Looking at the Stars while making economic policy…

John K Galbraith famously said: “The only function of economic forecasting is to make astrology look respectable.” 

Least did he know economists would take this seriously!

RBNZ Deputy Governor titles his speech: Looking at stars! Just that these stars are the unobserved variables which economists try along which economists shape the economy:

When we model the economy, the concept of a frictionless economy is represented, somewhat imperfectly, by a collection of interrelated and unobservable trends of key macroeconomic variables.5 These trends are the anchors around which we aim to stabilise the economy, and thereby inflation over the medium-term. While the Bank cannot influence many of these trends, estimating and understanding them is crucial for monetary policy to be set appropriately. As such, we devote a significant amount of time and effort to it.

In our economic models, these unobserved trends are conventionally denoted with the superscript ‘star’ (*). Three particularly important trends are: r* – the neutral interest rate; Y*- potential output; and e*- the equilibrium real exchange rate.

Another important unobservable variable is core inflation, or π*. Core inflation, along with future expectations of it, is a key variable we can influence. Although we target headline inflation, there are components of inflation we cannot control, such as commodity prices (e.g. oil), and changes in central and local government charges (e.g. changes in GST). Core inflation is useful because by filtering out temporary or unusual features, it provides a better guide to future medium-term inflation.

The framework we use, assessing output relative to trend and the OCR relative to the neutral interest rate, is an approach adopted by many of the flexible inflation-targeting central banks.6 As such, numerous central bank publications refer either directly to one of the trends mentioned above, or imply the concept of trends in their framework.7

In a number of speeches and publications over the past few years we have explained our thinking behind the important trends, or ‘stars’ if you like. This speech draws on recent work to provide an update on how we think about the trends in the New Zealand economy.


One Response to “Looking at the Stars while making economic policy…”

  1. Oleg Komlik Says:

    Speaking of economic forecasting…

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