The Bank of England gets it wrong



The latest Inflation Report from the Bank is both a mea culpa and a muddle. They admit they got their forecasts wrong for the last year. They thought inflation would stay over 3% but it fell to 1.7%. They thought unemployment would be around 7.6% but it fell to an average of 6.8% and is now at 6.4%. Productivity grew at 0.75% less than their estimate and employment grew much more. They got the level of sterling wrong and the favourable impact of rising sterling on prices. They thought wages would go up by more than they did.


We can all make mistakes. Even expensive and well resourced forecasting outfits like the Bank can make errors. It is more worrying, however, if there is something wrong or weak in the underlying approach to the forecasts. I am afraid that is exactly what has been revealed by these errors.


At the base of all these mistakes is one simple concept that is difficult to assess and measure. The concept is that of “slack” or unused capacity. In the Bank’s world they can assess and quantify this. If the economy has a high degree of slack then there will be little inflation. If slack has gone then conditions can become inflationary as companies and individuals bid up wages to get people to leave their current job, and as they offer more to get quick delivery of goods and services.


So far so good, you might say. There must be some truth in this. There are two obvious problems. The first is it leaves out the issue of money. If the banks create too much money this can drive up wages and prices. If they lend too little and there is too little money around you can have a recession, like the one in 2008 which the Bank did  not forecast before the event.  The second is, how do you measure this slack precisely so you know whether we are in the inflation danger zone or not?


This second problem preoccupies current Bank thinking. It lay behind Mr Carney’s opening policy that they would need to look at raising interest rates once unemployment fell below 7%. This was a pessimistic view of the UK economy, where labour shortages would emerge in the fast growing parts, where skills shortages would emerge, and where many long term unemployed would remain out of work. When we rapidly got below 7%, the Bank changed its mind and thought maybe 6.5% unemployment could be the level where they needed to start to worry.


Over the last year we saw unemployment fall below 6.5% but still no signs of inflation in average wages, let alone more generally. As a result the Bank has now decided that maybe the UK economy can function in a non inflationary manner with unemployment above 5.5%, not 6.5%. The latest theory of the danger rate seems as little based on evidence as the previous two that have now been rejected.


As the Bank explains in its Report, all sorts of things can happen to offset the impact on wages of falling unemployment. More people can arrive from abroad and offer their services, as they have. More people can get out of long term unemployment, partly as a result of recent benefit reforms, and they have. More people who were not working, not on benefit and not even seeking work may change their minds and take a job – and they have. The Bank now accepts these changes disrupt its view that a particular unemployment rate can start to create wage pressures. The Bank should also remember the problem of averages. Average pay may not go up much if there are few pay rises. It may also not go up much if we lose too many people on very high pay, or if we create a lot of lower paid jobs. We have done both, as well as people facing little or no pay rises in various occupations.


The whole idea of slack has two parts. The first is labour availability. As the Bank knows, you can have skills shortages that drive up specific wages, and labour shortages in certain places which can drive up local wages without having a general wage inflation. It now has to recognise that the recent remarkable flexibility of the UK workforce means there is more labour around than a single unemployment figure suggests.


The second part of their idea is unused capacity in business. This probably has more meaning in the industrial sector, where a factory with machines may well have a rated output above its current production which you can measure. Even this however, is not that precise. Producing more means perhaps ordering more components and raw materials, and taking on more labour or getting agreement to new shifts and overtime. There is a variable response depending on other conditions. Can the suppliers, who may be abroad, respond quickly? Do you have the trained people to supervise the machiness and organise the extra output and orders?


It is more difficult assessing the capacity of the dominant service sector. How many more windows can existing window cleaners fit in to their schedule? How many more meals can restaurants serve if more diners turn up? How many more health club places can existing clubs sell before they are full?

Finding a general answer and expressing it as a single figure is not easy.


The Bank needs to recognise that its concept of slack has so far let it down badly. It needs both to ask is there a better way of accurately measuring it, and is it a good enough explanation of inflation in the first place? These academic issues matter, as interest rates and our future growth hinge on it. Just asserting we currently have 1% slack left is simply not good enough.



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  1. Mark B
    Posted August 15, 2014 at 5:35 am | Permalink

    Economic forecasting, is much the same as weather forecasting. You make predictions on the presumption of some known and unknown data and input that into your model. Of course, should your data be based on either false or inaccurate data, the results will not be as one might expect.

    As such, I always believe it is best to go in whatever the direction the wind is blowing.

    PS It’s August and I want to know if anyone else has put their central heating on, or is it me just feeling the cold in the mornings ?

    Reply Yes it is cold. I have put on the thick duvet and jumpers so far. Just like the very cold early mornings in April and May. It must be global warming!

    • Richard1
      Posted August 15, 2014 at 6:56 am | Permalink

      Is it true that the govt, via the green investment bank, are about to spend £630m of our money buying a stake in the Sheringham offshore wind farm (the one that’s wrecked the North Sea view off the coast of North Norfolk and which produces power for us at c 3x the market price)? Conservative MPs should question whether and why this is a good use of public money.

      • Lifelogic
        Posted August 15, 2014 at 7:53 am | Permalink

        It is clearly an idiotic waste of taxpayer money, this is clear to anyone numerate who thinks about it for a few minutes. So what is really driving it – follow the money perhaps?

        • Bazman
          Posted August 16, 2014 at 7:50 am | Permalink

          How does Hinckley Point fit into this with it’s £16 billion cost and guaranteed prices per Mwh for decades. You just keep repeating the same nonsense as you are unable to do anything else.

          • Lifelogic
            Posted August 16, 2014 at 12:13 pm | Permalink

            The deal does look expensive. It could have be done far more cheaply, but governments are not good at negotiations (it is not their money and they simply do not care very much). Far cheaper, better and more reliable than offshore wind though.

