RBNZ reliance on economic forecasts fundamentally flawed: Dickens

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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Comments from our readers

On 22 June 2011 at 10:48 am Ken said:
At last someone with a bit of common sense!!! I thought there were none left! Question...is interest rate manipulation the best way to control inflation? Don't you punish the wrong folk that way?
On 22 June 2011 at 11:24 am walter said:
agree with ken!..when you have the RBNZ indicating rate rises cause of high dairy prices, you got to ask the quality of those running the RBNZ..there are many more ways to control inflation just by raising and lowering interest rates..thats the simplest form needing no brain power and can lead to boom or bust quite easily..boom 2006-97, bust in 08-09..sometimes PhD works in reverse of reality...
On 24 June 2011 at 5:01 pm Andy said:
Yes Ken - totally agree with you too. The Reserve Bank needs to understand that the only certainty in Economics is uncertainty! Driving the car with only rear vision is a great analogy. I do differ slightly on the interest rate theory though. I don't think increasing the OCR has as much effect on the housing market as suggested. It only starts to bite later on. A smaller example of this is cigarettes - the price continually increases and the sale do not drop accordingly. I believe the housing market is more dominated by supply and demand, which in turn is influenced by population control - immigration and emigration. Building stimulates productivity through skilled and unskilled labour, professional services, furnishings, electrical goods and then management and maintenance. If you stop the building industry, the labour goes overseas, and the country loses its root system.

In short, I think the OCR is the wrong tool to be using to control inflation. I think it actually does the opposite. Especially if we remember that any adjustments can take up to 18months to take any significant effect.
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