Bill Jamieson: ‘Beckham’ model misses the target

WHEN the head of the central bank declares “with hindsight we should have shouted from the rooftops”, a clearer signal could not have been given of problems at the heart of monetary and interest rate policy.

The Bank of England today has big problems at its heart. They will be well to the fore this week when the Monetary Policy Committee meets to decide whether the economy needs more monetary stimulus in the form of quantitative easing. There are deep divisions within the MPC. And they are due in large part to growing doubts over the Bank’s forecasting methods. Here we really do have something to worry about.

Even if such doubts did not exist, it should not be necessary for a central bank governor to “shout from the rooftops”. Either something is wrong with Sir Mervyn King’s speeches or the audience has some hearing disability, perhaps even a perverse refusal to heed news it doesn’t want to hear. It would certainly not be the first time this country has fallen victim to collective deafness when warned of lax spending and borrowing.

As for central bank governor speeches, they have a house style and tend as a rule to have a muffled and often Delphic quality to them. This is deliberate, for the reaction to be most avoided is one of alarm or panic. The default position of a central bank governor has historically tended to be one of reassurance. Indeed, “shouting from the rooftops” would until recently have been a disqualification for the job.

But today in global markets, with such a cacophony of raised voices, there may be an argument that this style is arcane and needs to change. When warning of an asset price bubble or lending practices imprudent by historic standards, such speeches need to be more staccato, the sentences shorter and the style more urgent. At the least they should contain a purple passage whose wording is compelling and the meaning unambiguous.

Unfortunately, the problem is not so simple. The economic world is complex. Causes and effects are intermingled. Analysis of economics and finance is seldom as clear and unambiguous as to make shouting from the rooftops a practical option, even if we trained the governor to declaim like Caesar or project like Placido Domingo.

Ambiguity is never more evident than now. Analysts are divided on the most fundamental question in economics: are we growing or slowing?

This division reaches to the top of the bank and into the MPC. This week it has to decide whether another burst of QE is needed to help lift the economy off the floor. Talk is growing of a further £25 billion boost, taking the total to £350bn.

What does the Bank’s own economic analysis and forecasting machinery tell? The MPC’s deliberations are informed by the Bank of England’s Quarterly Model (BEQM, pronounced, so I am told, “Beckham”). This should be the purring Rolls Royce of data analysis, the whispering Daimler of prediction. Unfortunately, this Beckham model has been shooting pretty wide of late. There has been an almost continuous over-estimation of future economic growth and an equally continuous under-estimation of inflation, presenting a headache for the Bank’s chief economist, Spencer Dale. This is not a methodological model in which either independent commentators or MPC members have full confidence.

A concern with “Beckham” is that it has not been recalibrated to take into account the changed behaviour of the banks in recent years and in particular bank lending (or the paucity of it) and its impact on the broader economy. “Beckham”, say the critics, has not been re-engineered to take into account the change in bank behaviour subsequent to the financial crash, recession and de-leveraging.

This might account for the over-estimation of growth. I am less sure whether it explains the under-estimation of inflation. Here the explanation may in fact be more troubling: the Bank’s modelling machinery may not have factored in the extent of negative feedback from its own policy of resort to QE (or its close relation) by central banks in America and the Eurozone as well as the UK. A policy of continuous monetary easing, and on a scale without modern precedent, is a phenomenon that in another age would certainly have central bank governors shouting warnings from the rooftops. But the spectre of stagnation, high unemployment and a “lost decade” of growth is driving monetary policy, and indeed driving over concerns about its potential inflationary effects on raw material, commodity and asset prices.

The MPC has seldom been in more need than now of a reliable and credible forecasting model. Signals in recent weeks have been contradictory and confusing. Two weeks ago official figures showed the economy contracted 0.2 per cent in the first quarter, putting the UK in formal recession. This is a preliminary estimate, subject to revision, and has already been hotly disputed. Recent business surveys have been more upbeat and also challenge the “double-dip-recession’ reading.

However, last week brought a disappointing Purchasing Managers Index reading for services, with the largest fall since last November. The April British Retail Consortium survey due this week is expected to show a significant fall from March while industrial production figures are also set to show a fall. Add to this the weakening in house prices – the latest Halifax reading recorded a 2.4 per cent fall – and the case for easing begins to look powerful.

But set against this are inflation concerns. MPC member Adam Posen, a previous advocate of QE, has warned that core inflation has stopped falling while Paul Tucker argues that CPI inflation is set to stay above 3 per cent for the rest of the year – well above the 2 per cent target. Finally, Sir Mervyn King declared in a radio interview last week that there were signs of a coming recovery. What, then, would be the case for more QE? Indeed, what of the effectiveness of the £325bn of QE expended so far? Don’t shout it from the rooftops: the Bank has no sure answers – it is, and not for the first time, flying blind.