RBNZ reliance on economic forecasts fundamentally flawed: Dickens

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Basing monetary policy on economic forecasts is a fundamental flaw in the way the Reserve Bank operates, says economist Rodney Dickens.

Wednesday, June 22nd 2011, 5:00AM 3 Comments

by Jenny Ruth

This approach leads to economic activity, especially housing market activity, being more volatile than it otherwise would be, says Dickens, who used to work for the Reserve Bank, went on to be head of research at ASB Bank and who now runs his own consultancy, Strategic Risk Analysis.

It also means the incomes of retired people, who often have a sizeable portion of their wealth in interest-bearing investments, are more volatile than they should be.

That's even if the forecasts are of good quality but the central bank's forecasting record is "generally poor and at times abysmal," he says.

For example, in its March 2004 forecasts, the Reserve Bank forecast rising unemployment and falling labour costs but the opposite occurred, Dickens says. At the same time, it was forecasting 90-day bank bills were drift sideways over the subsequent three years.

While it predicted 90-day bank bills would average 5.6% in the March 2007 quarter, they actually averaged 7.8% and went on to peak at 8.8% in the March and June quarters of 2008.

The Reserve Bank's latest forecasts in its June 2011 monetary policy statement (MPS)aren't even internally consistent, Dickens argues. The central bank is currently forecasting both rising building activity, excluding the rebuilding of Canterbury, and rising 90-day bank bills.

"Interest rates are the most powerful driver of residential building activity and whenever they have risen significantly residential building activity has subsequently fallen," he says.

Similarly, the June MPS forecast a sharp drop in the unemployment rate over the next three years but that labour costs will zigzag sideways.

However, falling unemployment "means a tighter labour market and increased bargaining power for employees," and is likely to lead to rising labour costs, he says.

Dickens' arguments about the reliability of economic forecasts are nothing new - former Reserve Bank governor Don Brash used to talk about setting monetary policy being like driving a car with only rear vision.

In a further report next week, Dickens is promising to offer an alternative and superior approach to making OCR decisions.

Read Rodney's full report here

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