The ever-changing market trends and economic prospects make it difficult for economists and central banks to achieve accuracy in forecasting all the time, Reserve Bank of New Zealand (RBNZ) Assistant Governor Dr John McDermott said.
Speaking at the Financial Services Institute of Australasia on ‘The role of forecasting in monetary policy,’ in Wellington on March 15, he said that forecasting economic conditions and making good monetary policy decisions were serious challenges. “Forecasting can be difficult because the economy is never static and monetary policy actions take time to influence inflation. But forecasting is an important element of the communication of policy and risks of RBNZ,” he said.
According to him, there was no single correct way of perceiving the economy.
RBNZ draws on a range of official data, statistical models, surveys, business visits and market monitoring to shape its view of the economy, he said.
“The forecasting framework accounts for some fundamental economic principles to anchor our analysis and dialogue. These include the big lesson from the 1970s experience, that you cannot sustainably get higher growth by tolerating a bit more inflation and that to try to do so will eventually cause high and variable inflation, and damage the economy,” he said.
Current challenges
Dr McDermott said that monetary policy currently faces forecasting challenges, including the treatment of the persistently high exchange rate, high household debt and accounting for the substantial Canterbury rebuild.
The Bank must predict the balance of the opposing economic forces, recognise the uncertainties and account for trade-offs, he said.
“For example, it may seem that there is room to cut interest rates, given that we are below our inflation target. But we have had to weigh up such a cut that would also probably exacerbate the current strength in house prices, resulting in higher debt levels and potentially raising financial stability issues.”
Dr McDermott said RBNZ put in extensive efforts to ensure that the economic outlook and the strategy framing monetary policy decisions are as clear as possible, as this helps policy makers, firms and households to plan for and adapt to changing circumstances.
“The Monetary Policy Statement acts as a record of our monetary policy deliberations. Some other central banks instead publish minutes of their monetary policy meetings, which amounts to much the same thing,” Dr McDermott said.
He said that RBNZ anticipates and considers a range of economic outcomes.
“This enables us to keep the Official Cash Rate (OCR) as well-positioned as we can, and our policy strategy well-understood, so that our efforts to maintain stable inflation do not cause more economic volatility than necessary,” Dr McDermott said.
