Twice a year, in June and December, De Nederlandsche Bank publishes its projections for the Dutch economy: expectations about economic growth, production, inflation, exports, imports, public debt and employment. The predictions are the outcomes of a macroeconomic model. For many years, this used to be the Morkmon model – but it had fallen behind the times and needed improvement. It took three years to build a new one, dubbed Delfi, which is short for Dutch economic linkages, a forecasting instrument.
Why a new model?
'The Morkmon macroeconomic model had been in use since the 1970s. It had last been updated in the mid-1990s, however, and so a replacement was urgently needed. Also due to recent developments in datasets and data definitions, causing misalignment between the data and the model. Moreover, some recent developments in the Dutch economy were absent from the old model.'
What recent economic developments can you monitor now that you couldn’t before?
'In the first place, the huge growth of reexports: the exportation of foreign products to a third country via the Netherlands. For instance, clothing from China that arrives in Rotterdam and is moved on straight to, say, France. Reexports now account for half our total exports. That is a major structural development. With the old model, we could only measure total Dutch exports, while Delfi allows us to make the distinction between both types of exports.'
Any other new elements in the Delfi model?
'Another thing is demographic ageing and its effect on the long-term growth potential of the Netherlands – let’s say in ten years time. Demand for that kind of information is getting stronger and stronger: from policy-makers at central banks, from politicians, from the corporate sector. The pension sector has also been modelled in so we’re able to chart how interest rate movements influence pension index-linking. That in turn provides a better idea of how the income of retirees develops.
Another new feature is that we look at production not only in terms of capital and labour, but include energy as well. That way, we can measure the impact of higher oil prices on production and hence on price movements.'
Did the credit crisis play a role?
'It certainly did. Coincidentally we had started building the new model in 2007, so at the exact moment the crisis set in. Some of the elements we built into the model might well have been left out if it hadn’t been for the crisis. Let me give an example. We have included an option to measure the impact of credit rationing. This allows us to calculate what happens if banks reduce mortgage lending or corporate lending. Think of the implications for employment, economic growth. And we also plan for Delfi to home in more closely on the interaction between the financial sector and the real economy.'
Do you also look at a banking crisis and its implications for the economy?
'No, that is, not yet. But it is on our wish list of future improvements. After all, a banking crisis may have huge effects on employment, the stock exchange and hence the economy. Not that it need to, by the way: not every banking crisis has the same impact.'
You can keep adding to the model?
'Not indefinitely. You can never capture everying inside just one model, or you’ll be left with a useless tangle. What you can do is build several versions. Either way, there still remains a lot to be done.'
Better forecasts thanks to the new model?
'No, that’s not the way to look at it. The model is more closely in line with current developments, therefore you can underpin your projections more accurately. That’s where the benefit is. But it doesn’t mean every future projection will be spot on. Whether our predictions come true depends on the development of world trade, so on an external factor. And even with the best model in the world we couldn’t predict the future of world trade any better than we used to. For that, we use the projections of DNB and the other Eurosystem central banks. Suppose they expect 4% growth. We feed that into our model and then calculate what it means for our exports and employment rate. However, if the expected 4% turns out to be 2%, that will have a huge impact on our forecast.'
How good are DNB’s forecasts, on the whole?
'You will always be slightly off. During the crisis we were way off. And so was everyone else, for that matter. World trade collapsed, which no-one could have foreseen. Things like that will knock over any projection, whatever the underpinning.'