Bank of England holds “wrong holidayThis week, celebrate the lessons learned from the financial disasters of the distant past. Some will argue that they, and their counterparts at other central banks, should focus on recent mistakes.
Advanced economies are experiencing their worst and longest-lasting inflationary bursts in a generation. However, almost all rate-setters have failed to see how far price pressures will rise — and continue despite record-sized monetary and fiscal stimulus.
Most rate-setters at the Fed didn’t foresee that inflation would rise, and then overestimated how quickly it would fall. Economists at the Bank of England and the European Central Bank have underestimated the size and duration of inflation. Across the world, poor forecasts have prevented central banks from doing their main job: maintaining price stability.
Failure to detect inflation not only risks financial instability by forcing central bankers to raise rates much faster than usual, but also threatens the credibility of institutions that rely on trust to steer economies towards sustainable growth.
Stephen King, senior economic adviser at HSBC, blamed their collective failure on rate-setters relying too much on their ability to control public expectations of future price movements.
In normal times, the rules governing companies’ pricing decisions and workers’ demands for wage increases could be influenced by the central bank’s own inflation target of around 2%.
But what the forecasts fail to show is that these rules only apply when inflation is largely stable. Once price pressures spike – and stay high – people start to believe that “central banks are talking bullshit now”. Skepticism abounds, with recent inflation data more important than the central bank’s insistence that its policies can calm price pressures.
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With a reputation tarnished for failing to foresee inflation, the central bank had to raise rates aggressively — by as much as 75 basis points in a single policy vote — to convince investors and the public of their commitment to low inflation.
In some ways, this has also led to introspection.
The ECB pleaded guilty to underestimating inflation and pledged to focus more on underlying inflation than forecasting models going forward.The International Monetary Fund also Openly speaks out about ‘miscalculation’ of its forecast — though that frankness doesn’t appear in any of its flagship reports.
The BoE took a more hawkish tone, saying its error had nothing to do with a mistake in how its forecasts were formulated, but was the result of major shocks such as the war in Ukraine that it could not have predicted.
While other groups are less defensive, economists elsewhere warn that the public should pay less attention to whether the forecast turns out to be correct.
That’s unlikely, they argue, and the public should pay more attention to whether these forecasts reflect timely insights into the economy.
Richard Hughes, head of Britain’s independent fiscal watchdog, the Office for Budget Responsibility, admits that failing to detect the buildup of price pressures and underestimating the fall in productivity growth since the global financial crisis is one of the “two major problems” committed in recent decades. macro forecasting errors”.
However, predictions are still “the best understanding of the future that depends on what you know about the present,” he said.
He highlighted the similarities between these forecasts and financial market pricing, which also changes as the facts change. “(The market) ‘reacted to the news,’ and (we) ‘got it wrong,'” Hughes said.
Aleksandra Dimitrievich, head of global research and development at credit rating agency S&P, said the purpose of the forecast was not to round out numbers to the nearest decimal point, but to “look at the narrative, the direction and the risks”.
“By definition, a prediction is never right. The question is whether it’s useful,” Dimitrijevic added.
The OECD’s new chief economist, Clare Lombardelli, points out that dire forecasts of a cold winter across Europe are based on assumptions about the weather, which, luckily, is warmer than normal – meaning Both natural gas storage and economic growth were maintained.
Failure to forecast major economic trends doesn’t mean forecasters are clueless, said Daniel Leigh, team leader for the IMF’s World Economic Outlook.
Even if the final results are incorrect, officials and ministers find the fund’s forecasts useful because they give a sense of scale and explain possible knock-on effects of global trends, he said.
“It is imperative that policymakers understand the expected outcomes and risks so they can take the necessary steps,” Leigh said.
Others, however, were less sympathetic.
The Fed’s initial forecast that high inflation would be “transitory” was “one of the worst forecasts in decades,” said Mohammad El-Erian, dean of Queens College, Cambridge University and adviser to Allianz.
He argued that if the Fed had more carefully examined the evidence from businesses and the implications of its own actions, it would have detected the severity of rising inflation earlier.
Lombardelli acknowledged that central banks face a particularly tricky task as they not only make inflation forecasts but also set policies to influence price pressures two years from now.
“If you’re a policymaker, how do you see the impact of policy?” she said.
This challenge is especially acute in an environment like the current one, where the consequences of the pandemic and Russia’s invasion of Ukraine are unpredictable.
El-Erian believes that achieving this goal will be difficult, especially for the Fed.
Central banks, especially in the United States, have made major “unilateral” forecasting errors without admitting it. The errors could be blamed on models “failing to keep up with major structural changes in the economy”, looking at “micro data” too late, and groupthink.