Bank told forecasts are flawed

 
Tim Wallace
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INFLATION has been damaging British living standards and dragging down the economy – but the officials who are meant to keep a lid on prices didn’t do enough to help because their forecasts were too often wrong, according to a Bank of England report out today.

And even though the Bank was consistently worse at predicting changes in growth and inflation than other economists, it stuck with its flawed model, making excuses for its errors instead of trying to improve its forecasts.

The report from trouble-shooter David Stockton, who used to work for the Federal Reserve, recommends the Bank hire more experienced staff to boost its economics team, look more closely at the views of Monetary Policy Committee (MPC) members who do not conform to the group’s consensus, and open the MPC up to greater scrutiny.

Interest rates are set by the MPC to control inflation – higher rates should mean lower inflation, and vice versa.

But as interest rates take up to two years to change prices, it has to rely on forecasts. Although the crisis “exposed virtually all major macro models as being woefully ill-equipped,” Stockton notes the Bank’s is worse than most.

For example, the MPC thought inflation would fall to below one per cent by 2010. Most other economists thought prices would rise by nearly two per cent.

But in fact inflation soared, hitting 3.5 per cent in January 2010. Meanwhile the MPC held interest rates at rock bottom, and blamed the high inflation on “temporary factors” like oil and food prices.

Stockton warned these excuses may start wearing thin unless there is an improvement soon.

“The MPC will need to make an effort to prevent the standard list of reasons that have been developed to explain its errors from becoming the Bank’s ‘catechism of forecast errors’,” he said.

The Bank of England welcomed Stockton’s report.

“Given the challenges experienced by forecasters during the financial crisis, we will consider carefully the ideas for improvement in the review,” it said in a statement. “Analysis of past performance is already a part of MPC’s forecasting process, but we accept that the Bank should do more in this regard.”

Two other reports into the Bank’s response to the financial crisis have also been published. City grandees Bill Winters and Ian Plenderleith praised the Bank’s efforts to save the financial system in the crisis, and said it had done a good job of improving its liquidity programmes since.

But they added the Bank should do more to prepare in case a non-bank financial crisis emerges, where its liquidity programmes could do more to help stem any future problems in other financial sectors.