Tracking the Bank of Canada’s staff projections through the 2008-9 recession
The Bank of Canada has released an archive of the staff projections prepared for the Governing Council for the quarterly Monetary Policy Reports. There’s a five year lag, so the most recent set of projections are the ones prepared in 2013Q4. While these projections don’t answer the question “What was the Governing Council thinking?”, it does answer the question “What projections were the Governing Council looking at?”
There’s lots of things you can do with this archive; there’s a BoC staff report evaluating the quality of the forecasts for things like GDP and inflation. And they also provide a new real-time database, since the historical data associated with a given projection have not been updated to reflect data revisions made after the projection was made.
But for now, I’m going to look at the projections for the output gap and the policy rate. The availability of that second thing is probably the most interesting part of the projections archive. One of the problems with interpreting the Bank’s projections is that they are made conditional on a certain set of assumptions for how interest rates will evolve in the future, and that part of the projection is not made public in real time. But now we can see the paths for the policy rate that the staff was using to underpin its projections.
These paths would not have been picked arbitrarily; the projections for the policy rate are the staff’s estimates for what it would take to get back to normal. They would have emerged as the result of an attempt by the staff to produce projections in which the economy returned more or less to normal six to eight quarters out: the economy operating at potential and inflation on target.
I’m going to break things down by two-year intervals. Here are the projections for the output gap made over the period 2007Q4-20094:
This looks a lot like the charts in this post from 2011. Two things were happening to the projections as the economy fell into recession. Firstly, the projected path for the output gap deteriorated as new data came in. Moreover, the most recent estimates for GDP were being continually revised downwards. You can see the news getting worse and worse as the projections get revised downwards, but things start to turn around by the projections made in 2009Q3.
This is an interesting chart. The outlook looked pretty good in 2007Q4; the projected policy rate wasn’t expected to change over the planning horizon. And even as bad news came in during the first three quarters of 2008, the Bank’s projection wasn’t thrown off its previous path by all that much: the reductions in the policy rate that were carried out over that time were expected to be enough to bring the economy back to normal.
The big change came in 2008Q4, in the wake of the collapse of Lehman Brothers and the seizing up of credit markets. The 2008Q4 projection and those that immediately followed had a policy rate that hit the lower bound and stayed there until mid-2010 or so. But as the economy pulled out of recession, the projections became slightly more optimistic; the projected paths of the policy started being revised upwards.
Now lets move on to the post-crisis years of 2010-11. This is where you start to see the pattern of projections that repeatedly showed the gap being closed two years away from the date of the projection. In 2009Q4, the gap was expected to be closed in 2011Q4, while in 2011Q4, the gap was expected to be closed in 2013Q4. Not to put too fine a point on it, the credibility of the Bank of Canada’s projections began to be progressively strained over this period.
The projections for the policy rates tell the same story: paths for the policy rate that increased, but with a fixed and always-shifting delay. But in 2011Q3, the staff capitulated, as so may analysts did in the wake of yet another financial crisis during the summer of 2011 (a combination of yet another euro zone crisis and US debt ceiling shenanigans). The staff resigned itself to the “low for long” scenario.
As we moved through 2012 and 2013, the staff’s projection for the output gap began to dig in its heels, predicting a closing of the gap sometime in 2103. Or at least it did up until 2013Q4.
I’m not entirely sure what is going on with the last projection in 2013Q4. It looks like the historical series was revised down, taking the entire projection down with it. But what’s with huge projected jump in 2016Q4?
Looking at the policy rate projection, it looks as though that downward revision was enough for the staff to resign itself to another four quarters with no change in the policy rate.
The projection end there: the fall in oil prices and the subsequent weakening of the Canadian economy came at the end of 2014.
Sometimes the Bank of Canada gets criticized for not providing enough forward guidance for interest rates to financial markets, but I think it’s just as well that the Bank keeps these projections to themselves. This isn’t a snarky comment about the Bank’s ability to make projections. The risk is that financial markets would put too much weight on these policy rate projections, and not enough weight on the data. Changes in the policy rate projection would become a source of uncertainty in its own right, and the last thing the Bank wants to be doing is amplifying noise and uncertainty.