          • Bazman
            Posted August 16, 2014 at 1:32 pm | Permalink

            It is massively subsidised is my point and it would have been cheaper if it was not state owned ie by the French and the Chinese who are using it to subsidies their own energy needs.
            If the subsidy was not so high they would not have got involved so don’t tell us about negotiation. How far would all of this money gone on other energy sources and research into cheaper sustainable methods?
            Remind us again of the idiotic waste of taxpayer money, this is clear to anyone numerate who thinks about it for a few minutes. So what is really driving it – follow the money perhaps?

      • bigneil
        Posted August 15, 2014 at 8:07 am | Permalink

        Heard on Radio Derby this morning of some wind turbines, been up several months, now turning very slowly, not generating, may not be generating for several more months. They are reported as interfering with radar at East Midlands Airport. Speechless.

    • Roy Grainger
      Posted August 15, 2014 at 7:46 am | Permalink

      “You make predictions on the presumption of some known and unknown data and input that into your model. Of course, should your data be based on either false or inaccurate data, the results will not be as one might expect”.

      You can also add that even if your date is perfect then if the model itself is wrong the results will also be wrong. These large-scale empirical models where the fundamental causalities are not understood will always be prone to error – in economics and climate modelling.

      • Brian Tomkinson
        Posted August 15, 2014 at 9:01 am | Permalink

        Remember these words from Donald Rumsfeld : “Reports that say that something hasn’t happened are always interesting to me, because as we know, there are known knowns; there are things that we know that we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns, the ones we don’t know we don’t know.”

    • Bob
      Posted August 15, 2014 at 8:53 am | Permalink

      ” It must be global warming!”

      More likely Geoengineering (chemtrailing).

    • margaret brandreth-j
      Posted August 15, 2014 at 9:10 am | Permalink

      Come on John ,that is more a bazman response than yours. Play or slack can be brought into all measurements , but there is an overall trend.

    • oldtimer
      Posted August 15, 2014 at 9:42 am | Permalink

      There is as much a fog of economics (and of climate forecasting) as there is of the fog of war. This renders all such forecasts little more than guesswork. However well informed they the experts are about the aspects they know or claim to know, there remain the unknowns they do not understand or even do not know about.

      Research (See Expert Political Judgment by Philip E Tetlock) has shown that about half of all forecasts made by “experts” are wrong, roughly the same proportion of all business mergers or acquisitions that fail to deliver the value claimed for their justification in the first place. In short your guess or mine is just as likely to be accurate as any so-called “expert”. What matters as much as your guess, and the decision that flows from it, is evaluating the consequential risks that flow from it or the practical alternative choices open to you. UK “climate” policy and the decisions and subsidies and waste that flows from it is the egregious example of current public policy.

  2. Narrow Shoulders
    Posted August 15, 2014 at 6:11 am | Permalink

    Mr Redwood an interesting and thought provoking article with many strong points.

    Does the bank’s model take account of other bank’s ability to create money through debt in it’s forecasts? How can it possibly be acccurate within the parameters of fractional reserve money creation, either knowing accurately the paying down of debt ofrthe creation of broad money?

    Also is the government’s largesse with tax payers’ money factored in? Low paid workers in general but particularly transient migrant workers do not need pay rises as their housing costs over a certain level are largely paid through benefits. They are protected from this large inflationary factor from which the rest of us suffer and consequently do not negotiate those costs down which has a negative impact on those of us without the safety net.

    The coming of Universal credit where an employee on minimum wage will be able to take home £36K per annum without paying much in the way of tax or NI through having their wages subsided with benefits will depress wage rises even further.

    I would like to take home £36K with no transport costs for stacking shelves in my local supermarket but unfortunately once you are in work it becomes difficult to get on the benefits gravy train. Much easier to turn up from anywhere that issues you with an EU passport with your multiple offspring needing school places with your hand out and a “can do” attitude to get that low paid taxpayer subsidised job.


    Reply Yes the Bank does study money and lending in the banking system, but as its discussion shows, it seems to place too much emphasis on the imp-act of its imprecise definition of slack.

    • Lifelogic
      Posted August 15, 2014 at 6:59 am | Permalink

      If the bank studies lending in the banking system then they will know that the government & EU regulatory, capital and slotting regulations are stopping banks lending in many areas, this is hugely damaging. Also the banks now have huge fees and margins, between what they pay for their deposits (virtually nothing) and what they lend out at from base + 3% to 40+%. There is a total lack of real competition in the industry. What industry can buy in at one price sell on at say 10-80 times their costs? Often to customers rather more financially sound than the bank and fully secured.

      Get some new competition going. The banks should not be able to recover historical losses by just ripping off new customers and damaging growth.

      • Bob
        Posted August 15, 2014 at 8:29 am | Permalink

        “The banks should not be able to recover historical losses by just ripping off new customers and damaging growth.”

        Well said lifelogic, but it’s not just “new” customers that are being ripped off.

        I suppose the government are reluctant to encourage competition in the sector while they’re still holding bank shares.

        • Lifelogic
          Posted August 16, 2014 at 5:10 am | Permalink

          Indeed existing customers too are being ripped off with huge margin and fees with damaging effects on investment, jobs and expansions.

          • Bazman
            Posted August 16, 2014 at 5:43 pm | Permalink

            Like the housing market and in particular the rental market then?

  3. alan jutson,
    Posted August 15, 2014 at 6:23 am | Permalink

    So many errors ?

    Yes do not forget that HMRC got their tax receipt figures wrong as well.

    Government departments seem to not be able to work to budgets.

    The Government is still borrowing.

    The National Debt is still rising.

    Immigrations on a huge scale is still happening.

    Perhaps the simple reason why all of this is prone to error is the fact that the alternative economy seems to be growing and growing fast.
    New people coming here are coming from areas where the alternative economy is a way of life.
    So is it any surprise that they carry on as usual, and then others join in, as that is the only way they feel they can compete.

