Learn to love economic forecasts
Forecasts are more useful than you may think. Acuity economics columnist Donal Curtin looks at ways business can extract maximum value.
- It’s useful to assemble a range of forecasts but evidence shows that “consensus” forecasts are the best. And the guy who was right last year
- Economic indicators are a useful addition to a management toolkit and can show where firms can expect dollar sales to grow
- It pays to follow economic forecasts and to adjust business and hiring plans accordingly
By Donal Curtin.
They’re everywhere. Your bank’s got one, your broker’s got one. They cost nothing, and cynics may feel you get what you pay for. They’re economic forecasts.
But what use are they? Especially as the greatest economic shock of our time – the global financial crisis (GFC) – appeared largely out of what the economic forecasters thought was a cloudless sky. Even before the GFC, there were jibes that economic forecasts existed only to make weather forecasters look good by comparison.
Getting a story
Forecasts are more useful than you might think. Grab one and have a look. The first thing to know – and it’s a bit of a shocker to say it to numerate people like accountants – is that often the precise numbers don’t matter a hoot. At the time of writing, for example, the Westpac team thinks Australian GDP will grow by 2.7% in 2018, while the National Australia Bank (NAB) team has picked 2.9%.
Is that a material difference? No, especially when you realise that the official GDP numbers are themselves squishy. A recent update by Statistics New Zealand, for example, found an extra 2.5% of GDP over the four years to June 2017 compared with what it first thought.
We don’t even know for sure where we are, or have been, let alone where we’re going next. So don’t obsess over the decimal points.
What you’re getting, in short, is not precisely machined data: you’re getting a story. It’s a coherent story: the bits fit together, it makes overall sense. And economists are well-placed to tell it. The better economists don’t just plug data into computer models in their offices. Typically they get out to talk to customers in their businesses, speak to industry associations, and visit export markets. They likely see more of what’s happening than you do. So their stories distil a good deal of disparate data and anecdotes into something simple and meaningful.
In particular, their stories tell you, however roughly, whether the business outlook is above or below par. The exact numbers don’t matter, but GDP forecasts that are clearly below 2.75% or so, or clearly above 3.25% or thereabouts, in either Australia or New Zealand, are telling markedly different stories. Below the GDP figure of 2.75%, unemployment will be rising, consumer confidence weakening, businesses operating with slack capacity. Not good. But growth above 3.25% gets unemployment down, households spending, businesses hitting capacity constraints and investing. They’re qualitatively different stories, worth listening to.
Related: Beyond the GFC: Where to next?
Will there ever be another GFC? Economic historian and Harvard professor Niall Ferguson will speak at the World Congress of Accountants (WCOA) on the subject.
The growth number
They also serve as a useful sanity check. Try this: grab any of the current forecasts for either Australia or New Zealand, and add together the forecast for GDP growth (probably 3ish) and inflation (probably 2ish). Now you’ve got a figure (5ish) that tells you what the typical firm can expect its dollar sales to grow by this year. So, what does your business plan look like? What, exactly, are you planning to do to make a difference to your organisation’s fortunes if your figures are well away from the average? Sure, you’re not the “typical” firm, and conditions in your line of trade might be stronger or weaker than most, but it still imposes a useful discipline on excessive optimism or caution in business plans.
Or on the cost side, try adding the forecast for wage growth (2ish) and employment growth (also 2ish) and you get a stab at the 4ish dollar rise expected for the average firm’s wage bills. What’s in your budget? If it’s lower, what makes you think you can get away with not hiring, when most folks are, or with not paying the market rise in the rate for the job? What’s more, the forecast numbers don’t have to be very accurate if they nevertheless give you the right signal to act. Forex forecasts, for example, can be well off the mark, but still give the right signal to hedge or not to hedge. Ditto interest rate forecasts, which may well miss the actual interest rates that come to hand but give you the right signal to fix or to float.
It’s also useful to assemble a range of forecasts, rather than just rely on your bank’s estimates. The evidence is that consensus forecasts (collated from a range of views in the marketplace) work better than any individual’s. Australia’s currently a bit short of free consensus views, though there’s a twice yearly, and very useful, ‘Scope’ forecast round-up in the Fairfax newspapers. New Zealand has a long-running quarterly round-up collated by the NZ Institute of Economic Research. And while the consensus will steer you best on average, it’s probably a good plan to have a special look at who worked out best last year (in Scope it was Westpac chief economist Bill Evans), as they’re evidently reading the current tea leaves better than most.
Add it up
Consensus forecasts tell you a lot of useful things. They tell you how opinion has changed since the last round of forecasts. They tell you how opinion has changed since the previous round of forecasts: economists aren’t great at picking turning points, but shifts in sentiment are at least some sort of clue. They tell you where the greatest uncertainties are – currently, for example, the big question mark for New Zealand is the likely level of house building – and consequently show you where you might want to think hardest about risk management.
Related: Finance forecasting guide: Available from the CA ANZ Library
A quick start guide to financial forecasting: discover the secret to driving growth, profitability, and cash flow higher. Guide on how to create a reliable financial forecast.
You still need to be wary of over-relying on them. Twenty economists swearing on a stack of Bibles that the skies are clear won’t protect you from the next GFC, and you’ll still need to have your doomsday risk management in good shape. But in their own little way, they can be a useful addition to the management toolkit.
Editor’s note: This is the first of a regular economics column by Donal Curtin (Auckland) and fellow consulting economist Saul Eslake (Hobart).
Donal Curtin is a business economist based in Auckland, where he runs Economics New Zealand Ltd. He has been chief economist for BNZ and a member of New Zealand’s Commerce Commission.