Bank of England studies sweeping reform of forecasting

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The Bank of England could tear up its current process for producing forecasts and move to an approach closer to that of the US Federal Reserve under a review led by Ben Bernanke.

The former Fed chair was appointed in July to look at the BoE’s forecasting after the central bank was criticised for failing to foresee the recent bout of high inflation, which has proved more persistent in the UK than elsewhere.

Terms of reference for the review, published on Monday, suggested the BoE is prepared to consider wide-ranging reforms including to the way it gives guidance on the future path of interest rates.

The BoE said one question Bernanke would consider was “the appropriate conditioning assumptions in projections, including the interest rate path on which the forecast is based”.

At present, the BoE’s main forecasts for inflation and GDP are based on market expectations of how monetary policy will evolve, a convention that can lead to extreme effects at times of market turmoil.

The BoE also publishes forecasts based on unchanged interest rates but it has been unwilling in the past to go further and have individual rate-setters publish their own preference for the future path of rates — the “dot plots” approach adopted by the US Federal Reserve under Bernanke’s leadership.

James Smith, a former BoE official and research director at the Resolution Foundation think-tank, said it was striking that Bernanke had been tasked with “thinking beyond processes and models for inflation forecasting”.

The terms of reference also said the review should be “forward-looking” and not a “review of policy decisions”, suggesting BoE governor Andrew Bailey is keen to avoid it becoming a critique of the bank’s recent record.

The review would, however, be informed by “lessons from past experiences and from the experiences of other central banks”, the terms said.

The BoE also said the review would look at “the roles of the MPC and the staff in the development of the official forecast”. At present, the projections published in the MPC’s quarterly report on the UK’s economic outlook are based on staff analysis, but represent the collective judgment of the MPC.

Bailey made it clear in August that the MPC had found it necessary to make a judgment call that inflation, and the forces feeding it, would be more persistent than the BoE’s empirical models showed.

However, the BoE does not explain exactly how the MPC’s forecast differs from the analysis underpinning it, or how individual MPC members differ in their view of the economic outlook.

Tony Yates, a former senior BOE official, said this left the MPC room for “a lot of fudging” as it was not obliged to set out the extent of disagreement between members, the degree to which it had used its discretion, or where it had simply made errors.

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