The last government made much of the supposed independence of the Monetary Policy Committee of the Bank of England. The present government places similar emphasis on the independence of the Office of Budget Responsibility.
Both bodies find forecasting their main targets difficult. The Bank of England has regularly had to revise its forecasts for inflation upwards in recent years. Over its lifetime it has shown substantial bias in its typical forecast by being too optimistic about inflation, the very thing it is meant to be targetting and controlling.
The Office of Budget responsibility has to forecast and help control the public finances. These turn out to be very sensitive to the overall economic growth rate. Given the fact that the government pockets around 40% of all the activity in the economy through taxation, government finances are much healthier when there is robust growth. In such conditions extra revenue comes in automatically without any need to change rates. In its first reappraisal of its growth forecast the OBR had to revise down both its 2011 and 2012 estimates. I do not ascribe much importance to its decision to increase its forecast for more distant years.
Errors in these crucial forecasts by the very bodies that have to make decisions or publish warnings based on them is dangerous for our economy and recovery. The Bank may have thought it was helping by keeping interest rates low, yet the inflation it unleashed over the last couple of years has done more to depress living standards than any other feature of our economic performance. The OBR’s early optimism over growth led to a downward revision of crucial figures for controlling the deficit within nine months of the first forecast. This has not yet mattered, but it will be important in the future that they have a better track record to keep market confidence in the figures and the system.
The OBR’s downward revision to the growth forecast for 2011 and 2012 will lose the country around £5 billion of revenue in a full year, a continuing loss unless and until the growth loss can be made up. Whilst this is not a large sum compared to the £1500 billion of National Income, it is a large sum in terms of the political debate. Some of the strongest arguments over spending and taxes in Parliament are over sums less than the £5 billion of error in the official June 2010 forecast.
It would be good if these official forecasters would apply a little more scepticism to the balance. It would be good to outperform the forecasts from time to time, to show they are as balanced and as accurate as possible. As we have been discussing this week, the government is going to need a strong and convincing growth policy if it is to hit the exacting OBR targets for growth in 2013, 2014 and 2015, when they expect growth each year to be well above the old trend, let alone the more recent one.
June 1, 2011
My rule of thumb is that any organisation that feels the need to claim it is independent is probably not in any real sense. The BBC and government as a good example.
“a strong and convincing growth policy” – Just a growth policy of some sort at all would be good to see. Rather than the lack of bank lending, heaps of more insane taxes, ever more bloated state, more daft regulations and a mad energy policy.
Cameron’s words are worth nothing as we all know. Only urgent real actions will help and most of those so far have been backwards.
June 1, 2011
Cast rubber Cameron has squandered the value of his words by going back on them time after time. Promises by him are now totally worthless – only actual actions will convince anyone that he actually wants to create conditions for growth.
First step should be to reverse his insane no retirement rule. Otherwise much of the private sector will have to go bust and the state sector will be staffed by 90+ year olds doing little useful, hugely over paid and drawing big state sector pensions at the same time I assume.
June 2, 2011
The problem with allowing people to retire is that you have to support them and pay them a pension (although you could make the case that those willing to work on will be in least need of government support).
So, although we have billions to give to Ireland, Greece, Portugal, et al in the Eurozone, and we have billions to give to Pakistan, India, China et al in foreign aid, we have billions to give to the EU to fund, ahem, ‘worthy’ projects in various parts of the EU empire, when it comes to British pensioners (whose winter fuel allowance is being cut) ‘there is no money left’.
June 1, 2011
Perfect comment – they need to err on caution because this is tax payers money they are forecasting to spend.
June 1, 2011
Just to add I think the MPC needs to be clear it is tackling wage inflation and not cost inflation. The graphs show that is what they are doing, and economics tells us that is all they can do. So why not come out of the closet and tell us all their orientation. I certainly would respect their honesty.
June 1, 2011
The best speculators in the world have a hard time predicting the financial future when they have their OWN money at stake.The OBR and MPC have little to no chance when other peoples money is at stake. If the OBR was so good they would be running private funds and making fabulous wealth. And in any case, the MPC is merely a facilitator for the banks.
June 1, 2011
It should be pointed out that George Osborne has had several opportunities to put his foot down about excessive inflation, and has not done so.
