Full-steam Economy Makes Mockery Of Predictions

The Age

Saturday January 5, 2008

Nassim Khadem, economics correspondent, Canberra

IN 2007, the Reserve Bank's decision to raise interest rates twice in an election year wasn't just a surprise for federal politicians.

The move was also not foreseen by our panel of economists when The Age economic survey was carried out at the start of last year, mainly because many on the panel also wrongly predicted that economic growth would slow.

In fact, when the year began, most were tipping that rates would remain on hold and some were even expecting the central bank would cut rates.

They thought that three rate rises in 2006 would have been enough to slow demand in the economy - but households, boosted by tax cuts and higher wages, ensured that did not happen.

Just two out of 20 economists surveyed thought rates would rise. Westpac chief economist Bill Evans and BIS Shrapnel's Richard Robinson were the only economists who forecast the cash rate would increase from 6.25% to 6.50% by mid-year.

The Reserve Bank went a step further. It not only raised rates in August, but again in the heart of the election campaign in November.

The cash rate is now at 6.75%, and the central bank at its December board meeting indicated that were it not for tighter lending conditions resulting from the US subprime crisis, they would have raised rates to 7%.

While economists got the interest rate forecast wrong, many were expecting inflation to remain at the top end of the Reserve Bank's 2-3% target. The average forecast made by the 20 economists for the consumer price index was an annual rate of 2.7%.

Those who believed the CPI would rise above 3% were the Housing Industry Association's Simon Tennent, Dun & Bradstreet's Duncan Ironmonger, the Australian Workers Union's Brad Crofts, and the National Institute of Economics and Industry Research's Peter Brain.

The actual CPI number for the September quarter (the December-quarter figures will not be released until the end of January) was 1.9%, which was pushed lower by a 33.4% fall in child-care costs - a result of change in eligibility criteria for the child-care tax rebate. But the underlying rate of inflation remained above 3%, which ultimately tipped the Reserve Bank into action.

Our panel also underestimated Australia's gross domestic product. Although the December-quarter growth figures have not been released yet (and may change final growth outcomes for 2007), the September-quarter figures showed the annual rate of GDP grew 4.3%. This is well above the average forecast of 2.9% for 2007 and 3.2% for 2007-08.

Master Builders Australia chief economist Peter Jones made the closest prediction, tipping real GDP would be 3.3% for 2007 and 3.9% for 2007-08. Commonwealth Bank chief economist Michael Blythe closely trailed, predicting 3.1% and 3.6%.

Most of the panel had also expected the three-decade-low unemployment rate to edge higher, with the average forecast 5% . But the unemployment rate remained at historically low levels, reaching 4.5% in November (December figures are not available for another fortnight). Those predicting a 4.4-4.5% jobless rate were: St George Bank's Steven Milch, Michael Potter of the Australian Chamber of Commerce and Industry, and Steven Wojtkiw of the Victorian Employers Chamber of Commerce and Industry.

The panel, like Treasury, underestimated revenue. The average budget surplus forecast was $8.4 billion for 2007-08 and $8.55 billion for 2008-09. The actual surpluses, recorded in the pre-election fiscal outlook, were $14.4 billion and $14.3 billion - both above 1% of GDP.

LINK

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