    Perhaps we should be looking at getting back to a rather more simple method of running Government and our tax and benefit system.

    John, how much did we pay out in working Jobs tax credit last year, and what is the percentage increase year on year since 2009.

    Reply Tax credits were £29 bn last year, up from £23bn in Labour’s last year. They are bound to rise as more people work.

    • zorro
      Posted August 15, 2014 at 9:07 am | Permalink

      Reply to reply – That is self evident but does not make it right. Of course to will go up as immigration and low paid jobs continue apace. What is not right is that the state should be supporting low wages to such a huge scale.


      • alan jutson,
        Posted August 16, 2014 at 7:34 am | Permalink



      • David Price
        Posted August 16, 2014 at 9:30 am | Permalink

        It strikes me that economists are inherently socialist as they view people and jobs as fungible, it makes no matter that an engineer now flips burgers for a living, both jobs are equal in their eyes.

        Better hope that the overall GVA increases if we all expect to continue importing the range of goods at the rate we are. Disproportionate increases in Tax Credits suggests we are instead going in the opposite direction.

        • Bazman
          Posted August 16, 2014 at 11:27 am | Permalink

          In the job centre they are and the engineer with 40 years experience must take the job or face sanctions and some Tories have put forward the idea that people must face benefit sanctions in order to incentive them to get a better paid job. LOL!
          In their deluded world the rich are incentivised by money and the poor by the lack of.

          Reply In my Conservative world all respond favourably to earning more and keeping more of their money, which is why the government has concentrated on making it more worthwhile to work and on cutting tax for the lowest paid.

          • Lifelogic
            Posted August 17, 2014 at 4:12 am | Permalink

            To reply: Well perhaps, but the incentives to work (especially after the cost of work travel, childcare, clothing, lunches, reduced time to shop and DIY …….) largely non allowable for tax are often not very high at all and can still often be negative. The new enforced pensions laws reduce incentives further.

          • David Price
            Posted August 17, 2014 at 5:49 am | Permalink

            Baz, this issue is nothing to do with Conservatives, you are ignoring the recent statements from the Labour elite that agree with the position that welfare must be made a less attractive alternative to working.

            In my view there is far too much focus on the financial and related service sectors which are far too easy to relocate and disrupt through regulations. Better to encourage a wider range of economic activity that will bring all skills and capabilities in to work. You won’t do that by paying people not to work at the expense of those who do.

    • Hope
      Posted August 15, 2014 at 11:43 am | Permalink

      £5 billion to foreign workers which Cameron forgot to mention when he cites the UK want people from the EU to work here. Not at our cost and with the additional cost to all the public services ie housing, health, education and even road congestion.

    • Kenneth R Moore
      Posted August 16, 2014 at 8:43 am | Permalink

      Reply Tax credits were £29 bn last year, up from £23bn in Labour’s last year. They are bound to rise as more people work.

      Employment up 6% and the bill for working tax credits goes up by over 20%!. They can be expected to rise but not by that much!!.

      Why not just spend £50 bn on working tax credits and create another 2 million jobs ..who knows paying people to cut grass with scissors or provide hand car washing facilities in former petrol stations may then become viable ?.

      • Bazman
        Posted August 16, 2014 at 1:14 pm | Permalink

        I often get my car cleaned by East Europeans in old fuel stations nearby. They do a good job for a tenner or 15 quid with the inside too and you must admit the quality of fish & chips has gone up many times since they were in general took over by various foreign nationalities in it to win. My childhood memories of fish an chips are soggy and undercooked, with at least 7 within walking distance and many across the town so don’t talk about competition. My father would send me back with them to face some fat bloke watching TV and did not buy them very often because of this.
        The local trouble spot shop and takeaway in my street owned by various large supermarkets have both been bought by a local Indian man transforming both into really good local facilities selling Indian food with Fish & chips. Ironically the Fish and chips are better than the Indian food. Large customer base and no trouble.

  4. formula57
    Posted August 15, 2014 at 6:24 am | Permalink

    A most helpful, erudite analysis, not least as it helps explain why the Bank now seems to be giving forward guidance to hint at its future forward guidance. It really does not know what is going on, does it! (So much for Mervyn a few years ago shifting all of the Bank’s pension fund into inflation index-linked securities.)

    It is a deep worry if the concept of slack is after all not a good enough explanation of inflation in the first place. The fantastic boom in commodity prices generally will reverse, especially as China experiences its long landing as it rebalances its economy (per Michael Pettis), which added to other phenomenon of the like of investment strikes in the face of weak demand risks deflation and all its attendant ills.

  5. Mike Stallard
    Posted August 15, 2014 at 6:43 am | Permalink

    It was fascinating to listen to LBC on the subject of self-employment. I listened to person after person explaining how clever Londoners get round all the EU regulations by going self employed or employing self employed people. Once they are “independent” they can get paid much less, all the regulations sort of fall away and you can refuse to employ nubile and fertile women, the disabled, all the needy and workshy…
    I suspect that an awful lot goes on that the Bank does not really know about.
    And then there are the taxes which every worker has to pay…

    • Lifelogic
      Posted August 15, 2014 at 7:58 am | Permalink

      Indeed the mad regulations on employment force the need for zero hours contracts and self employment onto employers. They can often not compete otherwise.

      • Bazman
        Posted August 16, 2014 at 1:17 pm | Permalink

        Tell that to the employees of large companies making massive profits on the back of these zero hours contracts and the taxpayer subsidising both parties with benefits.

    • alan jutson,
      Posted August 15, 2014 at 2:22 pm | Permalink


      Yes you are right, the self employed are not covered by the minimum wage or many other employment regulations.

      This may sound harsh, but in effect these people sell their labour for whatever rate they desire, for the number of hours they wish to work.