The latest open letter from the Governor to the Chancellor, dated May 16th, is at the first link given below, and the Chancellor’s reply, dated May 17th, is at the second link given below.
There is nothing in the second letter to suggest that George Obsorne is even mildly concerned about the Bank’s repeated failure to meet the inflation.target.
In fact the Chancellor’s principle concern, expressed in the fourth paragraph, seems to be that the government should achieve enough “fiscal consolidation” to avoid any rise in interest rates.
http://www.bankofengland.co.uk/monetarypolicy/pdf/cpiletter110517.pdf
http://www.hm-treasury.gov.uk/d/chx_letter_170511.pdf
June 2, 2011
“CPI inflation to rise further than previoulsy expected this year due to additional increases in energy and import prices”
It is hard to imagine a more child-like statement, focussing as it does entirely on the factors which make up CPI rather than why these factors are increasing. Consider
Mrs F: “Why were you drunk again last night”
SF: “Because I drank several more glasses of red wine than originally planned plus cognac at the end of the evening”
I suspect she would be more interested in why I was drunk in terms of the underlying reasons for this, rather than the contributing factors per se.
If I may, Mr Osborne might more resonably ask
1. With the continuing debasement of the US dollar and congress recently breaking their own self-imposed borrowing ceiling, isn’t it ovious that energy prices in dollars will rise for some years yet? Given this is the case, Sterling appreciating against the greenback would protect the UK economy from US generated inflation, so why have you not put interest rates up given your central remit and your realisation that energy prices are a major factor in CPI?
2. What impact do you think the QE of £200B has had on UK inflation and on the exchange value of Sterling which is a direct contributor to UK imported goods inflation?
3. What incentive is their for savers to defer consumption and save with inflation at around 5% but interest rates around 0.5%?
4. How can banks ever recover their balance sheet by relying on the traditional banking model of encouraging saving given point 3 above?
5. Isn’t an inflation target (admitedly purely notional at this time) of 2% be anything other than a policy of crypto-theft from savers which simply allows government to spend about 2-3% more than they collect in the full realisation that inflation wil erode the gap?
6. When do you expect China and other buyers to scale back and eventually terminate their purchases of UK guilts given the recent Chinese rating agency downgrading UK sovereign debt? How are we on a path that is any different from Greece?
7. Isn’t it obvious that buy offering quite so many bonds, we are crowding out private loans from the marketplace and so nonsensical inititaives like Project Merlin are really just smoke and mirrors better suited to the command economy of the Soviet Union?
8. If our money was commodity backed, couldn’t interest rates be determined by the interaction between buyers and sellers, so why do you exist? Wouldn’t this more or less eliminate overall inflation for ever?
9. If successive governments actually ran balanced budgets instead of pursuing inflationary strategies and looting from the future, couldn’t the Bank of England be abolished?
If only George had read Von Mises.
June 1, 2011
I have just googled the OBR and it seems to be full up with career politicians and university people. Is this right? Oughtn’t it to be full of people who know and love the bank of England and also who have served in the industrial sector and who know that. Martin van der Weyer wrote a good piece about this in this week’s Spectator.
June 1, 2011
I think you have probably hit the nail on the head.
The government relies on academics for their forecasts. Academics prepare their forecasts by gathering information on current trends and then extrapolating this information.
As markets are cyclical this leaves them with egg on their face when the market turns and their forecasts based on extrapolated figures are now utterly ridiculous.
However nobody seems to mind that they have got it completely wrong and they just go on producing yet more forecasts that are again based on extrapolated figures.
June 1, 2011
As soon as the word “Responsibility” had to be included in the title I think everyone concluded that it would be neither responsible nor independent .
Double speak .
Is there any room for independent thinking , dissent and disagreement in the BOE and OBR ?
How do you think the replacement of the only hawk in the Bank of England monetary policy committee , Andrew Sentance , by a member of the shadow banking establishment looks to the man in the street ?
The Govt is not doing enough to improve the situation and it isn’t going to get better until the causes are dealt with .
That they ever thought that their “plan” was achievable can only be due to unbelievable naivety .
The slippage is starting to show already , anyone who has ever had to walk it rather than just talk it could see this was going to happen and it will get worse .
