MNI INTERVIEW: Clear Case For BOE Alternative Scenarios - Bean

The Bank of England could enhance its policy communication by publishing alternative scenarios for inflation, former Deputy Governor Charles Bean told MNI ahead of the April publication of a review into the BOE’s forecasting by former Federal Reserve chief Ben Bernanke.

Bernanke has taken detailed evidence from current and former Bank staff and policymakers in his review, which has also looked at the possibility that the BOE could publish its own projections for interest rates, but Bean said he saw more support for alternative scenarios.

"I’ve heard lots of people advocate scenarios, but there is more disagreement on rate paths,” Bean said in emailed comments. “Academics tend to be keener on rate paths than policymakers, in part because the latter are more aware of the practical problems. But I don’t think it’s obvious where Ben’s review will end up.”

One possibility is that Bernanke will set out the Bank's options, together with their costs and benefits, without being highly proscriptive. Bean said he would favour the publication of projections setting out scenarios with varying inputs, such as higher inflation than foreseen in the central forecast due to labour market rigidity. (See MNI POLICY: Bernanke Review Looks At BOE Rate Path, Scenarios)

CRITICISM OF FORECASTS

"It certainly makes them more useful if they also discuss an illustrative policy response. But even if they don’t, they can still be useful as a way of illustrating the potential quantitative importance, or unimportance, of particular risk," he said.

The Bernanke review was arranged after the Bank faced external criticism for failing to predict the surge in inflation that followed economic reopening after Covid and the spike in energy prices after Russia invaded Ukraine. Alternative scenarios could have been used to illustrate either real-world developments such as vaccine roll outs, or risks identified in economic theories, Bean said.

"They should cover whatever is most relevant at that particular juncture. This could be external risks. But it could be risks around the behaviour of domestic agents, private or public, or about the way the economy functions,” he said, pointing to the slope of the Phillips Curve as another example of something that be modelled in this way.

"Of course, to be able to provide such scenarios requires a pretty efficient and flexible modelling infrastructure, which I’m not sure is presently the case at the Bank," he said.

OPPOSES DOT PLOT

Bean, an LSE professor who was on the steering committee of the official fiscal watchdog, the Office for Budget Responsibility, would have reservations if the BOE were to begin to publish its in-house rate projections and would strongly oppose the adoption of a Fed-style "dot-plot”, in which Monetary Policy Committee members set out their own anticipated rate paths.

"My worry if the MPC provides a rate path is that it ends up being treated as a promise rather than just a central expectation that is almost certain to be wrong because of unforeseen events. This runs the risk of (i) making the Bank appear more certain about the outlook for rates than it is; and (ii) as a result, actually damaging the MPC’s credibility," he said.

“The dot plot is even worse in my view, as it draws attention to the (usually modest) differences between members, rather than focussing on the view of centre of gravity of the Committee ... The very worst outcome, by the way, would be if the Bank produced nine scenarios, where each scenario corresponded to the central projection of one individual member. That would be a real misuse of scenarios.”