      Some decide to work for below the minimum wage, others can get very significant rates indeed if their skills are in great demand.

      Thus the market and the demand for services and skills decides the rate for these people.

  6. petermartin2001
    Posted August 15, 2014 at 6:46 am | Permalink

    Dr Redwood,

    You are right there is something wrong somewhere. But its even worse than you suggest. If the BoE thought inflation was going to be 3% and it has turned out to be 1.7% then this implies they must have thought slack in the economy was going to be lower than it has turned out to be.

    On the other hand, if they predicted 7.6% unemployment and we only have 6.4% then this means they were expecting slack was going to be higher than it has turned out. So their thinking doesn’t look to be at all consistent.

    Slack is undoubtably much more than 1% in all sectors other than housing. Most businesses are greatly downsized since 2008, but, if they still exist, could quickly ramp up their production again and re-hire laid off workers. They need to have the paying customers to justify doing that, though.

  7. Lifelogic
    Posted August 15, 2014 at 6:49 am | Permalink

    One cannot help thinking that the Bank has political pressures determined by election dates, a general incompetent state sector think and the need to create the right image for lenders (given the government need to borrow endlessly to fund its endless waste). It is perhaps therefore unlikely to make sensible projections. Just as the green scam is dependent on pushing hugely exaggerated catastrophic warming predictions.

    After all these state sector economists, governments and bureaucrats all decided the ERM and the EURO were good plans (not to mention the idiotic wars), they failed to monitor the banks (that they were insuring through the deposit protection schemes), rescued the banks in an idiotic incompetent way (instead of the banks customers). They even fell for the catastrophic AGW scam and still waste billions on the lunacy. They suffer from state sector group think collective insanity and look after their state sector groups interests.

    In short they are far from independent or impartial.

    I heard someone complaining on the BBC about about £9,000 not being sufficient to cover the cost of many University Courses. In fact with video lectures and modern technology it is plenty. The industry huge scope for more efficiency, our universities need to wake up. It perhaps works out at £75 per days tuition per student. With the exception of perhaps medicine, veterinary and a very few other subjects it can easily be done for less than half that with modern technology and efficient management.

    If you have a bright maths, physics, English, history, law student then you need little but a few books and on occasional meeting with a bright Tutor. Academics are not generally that expensive as the jobs are very popular.

    Anyway students pay for living costs and books on top of fees. UK universities need some disruptive technology to shake them up. Mind you half of the courses are largely worthless anyway.

    The industry is a bit like fine wines and perfumes largely about brands and snobbery rather than genuine education. True Oxbridge and others have all lots of very expensive listed building to maintain, but should this really be a cost for new students to bare? I suppose it does gives them better May balls, wedding venues & photographs.

    Interesting to see the gender divide too with a third more woman than men choosing to go to University. Perhaps more men are deciding they just need to earn some money, rather than building up large debt for an often rather worthless degree? Woman have the advantage that they are much less likely to have to repay the full debt. This due to the jobs they tend to choose and the career breaks the tend to take to have and care for children.

    • Bazman
      Posted August 16, 2014 at 1:20 pm | Permalink

      Woman do not face social pressures and always choose to be hairdressers being your point? Idiotic views from a myopic middle aged man.

      • Edward2
        Posted August 16, 2014 at 6:58 pm | Permalink

        How rude you are sometimes Baz.
        Would you say that face to face?
        Somehow I doubt it.

        • Bazman
          Posted August 16, 2014 at 7:18 pm | Permalink

          Oh! I would! I don’t usually get the pleasure! Nonsense views and bigotry are only shared by fellow believers.

          • Lifelogic
            Posted August 17, 2014 at 4:15 am | Permalink

            Well why not put forwards with some sensible counter arguments instead if you have any?

          • Bazman
            Posted August 17, 2014 at 9:13 am | Permalink

            Woman do not face social pressures and always choose to be hairdressers as 96% 0f hairdresser are and the other 4% are probably hairdressers? Top chefs tend to be men, but most cooking is done by woman? Woman take A level maths and do better than men, but fewer woman take physics as a degree level subject? Most executives are men. the list goes on. It is all down to womans choices? They choose to be second class citizens in many countries. In my country there is God, man, horse,….dog woman rat. A joke a little bit close to the truth and in modern Europe too. If you believe that it is all down to their ‘choices’ You are deluded in the extreme.

          • Bazman
            Posted August 18, 2014 at 6:54 am | Permalink

            Where is your reply to this lifelogic. If you do not have one then stop repeating this nonsense.

      • lifelogic
        Posted August 16, 2014 at 7:52 pm | Permalink

        Woman who have no children already earn more than men do and far more woman now go to university than men do. But they do make different choices in their work life balance, the jobs they choose to take and the subjects they choose to study. Very sensible choices too in many cases.

  8. Gary
    Posted August 15, 2014 at 6:55 am | Permalink

    I cannot remember when a central bank forcast was correct. The best investors in the world are happy if they are correct 60% of the time. If they are wrong, they quickly cut their losses.

    The central bank politburo of bureaucrats blunders on for months or years with wrong decisions. If these guys were so good at forecasting they would be in private investment.

    Another point. Why aim for 2% inflation(money debasement) , why not 0%? Because they want to boil the frog slowly, they want to skim savings at a rate that they hope will be barely noticed. Of course, history shows it always eventually gets away from them and rampant inflation arrives sooner or later.

    • zorro
      Posted August 15, 2014 at 9:16 am | Permalink

      They would have more success if they flipped a coin when making decisions. I remember looking at their forecasts a few years back, and over a continual period, they were over 90% incorrect!


      • Lifelogic
        Posted August 16, 2014 at 5:07 am | Permalink

        Indeed and yet they still think they can predict the far more complex, unknowable and unpredictable climate system too, and for a hundred+ years. This just by taxing C02, but not in fact even controlling world co2 output at all.

