Throwing Good Money after Bad

The Bank of England is spending £3.5m to rebuild its forecasting model. Having failed to alert Britain of the looming disasters, it now wants to factor in some equations about the financial markets. But it is not incorporating an equation on the land market. So don’t expect it to perform any better in the future.

City economists hang on every word spoken by the Governor, Mervyn King. They took comfort from his assurance, three years ago this week, that simmering trouble in credit markets would not turn into an “international financial crisis”.

A year later, the Bank’s “central projection was for GDP to be broadly flat for the next year or so”. The forecast was published just as Britain was slumping into its worst downturn since the 1930s.

For the price of a glass of champagne in one of the City bars, the Bank could have purchased Boom Bust which, in 2005, provided the precise timetable for the ups and downs in the housing market and the trends in the nation’s income and employment prospects. For a fee of £3.5m, I would be happy to consult with the Governor on the next business cycle turning points which his new model will fail to predict.

Optimistic Bias

Charles Goodhart, as the Bank’s chief economist, should know where the bodies are buried. And he has just admitted that the Bank’s model “has got no banks in it and no possibility of default, which is perhaps one of the reasons the model got it so wrong over the past few years”. Wrong. Problems with the banks are symptoms, not cause, of gear-shifting changes in GDP trends. Zeroing in on the banks would not have provided the Early Warning System people need to prepare for bad times.

The Financial Times (Aug.10) has audited the Bank’s forecasting techniques to expose their assumptions. It turns out that the hundreds of economists in Threadneedle Street believe that growth continues unimpeded until – shock, horror! – the engine of growth grinds to a halt. But then, they assume, bad times will be short-lived. Such biases are costing millions of people their homes and jobs.

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