By Dr David Clark

A week may be a long time in politics but six months can be a millennium when it comes to Federal Budget forecasts.

Even just a few months can have a big impact on Treasury expectations for the year ahead - see accompanying graph.

If Treasury changes it mind so dramatically, no wonder the rest of us are so uncertain about the economic outlook and financial markets remain so volatile.

In a footnote in the 2008 Budget Paper Number 1, Treasury acknowledges that:

"The forecasts are based on several technical assumptions. The exchange rate is assumed to be around 93 US cents. Domestic interest rates are assumed to remain unchanged. World oil prices (West Texas Intermediate) are assumed to be around US$115 per barrel."

A week after the Budget, the $A had hit 96 cents and oil US$133.

But these key foundations to its whole outlook are rarely acknowledged, let alone Treasury's imperfect track record in previous years.

It is also sobering to see what it said about these key parameters in the 2007 Budget.

"The exchange rate is assumed to remain around its recent level... a United States dollar exchange rate of around 82 US cents. Domestic interest rates are assumed to remain unchanged at current levels. World oil prices (West Texas Intermediate) are assumed to move in line with market expectations, and remain above US$65 per barrel throughout most of the forecast period.

By the time of the 2008 Budget, the exchange rate was around 95 US cents and the oil price $US125.

Little surprise Treasury was way out with its CPI forecast for 2007-8. It now expects the rate to come in at 4 per cent. How accurate will be its 2008-09 forecast?

A major reason for the blurred vision of both Treasury and the RBA is that key economic data only become available significantly after the event.

For example, Australian quarterly GDP estimates have even been changed from a positive to a negative outcome up to 18 months after the original estimate was made!

Central bankers can also find themselves waiting up to 18 months for the full effects of changes they have made in interest rates to flow through the pipeline.

No wonder when they look forwards their vision can only be very blurry.

The empirical relationship between changes in asset prices, interest rate changes, and the ups and downs of economies and share markets, is even more complex and uncertain.

Hence all the uncertainty at the moment about such changes and what the RBA may do next.

Turning to Treasury's housekeeping forecasts, the accompanying graph also shows a lot more sand than rock.

For example, if Federal Government cash surplus numbers are often "off with the fairies" - we certainly cannot make dogmatic forecasts of the degree of stimulus to come from Budget decisions even one year out, let alone 3 or 4.

True, Treasury admits such in its very important distinction between estimates" (which are made only for a year ahead) and "projections" (which are made for the three years after that) but this crucial distinction is usually totally ignored in most Budget commentary.

No wonder it is impossible for investment advisors - let alone investors - to predict the course of interest rates and the likely effects of rate changes on financial markets over just the year ahead, when Treasury models, which can include over 500 equations, are so far out on such key economic parameters.

The message from the above? With the international situation also very uncertain and the Australian economic outlook the most uncertain it has been for some years, expect financial markets to remain jumpy and easily spooked for some time to come.

Dr David Clark taught Business Economics at the University of NSW for 35 years, was an AFR and Personal Investor columnist for over a decade, and is now an investor educator. The views expressed are those of David Clark's, not necessarily those of Vanguard's.