        Clearly they are mad what other explanation is there?

        • Bazman
          Posted August 16, 2014 at 1:21 pm | Permalink

          This is not climate science. Science it seems is only sceintific when it suits your views and supports your deluded world view it seems

          • Edward2
            Posted August 16, 2014 at 7:02 pm | Permalink

            But its not going according to the scientific predictions is it Baz?
            Was the “pause” from 1998 in any IPCC report?

            Perhaps you as an enhusiastic warmist would like to explain just who is deluded?

          • lifelogic
            Posted August 16, 2014 at 7:54 pm | Permalink

            Do you really think controlling the tiny % of world CO2 emitted by the UK will control the temperature in 100 years?

            Anyway most of their idiotic schemes (like bikes) do not even reduce C02.

          • Bazman
            Posted August 17, 2014 at 9:18 am | Permalink

            probably not, but the world is desperate for clean sustainable energy and will develop and find it where it can, so best get on with developing some to sell even if we do not save the world.
            If a system was developed to erode your energy bills you would not use it. You would do 360 and talk about modern technology developed by industry when much technology comes from government penalties, subsidies and coercion. Cars would be as clean as they are without this, though they are still quite dirty? As if.

  9. Richard1
    Posted August 15, 2014 at 7:05 am | Permalink

    Yes this does show the nonsense of using pseudo rigorous mathematical analysis with completely subjective inputs such as 1℅ slack. Look at the public sector. We keep hearing different public services are stretched to capacity and can’t do any more without more money. On examination it turns out much more can be done with less in many areas. Slack in the economy might as well be 10% as 1%.

    What the BoE should be worrying about is the continued unclarity on bank resolution mechanisms, continued high leverage in the banking system, continued disguised subsidy to the banks and the high probability that with these state mandated low interest rates there will be all sorts of investments being made which are not economic in conditions where the price of money is set by the market (malivestment to Austrian economists).

    • Gary
      Posted August 15, 2014 at 9:17 am | Permalink

      Excellent comment. Money , the most liquid commodity, has a price set by demand and supply in an open market, and rigged in a central bank market. By forcing the price of money to be something other than what the millions of participants in the market are demanding , the Central Bank ensures that the entire economy gets skewed. Investment signals , which are based on supply and demand prices, are distorted as the price of money impacts on the pure supply and demand of the targeted investment. Investment is misallocated and the economy distorts. The distortions are self reinforcing(Soros called them reflexive) , and eventually the misallocations become so out of equilibrium, you get a crash. That is the cause of the Austrian Business cycle, at its root, the mispricing of money by Central Bank politburo.

      • Richard1
        Posted August 15, 2014 at 9:35 pm | Permalink

        Yes I’m afraid that’s right. We don’t know when and where we will feel the adverse effects of this, but will surely see them at a some point.

    • Lifelogic
      Posted August 15, 2014 at 11:28 am | Permalink

      No shortage of malinvestment with this coalition. With HS2, green energy subsidies, CAP, the green deal, payments to augment the feckless, tram systems, HR experts, tax experts, motorist mugging experts, the dysfunctional NHS and about 50% of what government and the EU does.

      You would think malinvestent is one of the main aims of the coalition.

      • Bazman
        Posted August 16, 2014 at 1:23 pm | Permalink

        Payments to augment the feckless? Who are the ‘feckless’ or is this just an all covering generalisation?

        • lifelogic
          Posted August 16, 2014 at 7:57 pm | Permalink

          The feckless are people who could easily work, but choose to live off the backs of others who do work instead. As the government currently encourages them to do.

          • Lifelogic
            Posted August 17, 2014 at 4:17 am | Permalink

            I do not really blame the feckless very much, they are behaving rationally given the idiotic tax and benefit system that pertains.

          • Bazman
            Posted August 17, 2014 at 9:23 am | Permalink

            There are no feckless rich only feckless poor? Tax cuts for the rich and corporate tax cuts mainly owned by the rich are not benefits? Most social benefits are given to working people and pensioners. The truly feckless are small in number less than 1% an inconvenient truth for you Using these to cut the benefits to the working poor is not on. Besides how much private industry is supported by the benefits system, utilities, mobile phones, the rental market and so on?

  10. Alte Fritz
    Posted August 15, 2014 at 7:52 am | Permalink

    Very interesting discussion of slack. It seems to say much more than headlines comments on an unproductive economy/workforce depressing wages.

    Perhaps a thriving Eurozone would encourage fuller use of resources, banks permitting. Perhaps business needs to widen its sales horizons beyond the EU?

  11. Roy Grainger
    Posted August 15, 2014 at 7:54 am | Permalink

    The current low growth in wages is interesting. It is a problem (apparently) which much exercises the BBC who add it to the end of any good news report as in “Unemployment is down BUT WAGES ARE NOT KEEPING PACE WITH INFLATION”. Even if we think wage growth is a good thing, like Ed Balls does apparently, it is not clear what he would do about it. I imagine an immediate 10% pay increase across the entire public sector would do the trick but the resulting tax rises to pay for it would defeat the objective. How he would force wage inflation in the private sector is even more opaque, one obvious way would be to stop all immigration immediately but that is contrary to Labour’s EU policy. Reducing taxes thus increasing take-home pay (but not wages) is also contrary Labour’s policy. It is a mystery what actions he is proposing to take to address this.

  12. Brian Tomkinson
    Posted August 15, 2014 at 8:05 am | Permalink

    JR: “The Bank of England gets it wrong”
    We seem to have been reading this for years. After a year in office, Carney has failed to live up to his pre-appointment billing. His ever shifting criteria for determining the level of interest rates always reminds me of the Groucho Marx quip: “Those are my principles, and if you don’t like them… well, I have others.” I cannot accept that he is independent from government and I think interest rates are not rising because Osborne doesn’t want them to before May 2015.

