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Australian Government Coat of Arms

Budget | 2014-15

Budget 2014-15
Australian Government Coat of Arms, Budget 2014-15

Statement 2 (continued)

Appendix A: Macroeconomic forecasting performance

The Government's macroeconomic forecasts are prepared using a range of modelling techniques, including structural macroeconometric models and equations, spreadsheet analyses and accounting frameworks. These are supplemented by survey data, business liaison, expert opinion and judgement.

In 2012, the Secretary to the Treasury commissioned an independently‑overseen Review of Treasury Macroeconomic and Revenue Forecasting.4

The Review concluded that the forecasts draw upon 'the full range of information and modelling techniques used by comparable agencies overseas', and place broadly appropriate weight on the various tools available to forecasters. The Review made 11 recommendations on how to improve forecasting performance, all of which are being implemented. This appendix responds to Recommendation 5:

Treasury should include in the Budget papers a high level review of the economic forecast errors (nominal and real GDP) for the previous financial year, as a complement to the existing discussion of revenue forecasting errors.

Macroeconomic forecasts are always subject to a margin of error.5 Charts A.1 and A.2 show the magnitude of the Budget year forecast errors for real and nominal GDP growth over the past 20 years. The independent review concluded that, over the 20 years to 2011‑12, Treasury's forecasts of real GDP growth exhibited little evidence of bias, with accuracy generally remaining within a range of ½ to 1 percentage point. While forecasts of real GDP growth were less accurate in years during and immediately after the financial crisis, forecast errors have since returned to that range. The Budget year forecast error for nominal GDP in 2012‑13 was larger than its 20‑year average.

2012‑13 real and nominal GDP growth forecasts

Economic forecasts for 2012‑13 were first published in the 2011‑12 Budget. Subsequent forecasts were published in the 2011‑12 MYEFO, 2012‑13 Budget, 2012‑13 MYEFO and 2013‑14 Budget.

Chart A.1: Budget forecast of real GDP growth

This chart shows the Budget year forecasts for real GDP growth and the latest published outcome from 1991‑92 to 2012‑13.

Note: Outcome is as published in the December quarter 2013 National Accounts. Forecast is that published in the Budget for that year.

Source: ABS cat. no. 5206.0 and Treasury.

[View chart data]

Chart A.2: Budget forecast of nominal GDP growth

This chart shows the Budget year forecasts for nominal GDP growth and the latest published outcome from 1991‑92 to 2012‑13.

Note: Outcome is as published in the December quarter 2013 National Accounts. Forecast is that published in the Budget for that year.

Source: ABS cat. no. 5206.0 and Treasury.

[View chart data]

In 2012‑13, Australia recorded another year of below‑trend economic growth, with activity remaining patchy across certain sectors of the economy. Despite continued strength in resources investment, subdued activity in the household sector and non‑resources business sectors weighed on growth. Households continued to exercise caution as income growth slowed and non‑resources businesses remained reluctant to invest in the face of subdued profit growth and poor trading conditions. New public final demand also contracted for the first time since 1993‑94, reflecting efforts to consolidate fiscal balances at the Commonwealth and state levels. Below‑trend growth saw the unemployment rate start to rise, while inflation remained in the bottom half of the RBA's target band.

Chart A.3 presents the evolution of Treasury's forecasts for 2012‑13 real GDP growth. The absolute percentage errors for forecasts of 2012‑13 real GDP growth were largest in the 2011‑12 Budget (at 1.2 percentage points) and smallest in the 2012‑13 MYEFO and 2013‑14 Budget (at 0.4 percentage points), while the 2012‑13 Budget absolute percentage error was 0.7 percentage points.6 Over the past 20 years, Treasury's mean absolute percentage error for the Budget forecast of real GDP growth in the budget year has been 0.8 percentage points.

The main contributors to the GDP forecast errors were business investment and household consumption. Business investment in 2012‑13 was overestimated as both resources and non‑resources firms repeatedly scaled back investment plans, while household consumption was subdued by much weaker than expected wage growth.

Chart A.3: Evolution of real GDP growth forecasts for 2012‑13

This chart shows the evolution of real GDP growth forecasts for 2012‑13 from the 2011‑12 Budget to the 2013‑14 Budget. The chart shows that the latest published outcome for 2012‑13 was lower than the forecasts.

Source: ABS cat. no. 5206.0 and Treasury.

[View chart data]

In 2012‑13, nominal GDP grew by 2.5 per cent — the weakest growth since the early 1990s recession — with large falls in bulk commodity export prices contributing to a 9.8 per cent fall in the terms of trade and compensation of employees growing at its weakest rate since 1991‑92. Chart A.4 presents the evolution of Treasury's forecasts for 2012‑13 nominal GDP growth.

The absolute percentage error in the forecast of 2012‑13 nominal GDP growth was largest in the 2011‑12 Budget (at 3.3 percentage points) and smallest in the 2013‑14 Budget (at 0.8 percentage points), while the 2012‑13 Budget absolute percentage error was 2.5 percentage points. Over the past 20 years, Treasury's mean absolute percentage error for the budget forecast of nominal GDP growth in the budget year has been 1.4 percentage points.

The largest absolute forecast error in the components of nominal GDP growth was in the terms of trade, with a smaller forecast error recorded in domestic prices and real GDP growth. The forecast error for the terms of trade was largest for export prices, reflecting the difficulty of forecasting commodity prices during periods of substantial price volatility. The forecast error for domestic price growth reflected a smaller than expected increase in business investment prices, with cost overruns reported by resources companies not flowing through into higher investment prices as expected, and weaker consumer price inflation, which was muted by a higher than expected unemployment rate.

Chart A.4: Evolution of nominal GDP growth forecasts for 2012‑13

This chart shows the evolution of nominal GDP growth forecasts for 2012‑13 from the 2011‑12 Budget to the 2013‑14 Budget. The chart shows that the latest published outcome for 2012‑13 was lower than the forecasts.

Source: ABS cat. no. 5206.0 and Treasury.

[View chart data]


4 http://www.treasury.gov.au/~/media/Treasury/Publications%20and%20Media/ Publications/2013/forecasting_review/downloads/PDF/forecasting-review.ashx.

5 The uncertainty around the Government's GDP forecasts is quantified and presented as confidence intervals in Appendix B of Statement 3.

6 The absolute percentage error is an indicator of the accuracy of the forecasts, as it measures the distance between the forecast percentage growth rate and the outcome. All other things equal, a smaller number indicates a better forecasting performance.