Inside the consensus

The consensus economic forecasts collated by the New Zealand Institute of Economic Research (latest one here) are a remarkably useful tool.

The overall picture from the latest one makes a fair deal of sense, with ongoing growth expected of about 3% a year. In per capita terms, allowing for population growth of say 2% a year, it's not outstanding, but at least the current cyclical expansion, which started back in early 2011, has still got legs.

We've got fiscal policy delivering a decent-sized (and pro-cyclical) boost to the economy, monetary policy is also supportive, the world economy is showing every sign of strengthening, as you can see from the latest forecasts from the big multilateral organisations (the OECD's is here) and from global business surveys such as the J P Morgan / Markit one, and at home we've got, I reckon, fairly strong wealth effects from the national rises in house values.

The consensus numbers themselves are obviously of interest in their own right - and over time are likely to prove better than any individual forecaster's - and it's good to know that on the latest consensus view we are in for further economic growth, a falling unemployment rate, modest inflation, and the fiscal books in good shape. But the most interesting things, for me, lie in the fine detail of the outlook rather than the consensus numbers themselves.

First thing I always check for is revisions to people's thinking: that's because it's surprises that tend to move markets, rather than the eventuation of the widely anticipated, which tends to be already baked in. This time round, there's not a lot of change to the expected GDP track compared to what the forecasters thought last December: no joy, then, for the equity markets which might have been looking for some signal of stronger than expected corporate profitability.

The second thing I look for is where there is most uncertainty or disagreement amongst the forecasters. This time round (as it has been before) the key moving part is housebuilding.

At one extreme we've got the view that we'll have trouble even maintaining the current volume of house construction - the most pessimistic view is that it'll ease off a little as Auckland new builds don't fully compensate for the rundown of the Canterbury reconstruction - and at the other we've got the view that we are off to the races, with substantial increases in coming years. Presumably that view is some combo of a judgement that the Auckland building trades are not at full capacity and that KiwiBuild kicks in big and early. Can't say I see strong evidence for being down the gung-ho end of that spectrum.

One oddity is the reasonably modest consensus outlook for non-residential investment. You'd wonder why - if we're reaching labour market capacity constraints, as we may be - businesses aren't splurging more on gear, especially as the Kiwi dollar is reasonably high (the bulk of our capital gear is imported) and (to the degree that investment is interest-rate sensitive) financing costs are at unusually low levels. We're also starting from a position where we're not hugely equipped with gear in the first place: one researcher has calculated that we could close 40% of our productivity gap with Australia if our workforce had the same level of capital equipment as theirs.

I also wonder about the implied rates of productivity growth in the consensus outlook. In the year just finishing, GDP growth is expected to have been 2.9%, and employment growth 3.0%, which means that labour productivity will have declined a smidgen. But in the March '19 year, on the consensus view GDP growth will be 3.1% and employment growth will be 2.0%, so labour productivity will rise by 1.1%, and there are 1.7% and 1.5% productivity gains expected in the following two years as well. I'd love to see it happen, but right now I can't see what the mechanism is that will get our productivity performance improving so much so soon.

And maybe I'm cynical, but in our political system I simply don't see how fiscal surpluses will be allowed to grow and grow, from $2.7 billion now to an expected $5.7 billion in three years' time. Three billion more of the folding stuff available - I'll be mightily surprised if it withstands the clamour for increased spending.

A good start

The new Public Policy Institute at the University of Auckland kicked off yesterday with a public lecture by Professor John Hewson on 'The most risky and unpredictable global outlook in my lifetime'.

You'll most likely know Hewson not as a professor but as the former leader of Australia's Liberal Party. As Leader of the Opposition he lost the "unloseable" 1993 Aussie general election to Paul Keating and in the unsentimental way of politics was rolled in 1994 by Alexander Downer.

He left parliament in 1995 - inevitable, perhaps, but a loss. He was ahead of his time with his Fightback! economic policies, but as his Wikipedia entry notes, "apart from supporting right wing economics, [he] also supported abortion, gay rights and working mothers", making him one of that critically endangered species, the economically literate and socially liberal politician. And irrespective of where you stand on Fightback!, it's clear that Hewson would have made a better party leader and Prime Minister than several of the EQ-less muppets that followed him.