    • formula57
      Posted August 15, 2014 at 9:13 am | Permalink

      There will almost certainly be a modest rise in interest rates before the election to provide proof that the economy really is recovering and to give some relief to the majority who are savers rather than borrowers.

      Carney’s criteria for a rise are all form over substance in my view, to convince onlookers that there really is some plan and the economy is not a fragile as it is really. We must keep in mind the constraints imposed by necessary international cooperation that disallow a rise in Eurozone rates lest the many, many zombie banks go under as result. That could frustrate a pre-election rise here.

    • Bob
      Posted August 15, 2014 at 1:34 pm | Permalink

      ” I cannot accept that he is independent from government and I think interest rates are not rising because Osborne doesn’t want them to before May 2015.”


      • Lifelogic
        Posted August 17, 2014 at 4:19 am | Permalink

        Exactly and so the rises, post election, will have to be worse later.

    • zorro
      Posted August 15, 2014 at 7:27 pm | Permalink

      Agreed, as you say, this is groundhog day and pure political propaganda as I mention elsewhere. the fact is that they know that if they raise interest rates, they will have to QE/borrow to pay the increase in the interest bill.


  13. John E
    Posted August 15, 2014 at 8:32 am | Permalink

    It’s hard to avoid the conclusion that the Bank is just looking for any rationale it can find to leave interest rates unchanged until after the election.
    I really cannot see any reason to put off some return to normality, other than an underlying concern that the Euro crisis is not really over and could still end in meltdown. That would be the only thing holding me back in the unlikely event I was on the MPC, but I don’t suppose they can say that can they?

    Your point on measuring slack is absolutely spot on. Few manufacturing facilities even know with any precision what their true available capacity is; Industrial Engineering not being a common discipline in the UK. Even fewer run at anything close to that capacity.

    In Services as you say the concept is even more nebulous. When I get busy with routine paperwork or data entry I get a lady in the Philipines to do it for me. Larger enterprises outsource in a myriad of ways – software developers in India or call centres in Spain etc.

    It is pointless in an ever more connected world to try to model the UK economy in this way and focus needs as you say to move to the money supply.

  14. acorn
    Posted August 15, 2014 at 8:39 am | Permalink

    I would think Governor Carney has more data than he can shake a stick at, a lot of it conflicting. The EU will soon change the rules to (ESA 2010) and that may help solve the “productivity conundrum” as it is known in the trade.

    You can test your ability to be a central bank governor at . Start with the Video Summary: Labour Productivity 01-Apr-2014. Then work your way down from the top.

    I can see no reason to raise BoE Base Rate on this or any other recent data. There is no requirement to unwind the £375 billion QE. The Treasury and its Central Bank should agree to cancel the lot and leave the “reserves” at the central bank. That should liven up the pension and insurance funds search for income. Pay interest on those reserves if, required to control short term money rates.

    If you come to the conclusion that QE has done little or nothing for the UK economy, you won’t be far wrong. Austerity has just added insult to injury; kicking the economy when it was down.

  15. Max Dunbar
    Posted August 15, 2014 at 8:40 am | Permalink

    It has always struck me that The Bank of England and the way that it operates ‘independently’ is really a throwback to planned economies and the sort of quasi-soviet thinking that dominated British governments for some time after WW2. I remember Thatcher being advised by certain economists, one of whom preceded Mr Carney, that her approach was wrong. They were wrong.
    If you were given the opportunity Dr Redwood how would you reform the Bank, or would you advocate some alternative system more suited to a free market economy?

  16. Ex-expat Colin
    Posted August 15, 2014 at 8:54 am | Permalink

    BOE needs to knife and fork a Climate model or two (perhaps 10). High accuracy and with high confidence. Open black hole lid and drop money in.

    Anyway, seems were not trading much: The UK’s economic recovery is unlikely to be export driven as its biggest trading partner is “dead in the water”, a Bank of England policymaker has said. Professor David Miles and no prizes for what is dead.

    Without leaving the EU (just mulling it over) that dependency fizzles out. So that set of models ain’t any good either?

    BRICS kicks off with special arrangements for them and exactly where are we…just watching salaries droop and house prices rise. Oh..cut off exports to Russia, nearly forgot that + tit for tat.

    It is indeed cooler and wet, I thought that was largely the side effects of Bertha. Indian summer yet to come…..model says – not sure really or logical state of don’t care. Don’t want to use CH because don’t want to shelve out to subsidy.

  17. zorro
    Posted August 15, 2014 at 9:14 am | Permalink

    We have discussed on this blog many times how the bank is a rear view mirror driver. I agree with John that they do not gave a grip on ‘slack’ or what capacity there is in the economy. But we live in the era of QE, and effectively there will always be slack, particularly when you are importing hundreds of thousands to do low paid jobs and keep wages down. GDP per capita is the only real indication of a nation moving forward. The continual downward pressure on wages serves the elite very well.

    The BoE forecasts are nothing but pure propaganda with continually moving forecasts, and inflation figures which exclude housing costs. They are only there to justify continued ZIRP, there is no other reason for them to come up with their nonsense. The fact is that the government cannot afford normal interest rates without borrowing more or bringing back QE.


  18. ian wragg
    Posted August 15, 2014 at 9:20 am | Permalink

    It should be relatively easy to forecast growth when you are increasing the population by half a million a year and government is running an 6% deficit. I would have thought computing these 2 would give you a reasonably accurate forecast.
    I note the EZ with it’s 3% deficit limit and handle on immigration has no growth.
    Maybe our growth is an illusion which will evaporate after the GE.

  19. David Hope
    Posted August 15, 2014 at 9:26 am | Permalink

    Excellent article John.

