Forecasting is hard... but critical for the RBA

From Challenger Chief Economist Dr Jonathan Kearns

A quote attributed to many, from the Nobel prize-winning Quantum physicist Niels Bohr to legendary US baseball player Yogi Berra states: "It is difficult to make predictions, especially about the future." We could add the RBA (and all economic forecasters!) to that list.

Forecasts are critical for the RBA given monetary policy operates with long lags. In its forecasts in February 2020 (probably understandably), the RBA did not anticipate the pandemic would lead to a large rise in unemployment. But it was then also surprised that the economy and unemployment recovered so quickly. In February 2021 the RBA was forecasting that unemployment in mid-2023 would be 5.25%, it turned out to be 3.5%.

Similarly the RBA missed the rise in inflation. In February 2022 the RBA was forecasting ‘underlying’ (aka ‘core’) inflation would be around 3% over the subsequent two years, but it ended up peaking at almost 7% in late 2022.

But the RBA’s recent track record has been much better. The unemployment rate has been increasing only gradually, as the RBA forecast, from its low of 3.5% to its current 3.9% and underlying inflation has fallen sharply to its current 4.2%. A lot is riding on the RBA’s latest forecasts released on Tuesday for underlying inflation to continue to slow consistently this year, and reach 3% by mid-2025, as that will allow it to start cutting the cash rate. But the past few years have highlighted just how wrong forecasts can be.

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