Economic policy

Independent forecasters essential to good economic policy — Paolo Casadio and Geoffrey Williams

MAY 12 — Bank Negara’s 25 basis point increase in the overnight rate (OPR) yesterday took many people by surprise.

Based on data and forecasts for the Malaysian and global economy, 14 out of 19 analysts polled by Bloomberg hours earlier expected rates to remain unchanged.

In 2020 and 2021, economic growth forecasts for Malaysia by official and international agencies have proven to be overly optimistic and the equally optimistic forecasts at the start of 2022 now face the prospect of a downward revision due to recessions in Malaysia’s main export markets.

This leads many people to believe that economic analysis and forecasts for the Malaysian economy have recently been flawed due to two issues.

First, the angle or perspective taken in the previous scenario analysis and second, the methods used for forecasting.

Since the recent forecast results speak for themselves, we will not focus here on the numbers, but focus our attention on the forecast production process.

It is important to remember that forecasting is both an art and a science and relies somewhat on intuition in the absence of clear data to predict what is to come. This exercise is by definition very uncertain and subjective.

When developing the base-case scenario analysis, economists specify exogenous factors that are considered given or beyond the control of policy makers.

A Malaysian flag is pictured at Dataran Merdeka in Kuala Lumpur on September 15, 2021. – Image by Yusof Mat Isa

The price of oil or other international factors are typical examples of this, as are events that have already happened and therefore cannot be changed.

Forecasts are then calculated using equations and data to model the implications of the scenarios. It is therefore important to note that the models, estimates and all other methods used to determine the forecast are conditional on the assumed scenario and the main exogenous variables considered.

There are therefore two sources of error, first the errors in the scenario and then the errors in the calculation of the forecast given the scenario.

Recent scenario analysis in Malaysia has been retrospective. He looks back on the Covid-19 crisis and assumes that as these effects wear off, we will return to the previous “back to normal” situation. “Normalization” is a slogan we hear regularly.

Moreover, as the end of the Covid-19 crisis is in sight, new events such as the conflict in Ukraine, Chinese zero-Covid lockdowns, anti-inflationary austerity policies in major markets and complicated supply chain disruptions, are often downgraded. given the downside risks of the main scenario. They are considered temporary events that will soon disappear.

This “everything will be fine” perspective is reassuring, but from a methodological point of view, the current analysis is qualitatively close to the ideas received before the shock. Thus, similar scenarios bring similar predictions.

The common thread underlying many forecasts, including those from international institutions such as the International Monetary Fund (IMF), the World Bank, the OECD, central banks and governments, is that we will return to the same potential growth in 2022 or 2023 as before the crisis.

The downside risk is not fully developed and assessed to take into account and the structural impact of blockages or the prolongation or escalation of the conflict in Ukraine, further disruption of the international food chain, financial crisis widespread international currency centered on the US dollar as the international reserve currency and a possible extension of a stock market crash or debt crisis at the public and private, corporate and household levels.

We also have to take into account that it is not just a different scenario input in the same algorithm. The future behavior of economic actors will depend on how far consumers, businesses and markets have traveled before during the crisis.

This may have permanently changed the behavior, conditions, targets, and strategies of all major players in significant ways.

For example, summary dismissal or extended periods of homework may have changed attitudes towards work characterized by ‘great resignation’.

The gig economy and precarious, often poorly paid work could become the norm for millions of people. The depletion of retirement savings through EPF withdrawals may alter future spending and saving patterns or may force people to work longer.

Thus, not only do we have to consider a quite different base scenario, incorporating possible risk events affecting the economy, but we also have to consider different reactions and behaviors among economic actors, which will give us projections and forecasts very different.

Along with this, we must consider “path addiction” in which the situation evolves slowly, with memory or a step-by-step process, without suddenly and mysteriously jumping to the new equilibrium.

Of course, this is an incredible challenge and we should not underestimate its complexity, but we must make an honest attempt to integrate these critical factors into scenarios, forecasts and analyzes if we are to rely on them to effective decision-making and policies.

Right now we have a mechanistic approach, what economists call impulse-response analysis, changing one thing and holding everything else constant. This seriously compromises our ability to understand realistic trajectories for the economy.

Finally, we must consider the issue of subjectivity. Naturally, any reading of political economy is subjective, given the highly complex system and the interpretation and synthesis of many different factors.

It is important to have a wide variety of perspectives, analyzes and forecasts incorporating different worldviews. A little realism, even if it is disagreeable to conventional wisdom, is valuable for the debate.

This is why it is important to develop a number of independent forecasting teams. In an effective system, powerful insights can be extracted from forecasts based on different views and analyzes of the economy to guide policy makers in delicate and complex decisions.

Now is the time, following best practice examples from other countries, for the Malaysian government, as well as Bank Negara, to engage independent forecasting teams to help them with the resources they need to deliver the essential information. to effective decision making. treat.

From our experience in the economic community, we believe that this need is increasingly recognized and we hope that the government can achieve this.

* Professor Paolo Casadio is an Economist at HELP University and Professor Geoffrey Williams is an Economist and Provost for Research and Innovation at the University of Science and Technology Malaysia. The opinions expressed are those of the authors.

** This is the personal opinion of the author or organization and does not necessarily represent the views of malaysian mail.