    Issues like this are why I am not a believer in central banking. If we must have it then the aim should be to manage price stability by control of the BoE’s balance sheet.
    As Mises and many Austrians argue, you just can’t reduce millions of independent actors down to aggregates like GDP or inflation or measures like slack – as you demonstrate it’s very difficult to come up with a meaningful number.
    Moreover I really don’t think it is at all wise to try and decide interest rates according to such vague ideas.

  20. oldtimer
    Posted August 15, 2014 at 10:03 am | Permalink

    Thank you for that analysis. It seems to me to be quite impossible for the Bank of England to know how much slack there is in the economy. The world of work and business in is constant flux. The best the Bank can do is try to spot trends and their potential impact.

    Taxation has a huge impact on the willingness of people to work and to invest. If it is onerous and a disincentive then there will be less effort and less investment. Conversely lower taxes have the potential to incentivise work and investment. At present levels taxation is a dead hand on work and investment. Tax changes have the potential to release new capacity.

    Technology change is even more profound in its potential influence. For example changes beyond these shores are quite capable of making on shore UK skills totally redundant rendering all estimates of spare capacity in the affected sector meaningless – everyone is out of a job. The IT industry offers a continuing demonstration of the ebb and flow of competing technologies (in both hardware and software) and of the effectiveness of user industries in adapting to the benefits they offer – eliminating the need for some occupations and increasing the need for different sets of skills. I do not see how the Bank can define “capacity” or anticipate the ebb and flow of competition within the UK economy and between the UK and other economies.

  21. Richard
    Posted August 15, 2014 at 10:38 am | Permalink

    Could the apparent inconsistencies and/or incorrect forecasts be because it is not possible to measure/take into account the black economy ?

    Also, do economic models assume that the UK is a “closed system” when in fact today there could be large transfers of money abroad which leave the UK ?

    For instance, do we know how much of the £29 billion paid out in tax credit last year was sent abroad rather then spent in the country ?

  22. Robert Taggart
    Posted August 15, 2014 at 11:01 am | Permalink

    The BoE has had it wrong for some seven years now !…
    0.5% base interest rate – not helping us scroungers – with savings !

  23. Bill
    Posted August 15, 2014 at 11:22 am | Permalink

    A very interesting piece.

    I don’t know much about economics but I know a little about bureaucracy and it seems to me that part of the problem of imprecise statistics, malfunctioning models and bad financial forecasting lies with the giant bureaucratic machine on which government and the bank relies. Bureaucracy functions by ensuring that processes are broken down into their constituent parts and then controlled by protocols. What bureaucrats fail to do is to obtain an overall view of the purpose and direction of the various parts. This, I think, is what you have started to give us, and I welcome it.

  24. David Cockburn
    Posted August 15, 2014 at 11:53 am | Permalink

    Thank you for raising a very serious and important issue. I’d like to suggest that one of the problems with forecasting in UK, and it’s one which has been raised by the BOE, is the quality of our economic statistics. It may be that it would be worth our government investing in more and better measures.
    It might also be worth investing in other, competing, forecasts.

  25. John Swannick
    Posted August 15, 2014 at 12:38 pm | Permalink

    If you think the Bank of England is bad, have you been tracking the Met Office’s performance?? If you played more cricket, you would. Their forecasts probably cost far more than the BofE’s. It either needs privatising or outsourcing. Fir cones are cheap.

  26. Denis Cooper
    Posted August 15, 2014 at 12:43 pm | Permalink

    Surely it’s because we know that the forecasts are unreliable that we have to retain the flexibility to respond to the circumstances which actually arise?

    Which in my view is a very strong argument against our sovereign national Parliament approving international treaties which would unduly tie the hands of the government in the future, irrespective of how conditions develop and how MPs may wish it to respond in the interests of the people they are supposed to be representing.

  27. lojolondon
    Posted August 15, 2014 at 1:27 pm | Permalink

    Another great article, John. Maybe the most honest course of action would be to admit they have not the faintest idea how to predict inflation and wait until we have inflation, give it a couple of quarters and then raise the interest rate? This sounds really unscientific, but would just take one guy working at a desk, and we would probably end up in the same place as having thousands of very expensive people anticipating every result of every situation, and mostly getting it wrong.
    Sorry to say, the same applies to the Met. The met office costs £100m a year, do yourself a favour, write down the forecast for each day, then at mid-day and in the evening check what was forecast and what happened. Never more than 50% correct in my experience, and sometimes far, far off (Like the ‘Hurricane’ that was supposed to hit the UK last weekend – best summarised as a bit of wind and a bit of rain, nothing exceptional). That is on the next day report, they have zero idea what the weather is going to be like in one week’s time, and even far less of an idea what the weather will be like this season.

    • Bazman
      Posted August 16, 2014 at 5:48 pm | Permalink

      It was the tail end of a hurricane. Downgraded from a hurricane. Try listening instead of putting in your own facts.

  28. outsider
    Posted August 15, 2014 at 1:29 pm | Permalink

    Dear Mr Redwood,
    Thank you for this fine analysis, with which I heartily agree. One thing you do not mention is that the Bank seems to be focused entirely on the direction of interest rates and not at all on their level. In other words, it is acting only on its flawed computer growth model and ignoring the key role of a central bank in trying to provide as stable as possible a background to create (or rebuild) confidence.

    Under the widely accepted Taylor Rule, the “normal” level of interest rates is the target rate of inflation (in our case 2 per cent) plus the long-term risk-free rate of return, which might also be equated to long-term productivity growth. Taylor put this at 2 per cent making 4 per cent the normal level around which rates should vary according to the state of inflation and growth. For the UK, I suggest that this is now too high and the normal rate is now about 3.5 per cent.
    The Bank should aim to return Bank Rate from the emergency level to a normal level as soon as it is prudent to do so. We are clearly not there yet. Inflation seems broadly on target but, as you so conclusively show, it is impossible to know how far business conditions are still below par because of the break in productive capacity in 2008-10.
    The longer Bank Rate is held way below the norm, however, the more instability is built in to the system and the more certain we are to face another, hopefully less drastic crash a little down the road.

