Ben Bernanke says BoE must revamp main economic model

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The Bank of England must revamp its core economic model if it is to avoid repeating its recent failure to forecast rising inflation, former Federal Reserve Chairman Ben Bernanke has said.

The Nobel laureate, who was called in to review the BoE’s forecasts and associated processes, found “significant gaps” in the bank’s core business model, exacerbated by outdated software.

He added that the Monetary Policy Committee’s current “fan charts” – which show the probabilities of different growth and inflation outcomes under various assumptions – had “outlived their usefulness” and “should be eliminated”.

Bernanke was asked to review the BoE’s forecasts last year after British policymakers were criticized for failing to forecast a post-pandemic rise in inflation that would have been stronger and more prolonged than in previous years. other advanced economies.

Its recommendations suggest that a step change is needed to prepare the central bank for a more volatile economic environment, in which significant shocks such as the pandemic and the war in Ukraine could be more frequent.

The BoE said it was “determined to act” on the report’s 12 recommendations and would provide an update on the proposed changes by the end of the year.

Andrew Bailey, governor of the BoE, described the review as a “once-in-a-generation opportunity” to update forecasting approaches and adapt them for a “more uncertain world”.

Bernanke said an international comparison showed the BoE’s forecasting performance had been no worse than other central banks, and that “unusually large” errors were “probably unavoidable” given the unprecedented circumstances.

But the study also highlights serious flaws in the BoE’s forecasting infrastructure, in the way it deploys its staff and in its over-reliance on central economic forecasts to explain its policy decisions to the public.

Bailey said the BoE had been “challenged by the scale and unpredictability of the shocks that hit us”, but that conditions were now calmer and there was now “a growing story positive things to say about the economy.

The BoE must now urgently invest money and staff time in software modernization, Bernanke said, before “replacing or, at a minimum, fundamentally revamping” its business model, known as Compass, in the longer term.

In particular, he argued that the model should in future pay more attention to issues of productivity, labor markets and trade. It should also include detailed models of financial, real estate and energy markets.

Instead of using fan charts, Bernanke said the bank should publish a series of scenarios to explain its choices, the risks to its forecasts and the “robustness” of the plans in the face of uncertainty.

However, he stopped short of recommending that the BoE adopt the so-called dot plot, which he introduced at the Fed in the wake of the global financial crisis. The chart shows officials’ differing expectations for appropriate interest rate policy in the coming years.

While saying the US model would not suit the BoE, he said the MPC should consider publishing its own forecasts for long-term interest rates. Its central forecast is currently based on market rate expectations, meaning the MPC doesn’t always believe its own projections.

Such changes would be “highly consequential,” Bernanke said, arguing that the decision should be left for “future deliberations.”

The BoE should focus first on improving its forecasting tools – which will require heavy investment – while “acting cautiously in adopting changes in its policymaking and communications”, it said. concluded Bernanke.