Bank of England: Not Possible to Forecast Next Financial Crisis
Bank of England governor Mark Carney and senior colleagues have been questioned on Tuesday (21 February) by the Treasury Committee on the Bank of England’s Inflation report. Among those present at the hearing, were Andy Haldane, Chief Economist of the Bank of England, Ian McCafferty, Member of the Monetary Policy Committee and Dr Gertjan Vlieghe, Member of the Monetary Policy Committee. The focus was on the latest inflation report, the Banks’s new forecasts for higher growth and inflation, and Brexit.
Economics is like a “Michael Fish” Operation?
Haldane was firstly questioned in relation to his claim that the financial crisis was a “Michael Fish” operation. Michael Fish was the BBC’s weatherman who became infamous after he laughed at the possibility of an impending storm. During that “unfortunate” forecast, a few hours before the Great Storm of 1987 broke, he had said: "Earlier on today, apparently, a woman rang the BBC and said she heard there was a hurricane on the way... well, if you're watching, don't worry, there isn't!". But later in the evening, South East England was hit by a terrible storm that killed 19 people and caused massive damages.
Haldane said that forecasting was an essential part of economics, similar to weather forecasting: “Economists did fail to spot the warning signs ahead of the 2008 crisis, and there was ‘group think’ about issues such as leveraging.” Leveraging or gearing refers to the use of borrowed funds for an investment, expecting that the interest to be paid will be less than the profits made. The chairman of the committee, corrected Haldane by whispering “group non-think”, more likely.
But Haldane, wisely commented that past mistakes should become lessons: “We can hope and aspire to do better, because we have learned lessons [from 2008].” He concluded that there’s been improvement, better forecasting methods and there’s always more room for improvement. Particularly, in terms of the Brexit referendum, forecasting errors were much smaller than those made in the 2008 financial crisis.
Bank of England’s “equilibrium level” of UK unemployment
Ian McCafferty and Haldane failed to answer the committee’s question on when did the Bank decide to reduce the equilibrium level of UK unemployment from 5% to 4.5%. The equilibrium level measures how close Britain is to full employment. Equilibrium unemployment level is the difference between those who are employed at a specific wage rate and those who can work. There is equilibrium between demand and supply of labour, but unemployment exists because part of the labour force is unwilling to work at that specific time and for a given wage rate.
McCafferty, who said had accepted the change, although he favoured a smaller one, argued that “Britain is actually closer to full employment than current weak wage growth suggests.”
Mark Carney attempted to rescue his colleagues by saying that the Bank has comprehensive annual reviews of its economic measures. But the chairman of the committee, Andrew Tyrie, was dissatisfied with their replies, demanding that the Bank return with more information. He added that by cutting this rate from 5% to 4.5%, the Bank was inviting higher inflation but without changing the interest rates. The lack of conviviality between Carney and Tyrie was evident, despite the fact that back in December Carney had invited the whole committee to the Bank’s Christmas party.
The Guardian jokingly reported that Kit Malthouse was also determined “to get himself dis-invited from this year’s Bank of England Christmas party,” after he asked Mark Carney about forward guidance! When Carney joined the Bank, he had promised that interest rates wouldn’t rise until the unemployment rate fell to 7%, but this was dodged after there was a sharp fall in the rate. Carney avoided elaborating on questions about the future of interest rates.
Ian McCafferty mentioned that there might be “some hope” that interest rates could start to normalise in two or three years.
The world has changed
Malthouse also said that we are in a “sod it” economy, where people have given up waiting for any changes and improvements, instead deciding to move on with their lives.
Carney agreed that the world has changed and the “gig economy”—the current reality of temporary positions and short-term contracts for independent workers—is changing the labour market itself and the way wages work. The economy is also indelibly changed by new scientific developments, particularly, machine learning, and artificial intelligence.
Consumers are borrowing more
The Bank is worried about rising consumer borrowing. Carney explains that consumers are now transferring “a credit balance and get up to 40 months of interest-free credit. The company taking on the loan can also bank some future earnings from this new customer straight away.”
More “tangible” forecasts
Carney hopes that the Bank’s research will create more tangible forecasts about long-term risks. But those risks are always predicted and no one can ever possibly know for definite when a financial crisis will occur.
But forecasts are only ways to measure the possibility of something happening. Another member of the Monetary Policy Committee (MPC) and a former City economist, Gertjan Vlieghe, said: “We are probably not going to forecast the next financial crisis, or forecast the next recession. Our models are just not that good. Of course, the Bank should keep trying to improve and refine its forecasting models, but it’s simply wrong to think we will ever get certainty.”
Haldane also noted that the financial crisis has impacted people differently, depending on their income, where they live, how old they are and whether they own a house. But Quantitative Easing (QE) has generally helped every part of the population by supporting employment and growth, Haldane argued. However, housing prices went up, as the richest 5% received “£185,000 each. That’s enough to buy a house in my constituency,” Helen Goodman said. She represents Bishop Auckland, County Durham. Haldane agreed but he insisted that QE didn’t hurt the poor: “Have the effects been felt equally across the economy, across regions, across households, no, they haven’t. But does that mean that people been disadvantaged in absolute terms? There the evidence is very much to the contrary,” Haldane replied.
The MPC was asked whether the Bank would have done a better job forecasting the UK economy if its attitudes were more favourable towards Brexit. Haldane explained that the Bank raised its growth forecasts for several reasons, partly due to a recovering global growth and “somewhat stronger” consumer spending. But things are going to get worse, Haldane said: “people are going to face a squeeze in the months ahead as inflation rises.”
Indeed, last month, Carney warned that there are concerns about the UK’s exit from the EU and the UK’s increasing dependence on the rest of the world to fund its current account deficit. Relying on “the kindness of strangers” might be opening the UK to more troubles during and after Brexit. Worries of a weakening global economy, investors demanding greater returns to hold British assets and generally a global environment that is more volatile, will put the UK in a riskier position. And, unfortunately, the Bank of England doesn’t have a magic wand to fix, or a crystal ball to predict, possible problems.