His arguments about high unpredictability? Economists' analytical tools have broken down: printing money hasn't led to inflation, the Phillips curve has vanished, "impossibilities" like negative interest rates have materialised. Europe: common currency stresses haven't fully played out out, and he's pessimistic about the Brexit endgame. US: on top of everything else problematic, notably the Fed's challenge of normalising interest rates without knackering the US or global economies, there's  now Trump. Hewson had a great line, that what worried him most about Trump's 3.00am tweets was that Trump wasn't drunk at the time. China: debt, pollution, demographics, corruption, faked GDP growth, foreign policy adventurism. Everywhere: a breakdown of trust in established political processes. Geopolitics: North Korea in particular, where we're now at the mercy of an accident or miscalculation, but also elsewhere.

He spoke for nearly an hour without notes and (as the old TV panel game used to say) without hesitation, repetition or deviation: a class act. There was time for a few questions: I snuck one in, about what structural reform still needs doing in Australia. Lots, was the answer, across all policy areas, but only limited prospects of progress given the "Nope!" style of Aussie oppositional politics, for which he rightly fingered Tony Abbott. Another in the audience asked if Hewson saw any way of reducing the growing political polarisation we're seeing in a range of countries: short answer, no.

Not comforting, in sum, as a seasoned take on the global outlook. Personally, I'm more in "the world economy will muddle through" camp: the latest JP Morgan / Markit composite index of global economic activity continues to show ongoing (and likely accelerating) growth in the global economy, and if you take a look at The Economist's collation of the latest forecasts for next year you find that virtually every country of any consequence is expected to keep growing in 2018 (ex the haplessly mismanaged Venezuela). But equally I wouldn't be too surprised if some of Hewson's scenarios came to hand, either.

It was a lively start for the new Institute, which has also posted a first batch of policy briefings and which now provides some competition to AUT's established Policy Observatory and its set of briefing papers. I'm hoping for a bit of intellectual diversity, too: the market for academic hand-wringing over the evils of "neoliberalism" is already well supplied.

How strong is strong?

The economy's ticking along nicely. Tomorrow's GDP numbers for the September quarter are expected to show an 0.8% increase for the quarter, which would make it 3.6% for the year. And virtually all the recent data have been solid to robust. On the solid side, for example, there's the December quarter Westpac McDermott Miller consumer confidence index ("New Zealand households are in the mood to celebrate. However, it looks like the party will be more of a relaxing family barbeque, rather than a fullblown rager") while down the robust end we've had the latest (November) BusinessNZ/BNZ Performance of Services Index ("a picture of strength"). In per capita terms, it's not the boomer it might look like at first sight, and I'll come to that, but it's still a pretty picture.

Unsurprisingly, forecasters have been upping their estimates of what's down the track. The latest (December) quarterly consensus forecasts collated by the NZ Institute of Economic Research showed that likely GDP growth in the year to next March is now reckoned to be 3.5% (the September quarter consensus had picked 3.2%) and there has been a marked revision upwards for likely employment growth, which is now expected to be a stonking 4.8% compared with the 3.2% that seemed the best guess back in September. Forecasts for growth and employment over the three years to March '20 have been nudged a bit higher, and there isn't a single forecaster (out of the 9 polled) prepared to call a recession over that period.

But you knew that. What's my point? It's this: I reckon the short-term outlook may be even stronger than people currently expect.

Recently I've been playing around with my little Excel forecasting model, and I can't easily get the GDP growth numbers for the next year much below 4%. I've assumed there will be some kind of wealth effect on consumer spending, and I've assumed that there is enough capacity in the building trades to allow for another reasonably substantial rise in housebuilding. If that's your view of the world, numbers north of 4% start shimmering into view. Interestingly, according to the ANZ confidence surveys (for example, here), "Our confidence composite gauge (which combines business and consumer sentiment) is pointing to GDP growth accelerating to north of 4%. Capacity constraints (getting skilled labour) will put a dampener on that but we like the spirit".