Will we see a truly stark forecast from the OBR or will they just fudge the figures to make them look more palatable ?
June 1, 2011
John
Any forecasting model by its very nature will be inaccurate to some degree, the important factors are:
How large is the inaccuracy likely to be.
Can anything be done to imrove the model/information being used.
Does the size of the inacuracy make a significant material difference, and is it an acceptable error.
Is the organisation aware of the possibility of variations and the complications it may cause.
Clearly the Bank of England is failing in a large way as its forecasts are at the moment about 100% wrong, inflation being near double its forecasts for the past year or more.
The Office of Budget Responsibility I would suggest does not have a long enough track record as yet, but I would hope that it is monitoring itself internally (as I would hope would any responsible organisation) so that its performance can be as accurate as is possible.
Fact of life is, any forecast is an educated guess, based on some past performance facts.
The sad fact is the constant moving of the goalposts by all Governments on all sorts of policies, makes what was a good decision at the time ( general public/taxpayer/businesses) look absolutely crass some years later.
June 1, 2011
I also think the MPC needs to have so much leniency in their intepretation of the economy that the decision on interest rates needs to go back to the Chancellor – and what the BofE should do every month is give the Chancellor a qualitative report.
For example take the figures this month that banks have moved 300,00 people onto interest only mortgages in the last 3 years. Reposessions have fallen from 75,000 in 1991 down to to 10,000 in 1995, and 35,000 in 2010. (roughly). So to suddenly see 135,000 householders a year facing repossession or being repossessed – its double the rate of 1991. Banks have only put aside £1.6 trillion for house prices losses against a total mortage book of £1.2 trillion. This activity is only kicking the can down the road, once interest rates go up they will not escape the rising tide.
What is clear is there is going to be a house price crash or an inflation bubble.
June 2, 2011
If you want decisions on interest rates to go back to the Chancellor then that would be possible if he invoked Section 19 of the Bank of England Act 1998 on the Treasury’s “Reserve powers”:
http://www.legislation.gov.uk/ukpga/1998/11/section/19
The last paragraph would suspend the independence of the Bank of England with respect to monetary policy and permit Osborne to reverse the order of priorities laid down in Section 11, so that he could then openly put “growth and employment” before “price stability”.
I don’t think doing that would necessarily change the interest rates that were set, but it would be a more honest approach and would help to preserve whatever residual credibility the MPC still has.
June 1, 2011
You make, as usual, very good points about the forecasters, especially those that enjoy official status. At the moment the government appears to enjoy the confidence of the players in the bond markets (but I stand to be corrected closer to these markets than I am). What really matters are the forecast that these players are looking at and responding to. When or if they start to diverge significantly from the official forecasts then confidence in the government`s finances will drain away with very damaging consequences – as we see elsewhere in Euroland. If I was the Chancellor I would be nervous.
June 1, 2011
The only thing you can guarentee about forecasts is that they will be wrong. The only debate is how wrong. As with the last government, this one is just as happy to pack it’s forecasting organisations with those who will probably lean towards what the government wants to hear.
June 1, 2011
The MPC now has enough history behind it that it could review its past forecasts and the methodology which produced them and compare the forecasts with the reality.
It would then be possible to calculate a correcting factor to be applied to future forecasts, or to change the methodology to correct the errors.
As the MPC has not done this, and because the errors are always consistently in one direction, it is safe to assume that the bias is deliberate and the current level of inflation is entirely intentional.
If the OBR is going to do its job as intended, it too needs to apply a correcting factor to the figures provided by the MPC for inflation, before it does its calculations and projections.
Those of us who have lived long enough to have seen many Governments come and go will be unsurprised when everything is left exactly as it is and the MPC and OBR continue to feign astonishment and throw their hands in the air whenever the inflation forecasts prove (yet again) to be a considerable under estimate.
June 1, 2011
“it is safe to assume that the bias is deliberate and the current level of inflation is entirely intentional.”
Indeed it is.
June 2, 2011
It can be argued that the MPC’s history really only goes back to December 2003, when Brown unnecessarily changed the measure of inflation it must use from RPI-X to the EU’s HICP, more commonly known as CPI.
