Thursday, June 29, 2023
Does the Bank of England know what it's doing?
Last week, I argued that raising interest rates was no longer the fix-all solution for high inflation rates because oujt-of-control prices were not being led by demand, but by costs. Now the Independent reports that the Bank of England’s chief economist has reinforced that point of view, by admitting that the bank's forecasting model has become “unworkable” during Britain’s current inflation crisis.
The paper says that Huw Pill has conceded that the central bank’s model had produced misleading forecasts which failed to assess the ongoing impacts of the Ukraine war on prices and wages:
Speaking at the European Central Bank (ECB) forum on Wednesday, Mr Pill said the Bank used a model “based on last quarter century” when inflation expectations “were well anchored and there was little evidence of persistence”.
It comes as Mr Bailey defended the decision to hike interest rates to a 15-year high of 5 per cent, claiming the monetary policy committee had to make a “strong move” after studying a surprisingly bad inflation report last week.
The Bank has come in for fierce criticism from Tory MPs, who have accused governor Andrew Bailey and his team of being “asleep at the wheel” as inflation crept up in recent years.
Mr Pill told the forum that the Bank had adjusted to the Russian invasion of Ukraine, but had failed to anticipate “how that shock is going to propagate” with “second-round effects”.
The chief economist explained that the model used by officials downplayed the combined effects of high energy prices continuing to push up prices and wages during a period of labour shortages.
“As inflation moves away from [the] target, the everything-else-equal assumption that allows us to break down the contributions to the drivers of inflation in a linear way tends to become unworkable,” the chief economist said.
“The likelihood of second-round effects is much stronger when there is a tight labour market. The impact of the shocks is not additive to one another but has an important multiplicative moment.”
The Bank announced an external review of its own forecasting after it hiked interest rates to a 15-year high of 5 per cent last week – having repeatedly failed to accurately predict stubbornly-persistent inflation.
Essentially, then, we are having to endure high mortgage rates, low pay settlements and increasing hardship because the Bank of England's economists can't see beyond the end of their own nose. Time for a rethink.
The paper says that Huw Pill has conceded that the central bank’s model had produced misleading forecasts which failed to assess the ongoing impacts of the Ukraine war on prices and wages:
Speaking at the European Central Bank (ECB) forum on Wednesday, Mr Pill said the Bank used a model “based on last quarter century” when inflation expectations “were well anchored and there was little evidence of persistence”.
It comes as Mr Bailey defended the decision to hike interest rates to a 15-year high of 5 per cent, claiming the monetary policy committee had to make a “strong move” after studying a surprisingly bad inflation report last week.
The Bank has come in for fierce criticism from Tory MPs, who have accused governor Andrew Bailey and his team of being “asleep at the wheel” as inflation crept up in recent years.
Mr Pill told the forum that the Bank had adjusted to the Russian invasion of Ukraine, but had failed to anticipate “how that shock is going to propagate” with “second-round effects”.
The chief economist explained that the model used by officials downplayed the combined effects of high energy prices continuing to push up prices and wages during a period of labour shortages.
“As inflation moves away from [the] target, the everything-else-equal assumption that allows us to break down the contributions to the drivers of inflation in a linear way tends to become unworkable,” the chief economist said.
“The likelihood of second-round effects is much stronger when there is a tight labour market. The impact of the shocks is not additive to one another but has an important multiplicative moment.”
The Bank announced an external review of its own forecasting after it hiked interest rates to a 15-year high of 5 per cent last week – having repeatedly failed to accurately predict stubbornly-persistent inflation.
Essentially, then, we are having to endure high mortgage rates, low pay settlements and increasing hardship because the Bank of England's economists can't see beyond the end of their own nose. Time for a rethink.
