Sunday 12 February 2012

Bits & Pieces: RBA's Infallibility.

Moses with the Tablets of the Law.
Rembrandt (1659) [A]
An opening note for overseas readers: for diverse reasons, a favourite Australian pastime is to predict when the RBA will change official interest rates.


A few days ago SMH's Jessica Irvine published a piece on why economic forecasters engaging in this "hobby" often get it wrong. Read it here: it's a good read.

The piece was motivated by last week's surprise RBA decision to keep official interest rates unchanged. Bank economists (plus journalists, and commentariat) forecast a reduction, almost unanimously.

Don't get me wrong, Irvine makes a good case: it's these economists' job to make forecasts and they make them using imperfect information. They are vulnerable to confirmation bias, too.

Irvine: "The problem is, these economists are only human".

Fair enough.

She also mentions journalists: "And then comes the media, which, it must be said, doesn't deal well with uncertainty (a human trait)".

Again, fair enough. I have no objection.

Irvine doesn't mention the sundry commentary one finds in the blogosphere, but one could assume similar reasoning applies to the best of it: an all-too-human tendency to over-simplify and follow the leaders.

In contrast, "the Reserve, for its part, feels under no compulsion to fall into line with this game calling. Its board members have the privilege of waiting until all the data is in before acting", said Irvine.

This is much less reasonable.

Irvine implicitly assumes that the RBA's decision was right. This is most obvious in the preceding quote, but you can perceive it in the whole text.

I object to that assumption. The RBA is as much under pressure to make a decision, as the forecasters are to second-guess it in advance. It's the RBA's job to make decisions under pressure.

To make these decisions the RBA uses information, which is publicly available. Therefore, is not clear the RBA has any substantial advantage over forecasters in this regard.

Furthermore, the board members and staff preparing the RBA's board briefs are as susceptible to confirmation bias as any one else. Despite the RBA's mystical aura of infallibility, it's staffed and directed by humans.

In other words, the situation is probably much more symmetrical than Irvine's account suggests.

Asymmetry do enter the situation when one takes into account the consequences of a mistake, which Irvine didn't do: most likely a red-faced forecaster, in the case of a bank economist.

If the RBA makes a mistake the consequences would be more serious. And, at least in this occasion, it is not trivial the decision was right.

Image Credit:
[A] Moses with the Tablets of the Law. Rembrandt (1659). Wikipedia.

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