June 1, 2011
Can I just make one further comment. The record low interest rates and huge shift to interest only mortgages has allowed Gas, Electricity, Trains, VAT, supermarkets, clothing etc, to be raised in price without causing catastrophic pain. There has been very little resistance to these price rises as people can afford them. Imagine if people were repossessed because of gas price rises or train fare rises, then politicans would act to control them – and their profits.
Now we have 300,000 (and 400,000 next year) on the brink of repossession without rate rises it means we have not suffered the pain in small amounts and dealt with it – but we have kicked the can down the road. We may have up to half a million people facing repossession when rates go up a few percent. In 1991 it was 75,000. We have been patching over the problems but have been irresponsible by letting utility costs go up and putting more people in potential problems by not addressing over inflated house prices earlier. Young people are not going to be buying houses to save the market. It’s going to be almost impossible to get utility companies to roll back their prices given they are commiting that cash into investment and pay rises. A potential economic catastrophy -and I can’t see any way out of it – unless somebody else can??
June 2, 2011
Javelin ,
Imagine also that as well as paying for their houses people had to put aside sufficient money for their old age instead of spending it .
How little money would be left for utilities , trains , supermarkets then ?
That is the situation we have to get to .
As you point out the cost of living in Britain has to be brought down in price .
Part of the plan for doing this should be establishment of a not for profit pensions plan so that people get the benefits themselves than it just going to subsidising the financial services industry .
June 2, 2011
It’s a good point. The utility, train, and oil companies plus many more now just charge what they can get away with in a captive market. This is not competition and neither is charging the same in some sort of unofficial cartel by insider companies and their beneficiaries.
June 2, 2011
What is the real plan? because i do not believe what we are told.
It perhaps seems to me the priority all along has been the banks/banking system/bondholders/elite and the EU project and then let the adjustments rip as one happy family.
The bubble adjustments will take place , all HMG do is disperse the pain , with palliative pictures and letters. Arguably QE and ZIRP just distorts price signals and makes logical long term planing difficult.
The MPC/BOE should be failed and removed if they do not meet the mandate set for inflation with pay,pensions linked to the CPI target. Miss the target suffer financially. All current inflation protected HMG/EU pension schemes should suffer if the target is not achieved.
Clearly QE/ZIRP is not sustainable, so we should move slowly to more neutral rates, only unemployment/demand destruction will hold back inflation and it has limits.
The UK economic divide is growing and is an issue. Low pay v high pay, multinational effective tax levels versus sme/uk based real tax levels, example was article on tax paid by google v its uk revenue.
Until we can collect tax trade with the world in a balanced way we will run up huge state debts and consequent state problems. Currency devaluations may need to move to tariffs and balanced trade arrangements, to speed the adjustment.
We need a line by line look at all spends, there are no easy choices (as lives are affected) but some are much easier than others.
Housing needs to be completely reviewed to restore its utility function first and foremost-not for powering a banking model. Are 2nd homes in the public interest. Should offshore companies/trusts be allowed to own residential property?
Help for those with problems?
Those in difficulty with equity could be swapped into a part rent- part buy solution at a discounted market price- based on neutral interest rates. Those without equity may need to be helped into a market rent situation, with an option perhaps to repurchase later after clearing any negative equity. Some common sense will be needed as some situations could not be reasonably supported publicly. (The new limits on housing benefits being an example).
Business investors should within limits be encouraged into productive new investment for example new-build (25% of a block to prevent control and distortion). Business investors should be discouraged from existing stock unless it is out of use or no other residential buyers are available.
Oh and outlaw distributions from banks until emergency interest rates are lifted and ratchet up the balance sheet tax on banks.
June 1, 2011
At least when making discrete forecasts it is possible to calibrate one’s probabilities. For example if there are a set of events for which one has forecast with probability 0.1 then, after the state of nature has unfolded, one looks to see if 1 in 10 of such events actually occurred, etc. In this way it is possible to detect the sytematic errors in one’s forecasts, this gives two choices – keep them in the model and adjust, or learn and improve. Is such calibration possible with the MPC’s models?
Also in many areas of business one doesn’t use the most probable forecast, the size of the effects round this matter as well (think of the newsvendor problem) – are similar considerations taken into account by the MPC and others? [It is not obvious to me at at the moment that being 2% below target inflation is of equivalent value to being 2% above …history should matter.]
