6 May 2016

5 May 2016
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Take a look at Nicki’s Budget analysis here

Over the past decade, treasurers’ forecasts have been consistently, drastically, and optimistically wrong. How wrong? Well if the forecasts in Tuesday’s budget are similarly poor, Australia’s budget deficit will be bigger in 2019-20 than it is today.

For the financial years 2008-09 through 2014-15, on average bottom line forecast was out by $47.5 billion when looking four years ahead.

Even just two years out budget forecasting looks more or less a guessing game, with budget documents getting it wrong by a whopping $36 billion.

With the exception of 2013, governments have been fairly consistently predicting much rosier outcomes than ultimately occur.

Without actually doing the heavy lifting in policy they're just using optimistic forecasts to help them achieve that outcome.

Nicki Hutley, chief economist for Urbis, notes that the “gap is getting wider and wider and it’s becoming more consistent.”

“If it were just a matter of forecasting error you would expect that in some years you get higher, some you get lower, and that used to be the case in the past.”

Ms Hutley notes that Government budgets are now “entrenching a series of optimistic forecasts”, because politicians have repeatedly said that moving the budget toward surplus is something we need to do.

But she says they aren’t making the policy changes required to get there, and that raises serious questions about the validity of the budget process.

“Without actually doing the heavy lifting in policy they’re just using optimistic forecasts to help them achieve that outcome [a surplus], and I think that is something that is not a valid approach,” she says.

“We should all take [forecasts] with a grain of salt.”

Forecasting is difficult and predictions are often wrong (regardless of which side of politics is in power). This isn’t controversial and the Government acknowledges as much explicitly in its own budget documents.

Part of what makes forecasting budget outcomes so difficult is that relatively modest changes in some key economic factors translate to much larger changes across the economy.

While Government rhetoric is all about transitioning away from the commodities like iron ore that drove the mining boom, economist Stephen Anthony says revenue remains particularly sensitive to China’s own growth forecasts.

He says this budget has a “made in China stamp,” and is concerned that the accuracy of forecasts will ultimately rely heavily on external factors.

And this year’s budget documents show that little has changed from 2015, when economist Mr Anthony told ABC News that forecasting errors over the past decade had been almost entirely a result of unanticipated changes in government revenue.

Federal budgets are political documents and it’s instructive to view forecasting error in this context. Governments want to tell a good story about our future, but Nicki Hutley says it’s concerning if that comes at the expense of realistic forecasting.

The budget forecasts “three years of 3 per cent growth in real terms.” Ms Hutley asks, “how realistic is that?” She also notes that while it’s not possible to anticipate all events, “what you can do is base your central case forecasts on sensible parameters.”

With the RBA cutting rates this week (and some economists predicting further cuts) largely due to low inflation, Ms Hutley also questioned budget assumptions around inflation. “We’re saying over 2 per cent in the current year, and that’s just not very realistic,” she says.

Ms Hutley makes the point that erring on the side of caution is a sensible approach most business owners would understand.

“As a business owner I’m going to use conservative forecasts and I’m also going to provide some sensitivity testing around that to understand what those parameters do.”

We need to look to [the Government] for guidance on what the plan is and I think that's what this document doesn't have.

“People always need to keep in mind that there’s no certainty in terms of the economy, but I think the Government has a mandate to provide direction and to use the expenditures that they collect from taxes to help the economy to weather storms,” Ms Hutley says.

Steven Anthony makes the point that when forecasts are inevitably wrong, erring on the side of caution means governments won’t be left with “nothing left in the cupboard to deal with any external shocks,” which is the situation with this budget. He notes that there is “no flexibility” built into these forecasts.

Ms Hutley says that preparing the economy to weather a storm could include any number of things like important social reforms, funding the NDIS and Gonski or “providing training in areas where we don’t have enough skills to really take advantage of growth in the innovation economy that the Prime Minister loves.”

“We need to look to [the Government] for guidance on what the plan is and I think that’s what this document doesn’t have,” she said.

“Whether your economic forecasts go awry or not, you still need to have a plan to say ‘Well I’m going to go down here, and as things change I will change my course and adapt as well’. But if you don’t actually have even a direction to go in, then where are you leading the country?”