Historian Niall Ferguson raised hackles last week by retweeting a Wall Street Journal article by Greg Ip that blamed the entire economics profession for the failure to forecast inflation.
The article relates mainly to the US where the discussion of inflation in official circles has a very different tone to that in the UK. Over there, Fed chairman Jerome Powell (who remains well connected to the private sector) gives the impression that he feels genuinely let down by the Fed economists who failed to predict rising inflation and that he is now trying to take what action he can. He seems aware that at low rates of interest, monetary policy operates mainly through its impact on asset prices and so is attempting the difficult task of tightening monetary policy enough to reduce inflation while not so much as to cause more carnage in the markets than is absolutely necessary. Whether this is possible is genuinely unclear.
By contrast, the official narrative in the UK remains that monetary policy has little impact on inflation driven by supply constraints, though Catherine Mann, an MPC member, pointed out in a recent speech the need to maintain confidence in the currency markets. Those of us who were involved in policymaking in the 1970s know this only too well.
Because London is one of the world’s centres of economics consultancy, there is a thriving market in economic opinion in the UK. The Treasury comparison of independent forecasts for April 2021 contains 34 independent forecasts plus those of the official Office for Budget Responsibility (OBR). Of these 34 forecasts, two are from academic institutes and three are from international bodies. The rest are from the private sector.
The April 2021 comparison is important because it contains the forecasts made at the same time as those officially published by the OBR (oddly the comparison only contains forecasts from my own consultancy, Cebr, from August in the previous year, though we still managed to get a much better grip on inflation than the official forecasts made seven months later).
Of these forecasts, the median independent forecast for RPI inflation in the same year (Q4 2021) was 3.1 per cent, versus an official forecast of 2.4 per cent. For average earnings, which often give a better indication of underlying inflationary pressure, the unofficial forecasts were nearly double, at 3.5 per cent, the official forecast of 1.9 per cent. Of course both were below the actual outturns at 6.8 per cent and 5.6 per cent. But since the critical target is 2 per cent on the CPI, the fact that the bulk of independent forecasters foresaw a problem as early as April 2021 is an indictment of the official performance.
The forecasts for 2022 show a similar gap with the unofficial forecasters predicting 2.8 per cent RPI inflation compared with the official forecast of 2.1 per cent.
The failure to forecast inflation has not only been a problem for the OBR. Rather more importantly, the Bank of England, whose Monetary Policy Committee is specifically tasked with keeping inflation down, has been, if anything, even more behind the curve.
In February 2021 the MPC predicted an inflation peak of 2.1 per cent. In May 2021 the forecast peak was raised to 2.3 per cent.
In August 2021, acknowledging that inflation was already 2.5 per cent and above the previously forecast peak, the new forecast peak was raised to 4.0 per cent. In November 2021, noting that inflation in August had already reached 3.2 per cent, the Bank raised its forecast of peak inflation to 4.3 per cent.
By February 2022, noting that inflation had already reached 5.4 per cent in December, the Bank adjusted its forecast for peak inflation to 7.25 per cent. The May report, noting that inflation had already risen in March one percentage point higher than had been predicted in February, revised the forecast of peak inflation to over 10 per cent in Q4, five times higher than the 2 per cent target.
The Bank now expects an inflation peak of 11 per cent later in 2022!
The problem in the UK seems not to be so much a problem for the whole economics profession but much more for those officials involved in economic policymaking compared with the rest of us.
Monetarist forecasters like Tim Congdon, Juan Castenada and JB Hearn have been predicting rapid inflation since 2020. Others like me, Julian Jessop, Andrew Sentance, Simon French, Roger Bootle and Dilip Shah and of course former BoE governor Lord King since late 2020 or early 2021.
The real problem is the arrogance of the official economic policymakers. When he was Bank of England Chief Economist, I wrote to Andrew Haldane offering to get together some very experienced forecasters to help him with his forecasts after he had overseen some previous spectacular forecasting failures. He didn’t even bother to respond to the offer but simply referred me to some speech he had given.
There needs to be an investigation of why the MPC has failed so spectacularly. The investigation needs to take evidence from all those named above, who can explain why they were right and the MPC wrong. Such an investigation needs also to look at how MPC members are selected. At present they are selected by the Treasury and seem deliberately to avoid those with different views from the Treasury officials.
Considerable attention is given to the need for diversity (which is quite difficult in some aspects given amongst other aspects the gender bias in those who study economics). But it appears that very little attention is given to the rather more important requirement for diversity of views.
How to get officials to pay attention to the need for greater diversity of view? This is a hard one but I have a suggestion.
As Governor of the Bank of England, Andrew Bailey is paid an annual £575,000, a salary 3.5 times that of the Prime Minister. A salary that high, which is well above a civil service salary, requires the taking of responsibility including for the failure of his staff even where he is not individually implicated. If the investigation of the Bank’s failure to forecast inflation shows that the Bank has been culpable (hard for it not to, given that the rest of us have been so much better at such forecasting), he should be asked to resign. Only by punishing failure can officials be pressured to pay more attention to views different from their own.