I could easily be wrong. Perhaps New Zealand households have suddenly had an outbreak of financial prudence, or as RBNZ governor Graeme Wheeler put it in a recent speech, "Growth in real consumption per capita has averaged 1.6 percent pa in the current economic cycle – about ½ percentage point below the post-1993 average growth rate of 2.1 percent, despite the rapid increase in housing wealth...This more cautious consumer behaviour may reflect a reassessment of the ‘permanency’ of capital gains from household assets, and greater caution about the level and durability of future income growth".

Maybe. But I'd still be rather surprised if families, sitting on the biggest financial bonus of their lifetimes (especially in Auckland), continued to spend more slowly than usual. They may well (sensibly) discount the scale and the ultimate bankability of their winnings. But I don't see some wealth-related spendup being delayed for ever. Sure, some of it won't flow through to the GDP numbers: the new car and the trip to Melbourne go into the 'imports' box. But some of it will.

And on the capacity side, things are certainly tighter than they were: you could certainly read Stats' numbers on the recent slowdown in the growth of housebuilding (and of construction on general) as evidence that it's getting harder to assemble the crew for the next project. But on the other hand residential construction as a percentage of GDP isn't even up to past levels yet, as the chart below shows, and given the intense profit incentives to get houses onto the market, you'd expect us to go past previous peaks. My guess is that there's a dance in the old dame yet. And I also suspect (based on the technical economic methodology of Walking With Your Eyes Open Around The North Shore) that houses are going up quicker, which will help.

An economy that could well grow by 4.0% to 4.5% rather than the 3.5% that most analysts see in the cards would also part-explain a bit of an oddity - our low per capita GDP growth. In the June quarter our GDP (expenditure basis) was 3.8% up on a year earlier - but up by only 1.7% on a per capita basis. That was because the population grew by 2.1% (a natural increase of 28,200 plus net immigration of 69,100).

You look at that 1.7% per capita growth, and you could think two things. One is that it carries on our run of relatively slow productivity growth, and that's got to be right to some extent. But you could also think: hang on a sec. This isn't an economy with the look and feel of distinctly modest per capita growth. I appreciate that's an impressionistic judgement call, but I suspect the other leg to the apparently low per capita growth numbers is that they're a bit behind the actual pace of where the economy is (and is heading next).

It doesn't mean we've suddenly solved our slow-growth productivity problems. If anything, our reliance on construction in this cycle points them up: what we gonna do when the houses are up and the earthquake damage is fixed? And it doesn't mean that tomorrow's GDP number is going to be a little purler (any single quarter tends to have lumps in it). And 2016 was the year that gave us Brexit and Trump, so who knows what the next madness will be or what it might do to us.  But net net net, it wouldn't be too surprising if the next six to twelve months turned out rather better than currently expected.

A picture is worth...

What is it about graphs?

We're supposed to be living in a new world of 'dataviz' journalism where bright young things are taking data and doing clever stuff to it and turning it into attractive visualisations with insight and oomph. And some people are, like the folks at figure.nz. But as far as I can tell nobody in the major mainstream or social media has run with any of the graphs that the Reserve Bank's John McDermott included in his speech on Tuesday, 'Understanding low inflation in New Zealand'.

So here are some of the more interesting ones.

This is where inflation (or the lack of it) has been coming from, by sector.

Ex sin taxes on fags, and ex anything to do with housing (admittedly a fairly large 'ex' to 'ex'), there's precious little inflation around. Some of that is pure luck (world oil prices). And some of it, I'm pleased to say (wearing my 'competition is good for you' hat), is down to stronger competition in areas like air travel and (especially) telecommunications.

Here's another way of looking at it - roughly speaking, how much of our inflation is coming at us from world markets ('tradables') and how much we're creating in our essentially domestic markets ('non-tradables').

You'll notice that we're not generating much inflation of our own. John's not convinced that there's anything long-term about this, and reckons that there's cyclical stuff happening that explains it. Me - I'm not too sure. I suspect that the GFC put the fear of God into many business decision-makers and households, and the impacts haven't worn off yet: we could have inherited a change in behaviour that is more 'structural' than cyclical. It could be that greater caution about raising prices or asking for a pay rise helps explain why we're raising prices more slowly than we would have in previous cyclical upturns. We'll see.

