Former Federal Reserve chair Ben Bernanke has emphasized the necessity for the Bank of England to overhaul its primary economic model in order to prevent a recurrence of its recent failure to anticipate surging inflation. Bernanke, a Nobel laureate, was tasked with reviewing the BoE’s forecasting and related processes, identifying “significant shortcomings” in the bank’s baseline economic model exacerbated by outdated software.
He advocated for the elimination of the Monetary Policy Committee’s current “fan charts,” which depict the probabilities of different outcomes for growth and inflation under various assumptions, stating that they have “outlived their usefulness.” Bernanke’s recommendations indicate the need for radical change to prepare the central bank for a potentially more volatile economic environment marked by significant shocks like the pandemic and the Ukraine war.
The BoE has pledged to act upon all 12 of the report’s recommendations, with an update on proposed changes expected by the end of the year. BoE Governor Andrew Bailey characterized the review as a “once-in-a-generation opportunity” to modernize forecasting approaches and adapt them to a “more uncertain world.”
While Bernanke acknowledged that the BoE’s forecasting performance has been on par with other central banks, he highlighted major deficiencies in the BoE’s forecasting infrastructure, staffing deployment, and reliance on a central economic forecast to communicate policy decisions to the public.
Bailey acknowledged the challenges posed by the unprecedented shocks but expressed optimism about the economy’s current trajectory. Bernanke stressed the urgent need for the BoE to invest resources in modernizing software and, in the longer term, either replacing or thoroughly revamping its economic model, known as Compass.
He recommended that the model pay closer attention to productivity, labor markets, and trade, and include detailed models of financial, housing, and energy markets. Bernanke proposed the publication of a range of scenarios instead of fan charts to elucidate the rationale behind policy choices, the risks to forecasts, and the resilience of plans amidst uncertainty.
Former Federal Reserve chair Ben Bernanke has refrained from recommending the adoption of the “dot plot,” a tool he introduced at the Fed following the global financial crisis, for the Bank of England. The dot plot displays officials’ differing expectations for future interest rate policy.
While Bernanke acknowledged that the US model may not be suitable for the BoE, he suggested that the Monetary Policy Committee (MPC) should contemplate publishing its own forecast for interest rates over the longer term. Currently, the BoE’s central forecast relies on market rate expectations, leading to potential discrepancies between the MPC’s beliefs and its projections.
Bernanke emphasized that any such alterations would carry significant implications, stressing that the decision should be subject to “future deliberations.”
He advised the BoE to prioritize enhancing its forecasting tools, a task that would necessitate substantial investment, while proceeding cautiously in implementing changes to policymaking and communications.
