Budget 2021: From abyss to plenty in double quick time

Treasurer Josh Frydenberg with Treasury Secretary Steven Kennedy in Canberra. Picture: Gary Ramage

Forecasting is a dirty job, but someone’s got to do it. As Josh Frydenberg recalls, a year ago Australians “were staring into the economic abyss”.

Officials advised the Treasurer of a looming “economic Armageddon”, with gross domestic product collapsing by 20 per cent and unemployment doubling to 10 per cent.

But dialling interest rates down to near zero and pumping $250bn directly into households and businesses has turned penury to “plenty more” in no time at all.

That original view, now proved overly grim, was brought into focus by the best brains, computer models and data Treasury could find.

On Tuesday, Frydenberg will hang a new picture of how recovery unfolds. You can bet it will be prettier than the one he sketched on budget night seven months ago, with a jobless rate of 7.25 per cent this quarter and a 1.5 per cent contraction in GDP this financial year. Unemployment was 5.6 per cent in March, ahead of the end of JobKeeper, and GDP is likely to have grown by
1 per cent in 2020-21.

Treasury made a $60bn error when it forecast the wage subsidy scheme to cost $130bn, based on Australian Taxation Office estimates of its take-up rate.

“Economic forecasting is difficult at the best of times let alone in the middle of a once-in-a-century pandemic,” Frydenberg tells The Australian on the eve of his third budget.

“Treasury have done very well given the global and domestic economic uncertainty and the scale and frequency of decision making.

“Today Australia is in a much better position than we expected even as recently as the Mid-Year Economic and Fiscal Outlook last December. However, we cannot take the recovery for granted with the budget looking to lock in the gains and ensure Australia not only gets through the pandemic but is stronger on the other side.”

The budget rests on such forecasts, which depend on assumptions that are akin to a stab in the dark in some cases: the speed of the vaccine rollout, opening of international borders, and the return of migrants and students to our shores.

Treasury relies on the quality of data collections by the Australian Bureau of Statistics, which is headed by David Gruen.

Gruen was in charge of Treasury’s macroeconomic group during the global financial crisis, so he knows all about the fog of forecasting during an emergency.

“I think that access to the sort of real-time data available now, from both the ABS and private-sector providers, would have been very valuable, and would have enabled us, and the RBA, to be aware more quickly of how the economy was responding to the GFC shock,” he says.

In 2000, Gruen wrote a Treasury paper, Economic forecasters aren’t stupid; what we are trying to do is hard!

“I think forecasting the macroeconomy during the COVID-19 pandemic has been more difficult,” the Australian Statistician says. “That is because the COVID recession is unlike any we have seen in the period since the Second World War”.

He notes the first annual national accounts statistics were published in 1945 in the Commonwealth Budget Papers for the period 1938-39 to 1944-45.

“So there were no macroeconomic statistics at the time of the 1918-19 pandemic!” Gruen says. “The economic collapse in the June quarter 2020 was a result of restrictions imposed and changes in individuals’ behaviour to reduce the spread of the virus, offset by the economic support provided by governments.

“Once the restrictions were lifted and people became less scared of catching the virus, the speed of rebound was very hard to predict and it has turned out to be much faster and stronger than expected.”

Treasury’s forecasts are likely to match the RBA’s. The central bank sees GDP growth of 4.75 per cent by year’s end, with a 5 per cent jobless rate in December and 4.5 per cent a year later.

The views from the “official family” coalesce, informally given the gene pool, and formally with Treasury, the RBA, Prime Minister and Cabinet, Finance and the ABS forming the Joint Economic Forecasting Group Committee.

Treasury struggles to estimate company tax, frequently and pleasantly surprised on the upside by export prices, particularly iron ore. As well, the department has consistently over-estimated wages growth, a common error during an era of demographic change, technology disruption and global competition.

The key target for the RBA is inflation and that’s been impossible to stir in a slack economy. On Thursday, the bank’s deputy governor Guy Debelle said when adjusting interest rates down the track, the RBA would eschew forecasts and opt for the “lived experience” of inflation.

Amid a torrent of advice and lobbyists’ modelling to sway policy, a senior government figure recalls JK Galbraith’s quip: “The only function of economic forecasting is to make astrology look respectable.”

Sometimes it’s a case of garbage in, garbage out, with wobbly data sets. ABS chief Gruen says “the tools we have and the information available to adjust forecasts are much better than they were previously – much better than they were at the time of the GFC, for example”.

“That is because the digital revolution has generated a wide variety of real-time data, in huge volumes,” he says.

“This ranges from Google mobility data, to transactions data from the major banks, scanner data from supermarkets, Single Touch Payroll data on more than 10 million employees from the ATO. The ABS uses all these sources of data (other than the Google data) to improve the quality of the statistics we produce and to provide close to real-time assessments of the state of the economy.”

Then there’s hardware. Gruen cites Nate Silver’s 2012 The Signal and the Noise, in which he showed that, at least for the US, the use of more powerful computers had meant weather forecasting had become more accurate. Weather forecasters could accurately forecast more days into the future than they had been able to in the past.

“But, by contrast, there had been no improvement in macroeconomic forecasts,” Gruen says. “By memory, Silver had US macro forecasts going back to the late 1940s, so his results were based on a long sample.”

In response to a 2015 review, Treasury developed a wider range of forecasting techniques and has convened a 10-member panel of experts to provide advice. The experience of COVID-19 has been humbling for these public and private rocket scientists.

“I don’t think forecasting the macroeconomy has become more difficult,” Gruen says. “It has always been an imprecise exercise.

“Despite its imprecision, I think Alan Blinder put it best in his 1998 Lionel Robbins Lectures, when he said: ‘You can get your information about the economy from admittedly fallible statistical relationships, or you can ask your uncle. I, for one, have never hesitated over this choice.”