Another interesting one is this age breakdown of net migration

You might have had some preconception, especially given the publicity around the government's recent move to tighten up on 'family reunion' style bring-in-your-mum-and-dad-too immigration, that there was a lot of it about. There is some, and the number of older people coming in has been rising, but the reality is that by far the largest parts are younger people, and people in their prime earning years. John raised it in the context of different age breakdowns having different effects on inflation: more younger people (as at the moment) have a smaller impact on inflation than more older people.

And finally, there's this, which shows the Reserve Bank's history of trying to guess where the Kiwi dollar is going next (in overall trade-weighted value).

There will be those who will use this to poke the RBNZ in the eye, and I'm kinda bemused myself. It's odd that everywhere you go, from central banks to surveys of businesspeople, people (and I've done it too) keep making the same rather mechanical forecast: if the exchange rate is going up, it'll go up a little more, but then fall, and if it's going down, it'll drop a bit more, and then go up.

But it's a seductively easy thing to do, especially if you believe the exchange rate has wandered away from the One True Level where it needs to be, and that sooner or later it will revert to it. Easy - yes. Accurate? Not so much.

Roll up, roll up

At last year's NZ Association of Economics annual conference, I found a flier publicising Victoria's Master of Professional Economics programme.  And it gave me a bright idea.

I'd been thinking for a while about that awkward Catch 22 situation many economics - and other - graduates often face, where they can't get their first job without some experience and they can't get the experience without that first job. It applies all over the place across all sorts of areas - competition, regulation, banking, consultancy, investment management.

So I thought there could be a useful course which would give students both the traditional academic rigour and some practical hands-on exposure to one of the staples of many working economists' lives - figuring out where we are in the business cycle, and making enlightened stabs at where the cycle is headed next. And I got in touch with Dr Adrian Slack who is the director of Victoria's graduate programme in professional economics to see if Victoria would be interested in running with the idea. We talked it through and put together an idea of what it would look like.

The upshot, I'm pleased to say, is that Adrian has piloted the proposal through the approval system and it's up and running. MMPE523, 'Business Cycle Analysis and Implications' is good to go: as noted here, Prof Viv Hall and I will be taking it over the fences for the first time this coming summer trimester (November '16 - February '17). It'll cover the economic theory of cycles up to the present-day state of post-GFC reassessment, the history and causes of cycles in New Zealand - an area where Viv, with the Reserve Bank's John McDermott, is the pre-eminent cycle-dating guru - through to the practicalities of assembling the "where are we now" data, forming a coherent analytical view of what's going on, and building your own two-year-forward set of GDP forecasts. We're also planning on getting in some third parties (public and private sector) who can talk about their experience in building and using cyclical models and forecasts.

So the next time that dreaded job interview question comes round, and the student is facing, "So, tell me, have you done much forecasting?", the answer will be, "Well, yes, I've been quite pleased with how my GDP forecasting model has been going. And it's got something you might be especially interested in - as part of the exercise I've built this little model of...".

If this would suit anyone you know, spread the word. Adrian's the go-to man for more info.

Overoptimistic Budget forecasts?

My post yesterday about the Budget concentrated on what I thought were some of the key higher level issues. But perforce you can't cover everything, and I didn't spend any time on whether Treasury's economic forecasts looked plausible or not.

Reading the various Budget commentaries that have come out since, however, apparently it's an issue that bothers some folk. So in an effort to clear the air, here's a table that compares Treasury's main forecasts (finalised on April 13) with the latest set of consensus forecasts collated by the New Zealand Institute of Economic Research (published on March 14). I've made them a bit more comparable by using Treasury's March year forecasts, rather than the headline June year forecasts in the Budget, and which are available on p138 of the Budget Economic and Fiscal Update: this matches the March years used in the consensus forecasts. There are still differences between them (eg some March quarter compared with full March year numbers), but they make no real difference. The Treasury set go out a year further than the consensus does.

My conclusion? They're not identical twins, but they're clearly describing the same economy. Treasury's got a slightly stronger GDP track, and when you unpack it and look at the more volatile components of GDP (house construction and exports), you find it's down to Treasury expecting a bigger and longer burst of housebuilding than the consensus did, and they could well be right.