June 1, 2011
You won’t like this but; as I have been subjected to it in the last few days, I pass it on in the interest of debate. A few Germans suggested that Germany and UK, together, could kick the EU into shape and get rid of a lot of the bureaucratic crap. “we show you how to reduce public sector employment by 48% in 15 years; you (UK) become centre for EU global financial services business”. (roughly translated). That is; we join the Euro.
The “too-big-to-fail” problem will go away. No longer will your banks be several times the size of your GDP. Little German Landesbank could set up in UK giving some competition. Euro become world reserve currency. (all very roughly translated).
I say; why don’t you (Germany), leave the Euro and join us in the good old pound sterling. Much laughter. The Euro would drop like a stone and save Greece; Ireland; Portugal etc etc from Armageddon.
Anyway, the source of all this merriment is the following:- which JR will probably redact, again.
http://www.institut-thomas-more.org/en/actualite/why-the-british-citizen-should-reconsider-joining-european-monetary-union-2.html .
June 1, 2011
0.5% has helped landlords greatly who have been able to increase rents whilst cutting costs. It has probably prevented a severe adjustment in the property market as a whole but has done nothing for builders or first time buyers.
We hear that first time buyers are to be ‘helped’ by means of a return to 95% loans – the greatest problem being the £30k deposit required to buy even a box room.
Surely the best way to help first time buyers would be to allow prices to adjust to real wages and to stop increasing demand for housing through mass immigration.
June 2, 2011
It has main helped the banks rather than landlords (other than some with existing long term borrowing agreement). The banks have increased margins and fees hugely. Rents have mainly been fairly static (as tax increases, job losses and attack on benefits have hit tenants).
June 1, 2011
Both the Bank of England monetary committee and the Office for Budget (IR)Responsibility are putting out forecasts that are palpably wrong and manifestly self serving. The correct inflation target it zero, based on an index that excludes taxation and includes house prices, and the right growth rate is 2.1% pa, the thirty year average. It’s such obvious common sense that people avoiding these truths are like wild beasts flinching from fire.
Meanwhile, working in Sri Lanka, they have 10% inflation, a big balance of payments deficit because they (temporarily) reduced car import tax, a war torn country to repair and are perfectly happy to borrow – for now.
June 1, 2011
All good points and neatly documented, thank you John. When it comes to inflation, Mr. Osborne and Mr. King have become like the Ali G. character when he finally hears that he is completely wrong about something – “Talk to the hand, cos the head ain’t listening.” It’s a crying shame that out national finances and monetary policy are in the hands of such arrogant, self-centred people. Yes, indeed it would be nice if inflation occasionally undershot the BoE’s forecasts, but there appears to be scant hope of that. The shortfall in revenue you highlight in the near future due to inaccurate forecasts can easily be fixed: simply scrap the Overseas Development budget. Just about everyone living outside Hampstead and Islington can see the right in this, but Mr. Cameron is just like Messrs. Osborne and King – “Talk to the hand, cos the head ain’t listening.” Or perhaps they are more like Homer Simpson when he sticks his fingers in his ears and decides to ignore the real world?
June 1, 2011
The point being that if anybody in either organisation faced removal, demotion, or even significant loss of salary when they fot it wrong the organisations would be more “independent” and would be much more likely to be right.
Promotion within government, including to “independent” posts comes not from being right but from saying what the government wnats you to. This is deeply corrupting of every part of national life government has “advisors” about. If we pay for only lies we will get only liars.
For example when did we last have a science advisor, or member of the Met Office” who advised that catastrophic global warming isn’t happening or a drug advisor that advised we are not winning the “war on drugs”?
We did recently have the case of the advisor who, in 2000, publicly announced that by now young kids would never have seen snow & he is still gainfully employed by the taxpayer at “raising awareness” of catastrophic warming.
June 1, 2011
Spot on – “Promotion within government, including to “independent” posts comes not from being right but from saying what the government wants you to. This is deeply orrupting of every part of national life government has “advisers” about. If we pay for only lies we will get only liars.”
Very true and they all act as a group and never know quite when to change direction so they all head over the cliff even when they all must know they are going to – as with Major’s ERM fiasco.
