Reserve Bank Governor Lesetja Kanyago is hoping that AI will help speed up the updates of its economic forecasts. At a recent media briefing he remarked that “From the time we make assumptions to the time they go and generate a forecast, it could be a couple of weeks,” “But there is emerging evidence that says that AI could help us speed up the forecasting process. So, we might be able to generate forecasts quicker, and that speeds up our own internal processes.”One of the things … we have to look at is to what extent this technology can be utilised to speed up processes and make central banks very efficient.” News 24.
Which reveals an important reality. The forecasts of the SA or indeed any economy will only be as good as the accuracy of the key assumptions made that drive the model. The hoped for internal consistency of the forecasting model is not sufficient to the purpose. Accurate assumptions about the key drivers of the model, the exogenous variables as they are described in model building, are all important for accurate forecasts- and hence may need to be revised frequently
It is always necessary for forecasters to play catch up with changes in the environment. It makes any central bank with influence on a domestic economy data dependent- not forecast dependent. The term data dependent is a constant refrain of the FED and the SARB and inevitable given the forecasting failures.
Not only the SARB but every analyst everywhere will have turned to AI to help their forecasts. And every SA economist will be looking to AI to help predict the interest rate actions, or should we say reactions of the SARB.
They will know, as AI will have digested, that interest rate settings in SA will be little influenced by the current state of the domestic economy. As has been demonstrated again very recently. With lower inflation has come news of a decline in Q3 GDP. Meaning a still very high after inflation Repo rate accompanying a very weak economy and a reluctance to lower interest rates more aggressively. No model of the SA economy would deny that real interest rates influence expenditure, inflation and GDP. But inflation will also depend on what is happening on the supply side of the economy – particularly to the foreign exchange value of the ZAR and the prices attached to imports and exports. One doubts that AI will make the USD/ZAR exchange rate and hence inflation highly predictable.
If past performance is anything to go by a concern for the state of the economy and the supply side forces acting on inflation will not much influence the SARB. It will defend its narrow mandate – to control inflation- and therefore to have to fight not only inflation but inflation expectations that are thought to feed back to inflation itself. Any model that forecasts inflation using inflation expectations as a driver, must have an equation or two to explain inflation expectations. The influence of the ZAR on inflation and hence inflation expected would have to play their part.
Judged by the interest rate spread between US and RSA five year bonds, the ZAR was predicted last week to lose an average 4.7% p.a. over the next five years. Hardly a backdrop to less inflation expected over the longer run.
Data dependence must remain the SARB mantra given the unpredictability of the ZAR and its weak bias. Nor should concerns about inflation expected, so difficult to influence, be the fall-back position of the SARB to justify depressingly high interest rates. When the data clearly indicates that aggregate demand is falling below potential supply and the threat to inflation is not domestic in origin, the case for lower interest rates should not be denied. Matching domestic demands with domestic supplies is as much as the SARB could contribute to the control of inflation. Inflationary expectations, not inflation, are largely impervious to the state of the SA economy – as AI would confirm