iscover
RBA deputy governor Andrew Hauser gave a speech to the Economic Society of Australia in Brisbane today (12 August). Referencing the recent decision to keep the cash rate steady at 4.35 per cent, Hauser understands that not everyone was happy with this decision, with many hoping for cuts.
What he describes as overconfidence, those who claim certainty in the trajectory of the economy were whom Hauser took aim at in his speech, urging people to not put their faith in “false prophets”.
“A vibrant public economic debate, with diverse views, is healthy. But one feature of the landscape is less desirable – and that is the extraordinary certainty with which individual views about the outlook for the economy and the path of monetary policy can sometimes be expressed. ‘The economy is falling off a cliff’; ‘No – the economy is red-hot.’ ‘Rates up now – we’re way behind the curve’; ‘Rates are clearly far too high – slash them’; ‘It’s vital rates stay where they are’,” said Hauser.
“Those seeing things differently are castigated as incompetent, biased or on the make. And changes in view are presented as disastrous or humiliating failures. In short, it’s a world of winners and losers, gurus and charlatans, geniuses and buffoons. This isn’t unique to Australia of course – everywhere is prone to it in some way (witness the extraordinary calls for emergency intra-meeting rate cuts in the United States during the recent market turbulence, for example).
“Of course, eye-catching language sells newspapers, secures clients and draws crowds to the soapbox. But when the stakes are so high, claiming supreme confidence or certainty over what is an intrinsically uncertain and ambiguous outlook is a dangerous game. At best, it needlessly weaponises an important but difficult process of discovery. At worst, it risks driving poor analysis and decision-making that could harm the welfare of all Australians.
“It is right to want to be confident that the central bank will bring inflation back to target and maintain full employment: that is the RBA’s mandate, and we should be held to account for it. But the policy strategy required to deliver that outcome, and the economic judgements that inform it, simply cannot be stated with anything like the same degree of certainty. Those pretending otherwise are false prophets.”
Firm in his stance on the matter, Hauser said that this overconfidence is dangerous and doubled down on the decisions made by the central bank.
“Overconfidence is not unique to economic commentary: it’s a universal human failing. In my remarks today, I want first to illustrate some real-world examples, before turning to ways in which central banks can avoid falling prey to it in our own deliberations. By forming contingent hypotheses about the future – rather than overly precise point forecasts,” he said.
“By learning continuously – from our own forecast errors, from diverse quantitative models, from corporate liaison and other qualitative intelligence-gathering, from experience in other countries, and from internal and external challenge, including scenarios and ‘what-ifs’. By communicating clearly and openly about what we don’t know, as well as what we do. And by adopting policy strategies that reflect risks to the outlook, as well as the central case. I will describe how some of these tools were applied in our most recent monetary policy round, and how we hope to develop them further.”
The cash rate is forecast over medium-term goals, said Hauser. However, he also said that these forecasts aren’t always right and the RBA aims to learn from mistakes made.
“When we set interest rates, we have to look ahead – that is, make forecasts. That’s one source of uncertainty. Monetary policy works with long and variable lags – so our forecasts have to be medium-term, not short-term. That’s a second source of uncertainty. And most importantly of all, the things we are forecasting – inflation and unemployment – are the complex, time-varying outcomes of the decisions and interactions between many millions of people, companies and other organisations,” said Hauser.
“The starting point is to avoid placing too much reliance on point forecasts in the first place, and instead frame our policy decisions in terms of contingent hypotheses or judgements. Some judgements may be strongly held, and hence given a high weight in the decision; others may be very tentative and given only a low weight. Both the hypotheses, and the weights attached to them, are continuously updated through a process of learning.”
Highlighting how these decisions can impact people’s lives dramatically, the RBA has warned about becoming overconfident in forecasting, opting to play it safe.
“In my remarks today, I have set out some of the ways in which we can try to lean against overconfidence without falling into the opposite trap of saying nothing at all. By avoiding over-reliance on point estimates and instead framing our assessments in terms of contingent hypotheses. By continually adjusting the weights we place on those hypotheses through a process of learning – from our own forecast errors, from a wide range of analytical models, from qualitative data and intelligence, from other countries, and through what-ifs and scenarios,” Hauser said.
“And by communicating openly and honestly about where we are relatively confident about the outlook (and where we are not), where we are seeking to learn, and the balance of risks. Many of these tools are already in use at the Reserve Bank – and we will move further in that direction as we complete the implementation of the RBA Review recommendations.
“Of course, the billion-dollar question is how to map essentially uncertain judgements into policy decisions. That is really the subject for another speech – but the short answer is one should seek to choose strategies that are responsive to, and also robust to, your evaluation of the risks to the outlook as much as to the central projection. In some cases, uncertainty may induce you to be less activist – as you wait for more data, or try to avoid triggering tail risks through your own actions … But beware anyone who claims it is obvious what to do – for they are false prophets!”
[Related: RBA holds; inflation path has been ‘slow and bumpy’]
ISCOVER 
