In assessing its batting average when it comes to correctly forecasting inflation, the Bangko Sentral ng Pilipinas (BSP) admitted it had made more forecasting errors in 2023 compared to its 2022 performance, citing increased price volatility last year as culprit.
The BSP said that forecast errors in 2023 for both month and year-ahead forecasts were larger “due to significant volatility in commodity prices from continued supply disruptions in key food items and higher oil prices.”
This was based on a report called “Evaluation of the BSP’s 2023 Forecasting Performance” which is a regular review for the BSP in a bid to improve its macroeconomic forecasting models as well as “promote transparency in monetary policy formulation.”
The BSP has put in a lot of effort on enhancing its model development and capacity building for forecasting and policy analysis. It noted that the Department of Economic Research (DER) has constantly refined its models to “better guide monetary policy analysis and formulation” through multi-year technical assistance projects with the International Monetary Fund’s (IMF) Institute for Capacity Development (ICD) and the Japan International Cooperation Agency (JICA).
In fact for this year, the DER has ongoing technical assistance with the IMF to improve the Policy Analysis Model for the Philippines (PAMPh) as well as to undertake various projects, such as the nowcasting of selected macroeconomic variables, to support the scheduled transition to the PAMPh as the BSP’s workhorse model, said the BSP.
Meanwhile, the BSP included in its assessment the examination of the month-ahead inflation forecasts, annual inflation forecasts and the standard statistics for “forecast accuracy, unbiasedness, efficiency, and benchmarking.”
In terms of the month-ahead inflation forecasts, the BSP said its 2023 projections have “slightly” higher forecast errors than in 2022 and the historical average despite that generally, it said monthly inflation did settle within the BSP forecast range except for January and October.
“Nonetheless, the BSP’s month-ahead inflation forecasts registered lower forecast errors compared with the median estimates from private sector analysts in Bloomberg’s monthly survey,” said the BSP.
It cited as example the headline inflation for January 2023 which peaked at 8.7 percent year-on-year and exceeding the BSP forecast range of 7.5 to 8.3 percent. “Headline inflation exceeded the forecast range after electricity rates, domestic fuel prices, and prices of vegetables and meat rose by much more than expected due to supply disruptions and severe weather disturbances,” said the BSP.
As for the annual inflation forecasts, the BSP forecast range was three percent to six percent in 2023 with the final consumer price index (CPI) averaging at six percent by the end of last year.
It was in 2023 when the BSP shifted away from baseline CPI forecasts to favor a risk-adjusted forecast. The first time the BSP announced this forecasting method was in October last year which was the last time it raised the policy rate by 25 basis points to 6.5 percent in an off-cycle move.
In announcing the risk-adjusted CPI forecasts which is what it prefers now, the BSP said it has considered different scenarios that pertain to upside and downside risks to the baseline inflation outlook. It assigns probability values for each, it said, and that upside and downside risks are summarized in a risk matrix. “The risk-adjusted inflation is equivalent to the baseline inflation forecast plus the probability-weighted impact of the different upside and downside risks to the inflation outlook,” explained the BSP.
The BSP noted that forecast errors for the one-year ahead baseline and risk-adjusted inflation forecasts “were higher compared with the private sector’s mean one-year ahead forecasts, but lower compared with the IMF’s baseline outlook.”
As for its two-year ahead forecasts, this had a slightly lower forecast error compared with both the private sector and the IMF.
In terms of accuracy, the BSP said its inflation forecasts “have a statistically adequate level of precision with lower forecast errors compared to benchmark statistical models over the sample period.”
“Second, tests for unbiasedness and efficiency indicate that the baseline forecasts do not systematically over- or under-predict inflation across the sample period. (And) third, benchmarking with the private sector and the IMF forecasts shows that the BSP’s baseline forecasts have lower errors across the sample from 2011 to 2023,” said the BSP.
The BSP said its annual inflation forecasts have lower forecast errors compared with the private sector’s and the IMF’s average from 2011 to 2023 while the baseline annual forecasts have slightly lower forecast errors compared with the risk-adjusted forecasts over the period of 2011 to 2023.
The BSP first adopted the inflation targetting framework in 2002.
Under this framework, the government upon the guidance of the BSP has an annual headline inflation target range of two percent to four percent for 2004 until 2008.
“The inflation target range continues to be an appropriate quantitative representation of the medium-term goal of price stability that is aligned with the Philippines’ current structure of economy and outlook of macroeconomic conditions over the next few years,” said BSP Governor Eli M. Remolona Jr.