Central Banks Forecasts Not So Grim

The lead headline in the Irish Times today must have depressed many: “Economy to shrink 11% over the next 18 months, says Central Bank.”  Things feel bad now, how bad would they feel if output fell by another 11% over the next 18 months.  Well, this is not at all what was forecasted by the Central Bank and their forecast is actually not that gloomy at all.

First, the bank’s forecast is that the average level of GDP in 2009 will be 8.3% lower than the average level of GDP in 2008, and then that the average level of GDP in 2010 will be 3% lower than in 2009.  The Bank did not release a forecast about what will happen over the next 18 months.

Second, while the Bank (like the ESRI) do not release quarterly assumptions underlying their forecast, one can back out roughly what they might look like.  Seasonally adjusted real GDP in 2009:Q1 is already 5.8% below last year’s average level.  So, if GDP was flat for the remaining three quarters of the year, then the Bank’s figure for the year average over year average for 2009 would be -5.8%.  One way to get their figure of -8.3% is to assume a decline of  -1.8% over each of the last three quarters of the year.

However, if that were to occur, then even a flat level of GDP in 2010 would produce a year average over year average figure for 2010 of -2.7%.  So, in fact, rather than an 11% decline over the next 18 months, the banks figures are actually consistent with a decline in GDP from the end of June to December this year of 3.6%, followed by a very small decline in the first quarter of 2010 and flat GDP after. A more likely scenario that would produce the Central Bank’s forecasted outcome would see a larger fall in 2010:Q1 and perhaps 2010:Q2 followed by a recovery in the subsequent quarters.  In light of the severe fiscal contraction being inflicted on the economy over this period, this would not represent such a bad outcome.

Beyond the question of what the Central Bank forecast actually implies, there is the more general issue, which I have referred to before, of the difficulty in mapping forecasts based on year-average over year-average into commentary about what is actually happening now in the economy.

Rossa White of Davy’s has also written on this issue.  See here.

2009:Q1 Quarterly National Accounts Release

The latest Quarterly National Accounts release from the CSO is available here. The release has been poorly reported by the media outlets that I have seen thus far. The Irish Times reported that “The economy shrank by 8.5 per cent in the first three months of 2009” and this interpretation was repeated on the RTE 9 o’clock news.

The correct interpretation is hard to get wrong if you just take a look at the first page of the release, which says “Compared with the corresponding quarter of 2008, GDP at constant prices was 8.5 per cent lower.” So 8.5 percent is the cumulative decline over the past year rather than the decline that occurred over the first three months of the year.

The best read we have on what happened to the economy during the first quarter comes from the data on seasonally adjusted real GDP (though this is of course imperfect, given large revisions and uncertain seasonal factors, it’s the best we have.) This series declined 1.5 percent during the first three months of the year, not nearly as bad as the revised 5.4 percent decline that occurred during the fourth quarter of last year. So, while the year-over-year declines are unprecedented, RTE’s reporting of the story as implying the economy was contracting at an unprecedented pace during the first quarter is not correct.

In terms of forecasting for the year as a whole, Irish media and forecasters tend to focus on the year-average over year-average figure for GDP growth (averaging the four quarters of 2009 and comparing that to the average of the four quarters of 2008). An absolute best case scenario would be one in which GDP stays flat at its 2009:Q1 level for the rest of the year (so that technically, we would hit the bottom of the recession). This would imply a year-average-over-year average for 2009 of -5.8%. A more realistic scenario would see further declines on a par with the first quarter’s throughout the rest of the year. This would produce a year-over-year figure of -7.9%.

Today’s figures are actually a bit better than I would have expected in light of the big jump in  unemployment during the first quarter. I now think we are slightly more likely to avoid a double digit decline in average over average GDP growth than I did beforehand.

The other indicator that most people focus on, GNP, perfomed far worse in the first quarter. Real GNP was down 12 percent relative to year earlier, declining by 4.5% in 2009:Q1 compared with a 3.4% decline in 2008:Q4. The CSO discussed the different pattern of this indicator as follows:

The estimate of GNP is derived by adjusting GDP for income flows between residents and non-residents. The timing of these flows can be variable. They include, in particular, the profits of foreign owned enterprises which increased by some €713m between Q1 2008 and Q1 2009. The increase, in this quarter, in the net factor income flows is also affected by (a) reduced credits (inward flows),compared to Q1 2008, to Irish outward direct investment enterprises and (b) increased interest payments on government debt. As a result, the decline in GNP was more severe than that in GDP.

Clearly, item (b) here is a pattern that is going to continue, though I’ve no insight into item (a). It seems to me that forecasting GNP is more difficult than forecasting GDP, so I won’t try, though obviously this series seems more likely to record a year-aveage-over-year-average decline into the double digits.