What is it that I apparently know that the Bank of England economists do not?

October 19, 2011 Brian Green

There is a heightened sense of concern over the fragility of the economy after yesterday’s speech by Mervyn King, Governor of the Bank of England and the release of its monetary policy committee minutes today.

It all fuels the worry that we really are heading back into the deep doodoo.

The downsides are obvious. The upside is that this should help to pull inflation down in the medium term, after a series of “special factors” raised the rate to a level not expected by the Bank of England or the majority of the seemingly endless folk who make money out of economic predictions.

But hell’s teeth how badly wrong has the BoE been in its forecasting over the past three years? How much damage has this poor forecasting done to its credibility? And what price might the construction industry end up paying?

Ok the answer to the first question in the headline is definitely “not much if anything” when it comes to monetary policy.

These folk are seriously bright. They are better schooled in economics than I am by a matter of such huge magnitude it doesn’t bear thinking about. I am disadvantaged by there being just one of me, which makes triangulating tricky. And, while their focus is heavily monetary policy, it is a subject for which I have a passing interest. And they have a bigger computer and lots of sexy software.

I’d say I am pretty disadvantaged relative to the Bank of England when it comes to making stabs at the future path of inflation.

Yet as I contemplate the implications of inflation hitting 5.2% on the CPI scale I cannot stop wondering – with huge disappointment – how their quarterly punts at the path of inflation could have been so wrong and always in the one direction.

I am not saying it’s easy to guess inflation (and it is a guess however many fancy econometric models you have) or to second guess the possible impact of unknowable external factors. But if the sight of your rifle constantly shoots to one side, you fix it before you get shot.

Mind you, if you keep on saying that inflation will come back to its target in the medium term, eventually you’ll be right.

Things have come to a pretty pass when if challenged to bet I’d happily take short odds on my blog being more consistently accurate on the likely path of inflation over the past three years than the inflation reports of the Bank of England.

I say that having scanned back to satisfy my own curiosity on the positions I have taken on inflation since I started blogging. Statistically, though and in fairness, I have only to had to be slightly more bearing to do better than the Bank’s bank of economists.

But looking back, I have consistently warned or implied that the assessments of the Bank of England for the likely path of inflation (and I might add the assessments made by a huge swathe of professional economists paid good money for their expertise) were too low.

Leaving that aside, the more pertinent question is what has been the result of it being off target for so long and consistently in one direction.

I’m old fashioned in many ways. I like authority to be smarter than me. I challenge it because I like it to be trustworthy and tested.

I have great regard for Mervyn King. I like his style.

But something seems badly wrong with the assumptions used by the Bank to judge the inflationary pressures in the UK economy.

Why does all this matter?

High inflation combined with low interest rates erodes savings. In effect we end up with the perverse situation of savers paying their borrowers for the benefit of having access to their money and then paying tax on the pitiful interest gained. While this occurs in economic history on occasion it is clearly not sustainable.

In my more cynical moments I think that the unofficial official policy has been to avoid civil unrest and political discomfort by placing the greatest pressure on those who will squeal least – savers.

By the very nature of saving, you are putting away for future use. So, any pain caused by losses will be deferred.

I have no particular problem with elevated inflation and negative real interest rates being used as an explicit economic policy to stimulate growth. It has a place in the armoury. But the proviso should be that the Government compensates ordinary savers in some way for their losses.

If it were the case that this approach of sparing borrowers pain today at the expense of savers were being adopted by stealth rather than openly it would be profoundly unjust. Savers were if anything a bulwark against the insane lending that occurred in the lead up to the credit crunch, while borrowers (ill-advised admittedly) and their wayward lenders were in large part the problem.

Interestingly we have not heard much on moral hazard of late.

But in the long run the problem we face is that while this low interest rate approach may have led to a shallower recession than otherwise might have been the case (and heaven forbid that it should have been deeper), it may well lead to a longer depression and more sluggish growth for many years to come than had the Bank of England been more successful in meeting the 2% inflation target.

Furthermore, if elevated inflation, or inflation uncertainty, is eventually shown to be in part at least a significant cause of the weakening economy (note falling household spending), then the policy options having been taken by the Bank of England would be cast into doubt. This is not good news, you want your central bank to command authority.

What is also worrisome is that having allowed interest rates to remain on the floor its monetary policy options for stimulating the economy are pretty much limited to the quantitative easing experiment.

Why does this all matter to construction?

It matters because construction thrives very badly in a low growth economy. And it matters now more than normal because construction is so reliant on the private sector for growth.

So what should we be doing?

We should be concentrating more on fiscal policies and investing hugely in construction at least to the level of bringing back the resources lost during the recession.

This investment should be prudently targeted but much of this boost to investment should be in housing, new and repair and maintenance, and in essential infrastructure.

Below is a list of blogs on the subject

How worrying is the latest jump in inflation?

May 17th, 2011

Here’s what bothers me about inflation – for what it’s worth

June 14th, 2011

Inflation rate will fall next month, probably, but it needs to fall sharply

March 22nd, 2011

Inflation – a reason to be cheerful or a cause for concern?

November 16th, 2010

The problem with surprises on inflation

May 19th, 2010

Reasons to be careful – December’s higher than expected inflation