Look at appointments to the House of Lord follow the message be a government lackey and you will do well. Tell the truth and no one is interested. What matters is the latest government fashion not the truth.
June 1, 2011
Is it not rather difficult for the BoE to predict future inflation when costs of raw materials can increase substantially without there having been commensurate increases in demand or reductions in production? Is it not the function of the law to criminalise socially undesirable behaviour? Is it desirable that there should exist people who believe that they are entitled to extremely luxurious lifestyles without their having to add value one jot; in fact, they believe they are entitled to impoverish the many such that they, the few, can continue to indulge themselves at our expense. Is it not a fact that the recent commodities bubble wreaking inflation and riots around the world was a consequence of the activities of financial spivs? When are we going to stop shrugging our shoulders and pretending that financial tumoil is beyond human control and focus the law on the undesirable activites of some who operate in the financial sector? This is not about capitalism; capitalism is about wealth creation. These people do not create wealth; in themain, they destroy it by creating gross perturbations in the world economy whilst syphoning off comparitively much smaller amounts to suport their expensive lifestyles.
June 1, 2011
Watching BBC last night about the care home abuse,which was shocking,the most shocking was the fact that the Care Quality Commission was sent 3 warnings by the senior nurse who contacted the BBC,and he was totally Ignored. Of course we then got the usual apology and weasel words like “we will learn from this’ “put in place PROCEDURES” etc etc in other words Shut the stable door after the horse has bolted. Pointedly they showed the 16 story building of the CQC,my comment/question is how many staff to NOT DO ANYTHING except issue apologies after the event,and AT WHAT COST.Until the public service is cut drastically and at least 20% cut from it’s spending [Costs] all the forecasts in the world are useless,20% off this bill and NO Foreign Aid will boost this country into another era not to say the EU costs which could be eliminated at the stroke of a parliamentary vote.The public service is a self serving Parasitical monster
June 1, 2011
What are you trying to grow? The only viable industry left is the Carbon Religion. That tax will decimate whats left of British competitivness. I already mentioned the way fuel tax has let in the European transport. Carbon and energy tax is about to destroy the remaining industries. There will be nothing to grow.
June 1, 2011
How about renaming the ‘Office for Budget Responsibility’ the ‘Office for Stopping MP’s Spending Our Money Badly on a Lot of Things We don’t Want or Need, ever’. Or better yet, scrap the bloody thing (along with every other pointless quango) and just leave it to you MP’s to decide what spending is wanted, needed and vaguely useful. All the OFBR does is to let you all off the hook. It a politiocal expedient outsourcing exercise. I mean if you cannot be trusted with the purse strings why do any of you stand as MP’s? We elect you and pay you to do this work so bloody well get on with it.
June 1, 2011
Quite right. You wouldn’t plan your household finances by assuming you get a full bonus and inflation-busting pay rise every year. You might assume a modest level of income growth and medium bonuses (worst case scenarios are almost as inappropriate as best case), but you’d certainly keep your forecasts down so that you outperform them more than half the time.
June 1, 2011
Nicely put .
When I took on a mortgage for my house I assumed I would have periods out of work so didn’t overextend myself .
Currently making about 9% less than was making 4 years ago and expect it to decline further .
We are all in it together though .
June 1, 2011
Over the last six months British Banks have bought 91% of the Gilt issues.
http://www.telegraph.co.uk/finance/economics/gilts/8550716/Banks-buy-bulk-of-39.8bn-of-new-gilts.html
It is more than likely that inflation is keeping foreign buyers away.
It should be a major concern if the international market is avoiding Gilts because of inflation.
June 2, 2011
Waste of time and ink
June 2, 2011
Nobody believes these forecasts anymore, least of all the public. The MPC has lost all credibility. They are not independent, as they are more interested in propping up the fragile economy for Government than controlling rampant inflation which is their actual remit. Low interest rates allow real depreciation of high levels of debt in sectors such as the banks and Government, this is the real agenda. Inflation is a problem and interest rates should have started to rise slowly already.
As to the OBR I personally see little use for them, independent or not. It is obvious to everyone that there are not real growth policies, therefore merely forecasting what is already known seems pointless.
June 2, 2011
The forecast of civil unrest due to uneven distribution of wealth among the population due to unavailable opportunities and age may prove to be true.