The economic fallout from the COVID-19 crisis is one of those black swan events no one saw coming. In its aftermath, can we foresee what's coming next?
Partner, Deloitte Access Economics
Never has there been a more important time for economists than the coronavirus crisis, but never has there been a more difficult time to be able to forecast with confidence.
Everything “depends”. It depends on how the virus can be controlled, or not, and what that means for the health response, including its longevity. That flows on to demand and supply shocks, employment and income, and financial system stability. Each of these things is interwoven, so any change in one will have consequences for another.
Just take the Australian Government’s third fiscal rescue package, centred on the JobKeeper payment. This support means many people who would otherwise be registering as unemployed are now not needing to do so. At face value, this could mean that, under a best-case scenario, unemployment now peaks below 10 per cent, rather than above 12 per cent. Yet these people will still have lower incomes, which means lower spending, struggles with rent or mortgage payments, and so on.
"Never has there been a more important time for economists than the coronavirus crisis, but never has there been a more difficult time to be able to forecast with confidence." Nicki Hutley
Even in “normal” times, there is an element of art in economic forecasting. At the end of the day, an economic model is only as good as the inputs you use, and sooner or later some human judgement is needed, at least until we develop some type of machine learning that will give us perfect models. Part of what makes economic forecasting so interesting is that people don’t always behave rationally. The economic theory we learn in the classrooms or the lecture theatres at universities talks about perfect market conditions, and of course these rarely exist.
That said, over the years, macroeconomic practitioners have become quite good at being able to understand and predict with reasonable accuracy what economic growth is going to look like over the course of the next year, assuming you don’t have some black swan event.
Dr Shane Oliver
Head of investment strategy and economics and chief economist, AMP Capital
It’s hard to accurately forecast the economy at the best of times, and there’s that old quote by John Kenneth Galbraith, the American economist, where he said, “There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know”.
When you say, “Oh, it’s going to be 3 per cent growth or 4 per cent growth or something like that,” it’s always hard to get that right. Yet there is a historical tendency in Australia given normal levels of population and productivity growth to centre somewhere around 3 per cent, give or take a little.
In any one year, it is always hard to get it precisely right, but the hardest years to get right are the ones where a big shock comes along. Most economists are better off saying: “Well, despite all these worries, things will turn out OK, and we’ll have growth around average, give or take a little bit,” rather than constantly forecasting a boom or a bust because history shows that those things are more of a rarity. You might get lucky and get them right, but there’s lots of people out there who’ve been forecasting busts for years – they’re going to get lucky this time – but not for the reason they anticipated.
"In any one year, it is always hard to get it precisely right, but the hardest years to get it right are the ones where a big shock comes along." Dr Shane Oliver
It is difficult at the best of times to get it right, but in these circumstances, the normal relationship economists use has somewhat broken down. If you’re going into a downturn, you’d normally look at increases in the level of interest rates, tightening fiscal policy, excess in the economy, or if there is a boom going on that’s going to go bust at some point.
However, because this downturn is due to government-decreed shutdowns in response to a health crisis, we don’t have any of these things to look at. This may of course mean that things could bounce back quicker once the shutdown is over.
Professor Gary C. Biddle
Professor of financial accounting, University of Melbourne
If you ask, is it possible to see what’s coming, in a sense, yes we can because here’s an example of it having been done twice for the two biggest market collapses in recent history. I gave a three-month notice to the first one during the global financial crisis. I submitted a second public service warning six days ahead of our current market collapse that published the day before stocks fell.
If you ask how does one do that, I say, well, you have to think about all the things that are going on in economies, how they relate, what shocks could come to them, how would they play out and all these things.
You’re putting together a vast, vast landscape of influences on economies. These are very sophisticated markets in the sense that you’ve got people using fibre optics to get a micro- millisecond advantage on somebody else in trading. These are very advanced, very sophisticated markets. You’ve got BlackRock and other investment firms looking at 10,000 measures to how the economy is doing every day from every conceivable source.
"When you see markets tumbling, what it means is people are simply saying, “Hey, the real economy is going to head south too, if it hasn’t already”." Professor Gary C. Biddle
The share markets are forward-looking, valued based on economic activity in the future as investors see it, and then discounted to a present value. Basically, they are some risk-adjusted rates.
Have we figured out exactly how to measure that risk? No. That’s the holy grail of finance.
The real economy is just, by nature, going to lag behind the markets, because the markets are forward-looking. When you see markets tumbling, what it means is people are simply saying, “Hey, the real economy is going to head south too, if it hasn’t already”.
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Meet the experts
After spending the first half of her career as a macroeconomist for commercial and investment banks, Nicki Hutley now leads Deloitte Access Economics’ Urban Advisory practice. She has expertise in the application of economic modelling and analysis in the field of urban economics, addressing issues such as affordable housing, social and economic infrastructure investment, urban renewal, precinct planning, climate mitigation and social policies.
Shane Oliver joined AMP in 1984 as a research officer. He is now responsible for the overall investment performance of diversified funds and AMP Capital’s broad investment strategy, as well as economic and market analysis and forecasting. He also gives client presentations at both institutional and wholesale levels.
Gary C. Biddle
Gary C. Biddle is professor of financial accounting at the University of Melbourne and visiting professor at Columbia University Business School, University of Hong Kong and London Business School. His research appears in leading academic journals and in the financial press including CNBC, CNN, the South China Morning Post, The Economist and The Wall Street Journal.