By David Milliken and William Schomberg
LONDON (Reuters) – The Bank of England should overhaul its economic forecasting by scrapping communication tools that have been in place for a generation and upgrading “seriously out of date” technology, former Federal Reserve chair Ben Bernanke said.
Bernanke advised the BoE to publish more alternative scenarios for the economy, rely less on market expectations of interest rate moves for its forecasts and undertake other measures to improve its forecasting abilities.
But in a review published on Friday he stopped short of a more radical alternative of the BoE publishing its own forecast for where interest rates might head, saying that should be left for future discussion.
The eight-month review, commissioned by the BoE’s oversight body, came after a surge in inflation to its highest levels in more than 40 years in 2022 turned a spotlight on the central bank’s inner workings.
“While the accuracy of the BoE’s forecasts has deteriorated significantly in the past few years, forecasting performance has worsened to a comparable degree in other central banks and among other UK forecasters,” Bernanke concluded.
British consumer price inflation surged above 11% in October 2022, after Russia’s invasion of Ukraine and post-pandemic bottlenecks.
Some politicians and economists criticised the BoE for only starting to raise interest rates in December 2021, when inflation was already above target. The BoE has said an earlier start would have made little difference.
Bernanke described the BoE’s failure to foresee the surge in inflation as “probably inevitable” due to “unique circumstances”, and added that comparing the quality of central banks’ interest rate decisions had not been within his remit.
The biggest failure was in the BoE’s forecasting software which he said was “out of date and lacks important functionality,” he said.
The central bank’s central forecasting model had “significant shortcomings” that made it hard for staff to produce alternative economic scenarios and needed “replacing, or, at a minimum, thoroughly revamping”.
Bernanke said the BoE should eliminate its long-standing ‘fan chart’, which shows a range of possible future paths for inflation and growth based on a single set of assumptions.
Instead, the BoE should give a more qualitative assessment of risks and publish alternative scenarios that illustrate how the BoE might change interest rates if the economy did not develop as expected, and what impact these changes would have.
Governor Andrew Bailey said work was already underway to improve the BoE data platforms, which should be done in the next year or so, and that policymakers would set out further steps on communication by the end of this year.
NO ‘DOT PLOT’
Bernanke, who was head of the Fed from 2006 to 2014, did not recommend that the BoE move closer to the U.S. central bank’s ‘dot plot’ where each rate-setter anonymously publishes their own forecasts for interest rates, growth and inflation.
The BoE, unlike the Fed and the Swedish and Norwegian central banks, does not publish its own interest rate forecasts.
Bernanke said doing this would be “a more aggressive approach” and rate forecasts – collective or individual – would be “highly consequential” should be left for future debate.
If the BoE did go down this route, it would be better to produce a single rate projection, as Scandinavian banks do, rather than a Fed dot plot with individual policymaker views, he said.
Some senior BoE officials have previously opposed rate forecasts, worrying they would be misinterpreted as a commitment rather than a best guess which was likely to change.
Bernanke said this had not been his experience at the Fed, or a major problem for Sweden or Norway, though it did put pressure on policymakers to give a medium-term view even when they were uncertain.
“The problem with rate projections is they force you to take a stand when perhaps you don’t feel it is really appropriate,” he told reporters.
The BoE currently produces two sets of projections for inflation, growth and unemployment. One is based on interest rates staying unchanged, and the other on what financial markets think will happen to borrowing costs over the next three years – similar to the European Central Bank’s approach.
Investors often look at the BoE’s forecast for inflation two years ahead to get a sense of whether the central bank thinks the market path for interest rates is too high or too low.
Some former officials dislike this for locking the central bank into making forecasts which are based on interest rate assumptions that the policymakers themselves do not believe.
Bernanke said the BoE should de-emphasise forecasts based on market rate assumptions and be “exceptionally clear” when policymakers disagreed with them, or other assumptions.
Alternative scenarios or explicit changes to the assumptions, could be a way to do this.
Tweaking the main forecast output to conform more with what policymakers thought was likely was another option, but “has the significant disadvantage of sending inaccurate signals to market participants,” Bernanke said.
(Reporting by David Milliken and William Schomberg)
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