Forecasting Australia's economic performance during the Asian crisis

During the Asian economic crisis of 1997–98, published forecasts from a Bayesian vector autoregressive (BVAR) model consistently indicated that the crisis would have little or no effect on Australia's economic performance, despite the deterioration in the trade balance. The worsening trade deficit led many other forecasters to predict a sharp fall in Australia's GDP growth rate, as the countries most severely affected by the crisis represent over 60 percent of Australia's export markets. This paper argues that the more pessimistic forecasts attached too much weight to the links between Australia's external accounts and GDP growth. In particular, I show that forecasts for the period September 1997 to December 1998, conditional on the actual path of the merchandise trade balance, predict higher inflation and interest rates than unconditional forecasts from a model without the trade balance. There does, however, appear to be useful information in the individual components of the trade deficit. Conditioning on the actual paths of both exports and imports generally produces more accurate forecasts than conditioning on net exports. In particular, conditioning on the trade balance results in the least accurate forecasts for inflation and interest rates of any of the models considered here. On the other hand, conditioning on the individual trade flows produces the most accurate forecasts for inflation, and the second-most accurate for interest rates. Taken together, the results presented here lend support to the argument that Australia's trade flows represent the outcomes of optimizing decisions, rather than defining constraints on economic growth.