Jake's View

Flawed forecasts from fiscal working group defy laws of the universe

Fiscal group's inflation figures fail to account for temporary anomalies that will self-correct

PUBLISHED : Thursday, 06 March, 2014, 12:44am
UPDATED : Saturday, 08 March, 2014, 4:37am

Advisers warn of Greek-style debt meltdown

SCMP headline, March 4

Me, I happen to live on the third planet in orbit around a minor star called the sun in the Orion arm of the Milky Way galaxy. Where these advisers live I haven't a clue.

Hong Kong like Greece? The most Scrooge-like savers on earth compared to some of the greatest wastrels? We run consistently large fiscal surpluses and have net fiscal savings almost as large as our annual gross domestic product.

Yet we are told that we are on the brink of a fiscal crisis. What world indeed do these scaremongers inhabit?

There are indications … that the pressure on construction materials prices will ease soon

But, speaking of things Greek, my interest today lies in an Achilles' heel they exposed when venturing to provide some statistical background for their messages of doom - specifically the forecasts, on which their prophecies rest - of various measures of inflation up to the year 2041.

These are shown in the two charts as indices based on a value of 100 for 2013. The blue line in the first chart represents the GDP deflator, the broadest measure of inflation in any economy, and the red line is the consumer price index.

Notice how the two tracked each other quite closely for the first 20 years shown on the chart until about 2002 when the CPI began to turn around and rise faster than the deflator.

The reasons for this have mostly to do with pricing anomalies in merchandise trade and capital equipment during the period of deflation we suffered after the 1998 financial crisis, a deflation that was itself an anomaly. Nothing indicates these are permanent developments.

Yet the advisers, the chief executive's much touted Working Group on Long Term Fiscal Planning, blithely projected the trends of the past three years onwards into the future, little changed, all the way up to 2041.

It will not happen that way; cannot happen that way. Anomalies of this kind in any economy are self-adjusting. Natural pricing pressures would cause these two inflation measures to converge long before 2041. The basics of the working group's study are deeply flawed.

The divergence is even greater between forecasts of the deflator and one of its components, public sector construction costs.

Construction costs have indeed risen faster than the deflator recently, as the second chart shows, but it is absurd to assume that over the next 28 years they will rise by almost 250 per cent while the deflator itself rises by only 50 per cent. Yet this is what the working group did.

Already there are indications from commodities markets that the pressure on construction materials prices will ease soon while the next cyclical slowdown in our economy will lead to an easing of wage pressure.

I see from the membership list of the working group that it comprises several academics and accountants. This leads me to a subversive suggestion for their students and juniors.

The next time these sages accuse you of not having done your homework properly, turn around to them and say: "And neither have you."