Forecasting Australia's economic performance during the Asian crisis

During the Asian economic crisis of 1997-98, published forecasts from a Bay esian vector autoregressive (BVAR) model consistently indicated that the cr isis would have little or no effect on Australia's economic performance, de spite the deterioration in the trade balance. The worsening trade deficit l ed 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 Austral ia'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 interes t rates than unconditional forecasts from a model without the trade balance . There does, however, appear to be useful information in the individual co mponents of the trade deficit. Conditioning on the actual paths of both exp orts and imports generally produces more accurate forecasts than conditioni ng 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 individ ual trade flows produces the most accurate forecasts for inflation, and the second-most accurate for interest rates. Taken together, the results prese nted here lend support to the argument that Australia's trade flows represe nt the outcomes of optimizing decisions, rather than defining constraints o n economic growth. (C) 2001 International Institute of Forecasters. Publish ed by Elsevier Science B.V.