more readily we accept that our knowledge of the world is uncertain, the more willingly we acknowledge that perfect prediction is impossible, the less we will live in fear of our failures, and the more freedom we will have to let our minds flow freely. " 8 when an outturn is different from that forecast, the bank seeks to discover why, what it means for the outlook for monetary policy, and what we could do to make a better forecast next time. 9 we use our depth of experience to examine the data, distinguish the signal from the noise, and identify where to adapt our approach or where to maintain our existing views. for example, residential investment at the end of 2016 was considerably weaker than the bank had forecast. in seeking to understand this forecast error, the bank considered the composition of residential investment. we found that a sharp fall in transfer costs ( based on decreasing house sales ) was the cause of weak residential investment, rather than weakness in actual construction activity. accounting for this information should support better forecasts for this part of the economy in the future ( figure 2 ). 8 nate silver ( 2012 ), the signal and the noise : why so many predictions fail — but some don ’ t, penguin books. 9 for example see : kirdan lees, ‘ assessing forecast performance ’, rbnz bulletin 79 ( 10 ) june 2016 ; c j mcdermott, ‘ understanding low inflation in new zealand ’, a speech delivered to the bay of plenty employers and manufacturers association ( ema ) in rotorua, 11 october 2016 ; and geordie reid, ‘ evaluating the reserve bank ’ s forecasting performance ’, rbnz bulletin 79 ( 13 ) august 2016. figure 2 : residential building activity and house sales $ m 000s house sales residential building work put in place source : rbnz estimates. producing forecasts : avoiding biases and supporting robust outcomes forecasting can also help reduce human biases that are often present in decision making. our brains are designed to react to surprises by making sense of them. in seeking to do so, we often rewrite our perceptions from prior to these events. 10 even black swans may feel retrospectively predictable. this is known as ‘ hindsight bias ’ or the ‘ knew it all along effect ’. 11 as forecasters, we need to be particularly aware of this bias. to learn from our errors, we need to recognise that they are errors. by recording our quantitative forecasts and accompanying reasoning, we prevent ourselves from rewriting our original

tax treatment of these instruments – which have now been cleared up – were one of the reasons why german banks were so slow to issue such bonds. in addition, german companies legislation has thus far not explicitly provided for mandatory convertible instruments where the right to convert lies with the issuer. the 2014 draft act amending the companies act, which is currently making its way through the legislative process, will make it legal here in germany, too, to issue coco bonds, which would then convert to equity shares. banks ’ growing need for capital could be precisely the catalyst that might increase the importance of coco bomds in germany, too – which is all the more reason to be careful. attractive as these instruments may be to banks and investors, we must remember that these are very complex capital instruments, especially since they are governed by such disparate areas of the law as companies law, debt law, tax law and supervisory law. there is a risk that retail investors in particular, mesmerised by the relatively high returns on coco bonds, could lose sight of the risks involved. banks are aware of the danger : deutsche bank, for instance, issued its coco bonds in denominations of €100, 000 in order to restrict entry into coco bond business to institutional and professional investors. in the united kingdom, the sale and distribution of coco bonds to retail investors is even prohibited by law. bis central bankers ’ speeches now is the time for supervisors to develop a code of best practices for issuing coco bonds. while taking national legal systems into account, we supervisors need to strive for as much standardisation as possible in order to achieve convergence in the eu. it is important, though, that coco bonds actually be used to absorb the losses that the issuing banks could potentially incur. this challenge has been recognised by eu lawmakers and supervisors. the key tasks facing supervisors now are to observe the market very closely and to press ahead with efforts to improve the legal framework for coco bonds. once these tasks have been accomplished, coco bonds can be a useful addition to banks ’ capital structure. by helping to strengthen the capital base, they will make an added contribution to enhancing banks ’ resilience to future crises. bis central bankers ’ speeches