There may well be a timing element involved, too. The set of consensus forecasts was collated after a very rocky period for global markets in January and the first half of February, when people had been anxious over the prospects for global economic activity (and particularly over China), and this may have helped produce a slightly weaker GDP outlook compared with Treasury's set, which had the benefit of seeing markets recover confidence in March.

But these are marginal points around the edges. For all practical purposes the Treasury forecasts aren't meaningfully different from the consensus. There's the odd item I'd quibble with - I wouldn't be surprised, for example, if Treasury's expected drop-off in net migration didn't materialise to the extent they think it will - but overall there's not a lot of evidence that Treasury's forecasts are idiosyncratically off the mark or systematically biassed.

And if you've still got some "smoke and mirrors" conspiracy view of the Budget numbers and projected surpluses, as I mentioned yesterday the overall picture of the fiscal position gradually moving into growing surplus comes through even when you use the alternative, lower growth scenario that Treasury also modelled in the Budget documents.

Hold the rotten tomatoes

Every now and then (my last one was here) I've counselled folks to have a bit of forbearance when it comes to getting stuck into finance ministers or central bank governors. If they've stuffed something up because of mistakes any sensible person, in possession of the same data and same policy mandate at the same time, would not have made, that's one thing: throw the rotten tomatoes by all means. But that's not often the case: more often, they - like the rest of us - are manoeuvring best they can in a statistical fog, not entirely sure where they are, let alone what's round the next fogbank.

Today's Statement on Monetary Policy from the Reserve Bank of Australia had some graphs that make the point quite well. Here are the RBA's forecasts for Aussie GDP growth, core inflation, and the unemployment rate over the next two years - plus the confidence intervals around the central forecast, based on how well the RBA's forecasts have actually turned out since 1993.

Even if you are a good forecaster - and central banks tend to be at least as good as any others in the forecasting game - and your best guess is that GDP growth will be a little over 3% in two years' time, the likelihood (going by the 70% interval) is that it's actually going to be somewhere in a band from a bit under 2% to around 4.5%. 

In other words, your best call is that the economy is growing at or a little better than trend, and you probably don't need to do anything to monetary policy from a growth perspective. But it might turn out (given that monetary policy has long lags) that right now you should easing (because the economy is actually heading for well-below-par sub-2% growth) or that you should be hitting the brakes (because it could as easily be heading for boom-time 4.5% growth). And bear in mind that there's roughly a one in three chance that the actual outcome might be something else again - even slower or even faster. And (as you'd expect, since they're all linked) there are similar uncertainties over inflation and unemployment.

Let's not forget, either, that this is uncertainty about the future, when, in addition, there's uncertainty about the starting point of the here and now. That's why the Fed of Atlanta, for example, has felt it needed to come up with its "nowcast" of where US GDP currently lies. The rotten tomatoes will have their uses someday, but the reality is that monetary (and fiscal) policy making, real time, is a lot more difficult than it's often given credit for.

On the substance of what's actually happening in Australia, I was interested in these two graphs.

In the top one, you'll see that non-tradables inflation, the pricing pressure generated domestically and the only bit of inflation that a central bank can really expect to control over the longer haul, has been falling sharply over the past three to four years. In the bottom one, in the 'Administered' panel, you'll see that the prices that get announced to you in a largely non-market way - the rates, school fees, medics and medicines, the cost of a stamp - are also not going up anywhere near as much as they used to. They're still going up in Australia by 4% a year, sure, but it's nothing like the 7% they were getting away with four years ago.

And there you have the big puzzle for central banks everywhere (including ours), given that these patterns, and others, including sharply lower inflation expectations, are common across a wide range of developed economies. Inflation has headed lower than central banks (and everyone else) thought it would, given the cyclical state of the developed economies, and there's scant sign of it returning to the target bands central banks are meant to be policing. If anything, current inflation expectations suggest the undershoot will either persist, or get even larger.

So, as well as the cyclical uncertainty over where the economy is right now, and the cyclical uncertainty over where it might go next, there's an even bigger, structural one: why isn't inflation behaving the way it used to? And that's where life gets really tricky for central bank governors.

Because nobody knows.