. It even projected $20 billion budget surplus. It continued to reduce taxes, not only in the 2008 budget, but even in this one. So it is wrong to blame/accuse the Howard/Costello government and brand them to have got a structural problem. In that environment, lowering taxes and returning money to taxpayers was the right thing to do.

Further, there are inevitable uncertainties over the future and some events may be very surprising and unexpected. A government needs to lower taxes when it can afford to do so after it fulfils its duty as the government. It may need to raise taxes when things have changed unexpectedly. It may be unpopular to raise taxes. But one cannot expect that any government would be always fortunate enough to avoid the need to do it.

And even it were correct, it was likely to be of a much smaller degree and much less a problem than those who have coined this have lead or intend to lead people to think.

· The same structural budgetary issue now

Irrespective whether the structural budgetary issue during the late Howard/Costello government existed or not in the past when they were in government, the Rudd/Swan government has continued or even compounded the same problem, not only in its 2008 budget when few had foreseen the great recession, but also in this budget when it had been crystal clear that the world has been in a sever recession, government revenue had collapsed and budget deficit had occurred and will be rising rapidly.

It might be excusable they did in their 2008 budget possibly because of their ignorance of the problem. But it is another totally different matter now that they have done nothing to correct the problem in Swan budget 09 when everyone knows it is a problem and a big one.

Further it was even more extraordinary that one blames the past as mistakes when they did not know what would happen in future while continuing to do the same when it is known to be a problem.