The Bank of England has got markedly worse at forecasting the economy in recent years. Its economic model is faulty. Its systems are out of date. It has been reluctant to admit past mistakes. Communication with the public could be better.
If Threadneedle Street thought it was going to get an easy ride when it called in the former head of the US central bank, Ben Bernanke, to conduct a review of how decisions on interest rates have been made in recent years, it was mistaken.
Bernanke’s report is measured but still quietly devastating. It makes 12 detailed recommendations, and Andrew Bailey, the Bank’s governor, says he will act on all of them.
The backdrop to the report was the way the Bank responded to the coronavirus pandemic, the supply chain bottlenecks and the cost of living crisis of the past four years. The Bank thought price pressures would be short-lived and was taken by surprise when inflation rose to a 40-year-high of 11.1%.
After leaving interest rates at 0.1% until December 2021, the Bank’s monetary policy committee (MPC) then raised interest rates at 14 successive meetings so that they now stand at 5.25%.
Bernanke makes the point that other central banks also got their forecasts wrong in this period and, given the “unique circumstances” of recent times, the “unusually large” forecasting errors were probably inevitable. Even so, the accuracy of the Bank’s forecasts had “deteriorated significantly”.
Some of Bernanke’s recommendations read like a critique of the UK economy more generally, such as the lack of investment in new software – now being remedied – and the attempts to “paper over” problems with the model. Others are more specific, such as the need to publish other scenarios to its central view to help the public understand the reasons for decisions.
Bernanke provides two examples of where the Bank has stuck to methods that are well past their sell-by date. One is the Bank’s policy of tying its forecasts to what the financial markets think will happen to interest rates, even if what the markets think bears little relation to what its rate-setting MPC thinks.
“The MPC should de-emphasise the central forecast based on the market rate path in its communications and be exceptionally clear in warning about situations in which it judges the standard conditioning assumptions to be consistent with its view of the outlook.”
For more than 30 years, the Bank has used fan charts to convey to the public what it sees as the risks to its central forecasts for growth and inflation at various times in the future. Bernanke says these should be ditched because they have weak conceptual foundations, convey little useful information that could not be delivered more directly, and receive little public attention.
At a press conference to launch his report, Bernanke discreetly avoided answering the question of whether the MPC would have made fewer forecasting mistakes had his recommended reforms already been in place. Likewise, Bailey declined to say whether interest rate policy would have been different. But the message of the report was clear: the Bank could have done a lot better.