  29. Chris S
    Posted August 15, 2014 at 2:30 pm | Permalink

    It has always seemed to me that interest rates are a blunt instrument when used to control inflation.

    In previous economic cycles we have had the ludicrous situation where gas, oil electricity and road fuel prices have all increased dramatically and a Chancellor has then increased interest rates to “control” inflation ! The average family, already having had money taken out of their budget from paying for the high price of fuel – an unavoidable expense – then has more misery piled on by higher mortgage payments !

    The “cure” then has exactly the same effect as the original cause.

    Household budgets are already under immense pressure and any further tightening will choke off domestic spending and therefore growth altogether.

    There is really no need to increase interest rates until we actually see wages start to rise significantly and that seems to be a long way off.

    Those calling for rate rises over the next 12 months can offer no evidence that it will have any positive benefit at all.

  30. Lindsay McDougall
    Posted August 15, 2014 at 2:54 pm | Permalink

    The answer to the conundrum is that State institutions – and the Bank is one – should not be trying to micro-manage and should not use dodgy statistics.

    Inflation targetting is much better and gets to the heart of what monetary policy is about. However, there are two changes wanted to the old inflation targetting:
    (1) 2.5% is the starting point but why not reduce it progressively to 0?
    (2) Include asset prices in the index used.

    I get that impression that, over the last few years, the inflation index has been above target when house prices were falling and is now below target with house prices rising. The reason is simple: a given amount of personal wealth can be spent in more than one way but not on both simultaneously.

  31. Kenneth R Moore
    Posted August 15, 2014 at 9:25 pm | Permalink

    As the Boe’s assumption and world outlook are completely and utterly wrong it’s no surprise that forecasts are all over the place.

    They have been playing the game of ‘extend and pretend’ and so far getting away with it keeping interest rates low and dangerously inflating bond and equity markets. There is a price to be paid ofcourse for such recklessness and that could be the biggest crash in financial history.

    We are ruled by a bunch of college kids..professional politicans many of which have never had a proper job. They will always put short term career advancement before country – even if that means a gigantic financial crash. They could never get another job outside of the political bubble so the charade must go on for as long as possible.

  32. William Gruff
    Posted August 16, 2014 at 12:30 am | Permalink

    More people can get out of long term unemployment, partly as a result of recent benefit reforms, and they have.
    Thank the Conservative and Unionist Party, and the Liberal Democrats, for those reforms, and I sincerely hope that those who no longer suffer the indignity of long-term unemployment do thank the hard working and upright members of those parties who represent the will of the British people in our democratic parliament.

    Pardon my sarcasm.

    I am in favour of reforming our ‘benefits’ system, however, I think it the act of a cynical charlatan to assert that kicking people off benefits, often for no good reason other than that their answers to some rudely asked questions are not sufficient to tick a box on a form, is a benefit in itself, and one they should be grateful for. No one needs a job; what everyone needs is a living and that can come from the public purse far more agreeably than from wage slavery, as our MPs, especially the long serving ones with a good deal of tax payers’ cash in their banks, know well enough.

    There is a large number of people in England who are not ‘unemployed’, and so cannot be ‘helped’ into employment yet they have no living, have had none for some years and have given up all hope of ever obtaining one. They do, however, have a brain and a vote, and they have not given up all hope of some day changing the structures of power in this country. If such happens, cynical charlatans may wish they’d been more sincere.

  33. Wireworm
    Posted August 16, 2014 at 3:04 am | Permalink

    Excellent piece. An additional factor may be that the BoE underestimates the current deflationary environment, which is very difficult to quantify. QE is fine for boosting asset prices and is probably considered by the Bank to be an anti-deflationary tool, but it can have scant means of measuring its reflationary effect.

  34. Steve Cox
    Posted August 16, 2014 at 4:53 am | Permalink

    A good article John, and criticism of the Bank is welcome. It amazes me that an organisation that both failed to foresee and warn us of the impending crisis in 2008 in any useful way, and which did little to forestall it but indeed can be accused of stoking it by keeping interest rates too low for too long, has not only come through unscathed but has actually had its powers greatly increased. I believe that in due course we shall come to regret this, as the famous adage says, ‘There’s no economic or financial problem so bad that a central bank can’t make it worse.’

    Further to this, I’d like to make two other comments. Firstly it’s tiresome to see the likes of Mr. Carney casting around for any old excuse not to raise interest rates. Originally the excuse was the output gap and the level of unemployment, now he’s using the rate of increase in average wages as an excuse. What next, the Bank can’t raise the base rate because the phase of the moon is all wrong? Really, the way these supposed financial experts jump around from one flimsy excuse to another as suits them gives their utterances and forecasts about as much credibility as reading a horoscope. Many financial and economic commentators have pointed out that we need to normalise interest rates to provide a cushion when the next cyclical downturn arrives, which may not be that far off. It may be true that in a normal interest rate environment an inflation rate of 1.9% compared with a 2% target does not warrant any increase in base rate, but of course we are not living in a normal interest rate environment, something the Bank and its policymakers appear to have conveniently forgotten.

    Secondly, I am fed up with this government and its lackey institutions, such as the Bank, constantly taking the side of debtors and effectively telling savers to go and eat cake. I would expect this behaviour of a left wing administration, which says all you need to know about the leadership of the coalition. The Conservative party still has some credible, real-world, right-of-centre politicians such as yourself and Douglas Carswell, it’s just a shame that they’re all sitting on the back benches. The shower of champagne demi-socialists sitting on the government front benches are a disgrace to the Conservative ideal.

  • About John Redwood

    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

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