MNI POLICY: Bernanke Review Looks At BOE Rate Path, Scenarios

Recommendations for the Bank of England to publish a projection of its future rate path, and for it to put more resources into producing alternative economic scenarios are both under consideration by former Federal Reserve chief Ben Bernanke in his review of the BOE’s forecasting, MNI understands.

Regularly publishing preferred rate paths, rather than basing economic forecasts on expectations for future interest rates implied by market pricing, could see the Monetary Policy Committee follow a similar approach to that of Sweden’s Riksbank, which produces a central rate projection incorporating both a model and the judgement of policymakers.

One approach for formulating a rate path would be based on a calculation of policymakers’ preferred trade-offs between deviations of output relative to potential growth and deviations of inflation from target. In his “Lambda” speech in 2017, former BOE Governor Mark Carney set out the details of how such loss-function models capture trade-offs such as when policymakers opt to take time to return inflation to target in order to avoid hammering the real economy after a shock.

Depending on the weights chosen, such a loss-function approach could also be compatible with the so-called Taylor rule, which sets out how to set rates for different levels of inflation.

OPTIMAL POLICY PROJECTION

But it is not clear that all nine members of the MPC will necessarily see policy through this loss-function lens. One possibility might also be for the BOE to publish additional rates path scenarios, when for an example an MPC member wishes to illustrate the reasons for their dissent from the central forecast.

The Bank already frequently produces, for internal consumption, an Optimal Policy Projection, which uses an algorithm to determine the level at which rates stabilise growth at trend and inflation at target, with a greater weight placed on inflation.

It was this OPP projection which was used by Deputy Governor Ben Broadbent when he pushed back against what he considered to be overblown market rate expectations in a speech in October last year. Broadbent had previously opposed publishing the Bank's internal rate projections. (See MNI POLICY: BOE Turns Quiet Again On Market Rates Bets)

Former officials, such as ex-Deputy Governor Charles Bean, have also made the case for setting out alternative economic scenarios during times of high uncertainty, but struggles with staff resources and IT have meant that the BOE, unlike other central banks, has been stymied in its attempts to produce these, including during the Covid shock.

A recommendation by Bernanke to address this failure would be unsurprising. Alternative scenarios fleshing out the Bank’s thinking may also negate some of the criticism when its central projection misses the mark, by showing that it was at least aware of different possibilities. For example, the BOE could have illustrated the potential for a much sharper rise in wages in response to recent high inflation than the MPC had initially expected. (See MNI POLICY: BOE Hikes Whilst Seeking New Inflation Model)

NO DOT PLOT

One oddity with the BOE's quarterly forecast is that it goes through three steps - starting life as an updated staff forecast before informing and reflecting MPC discussions and then being reassessed as MPC members come to their policy judgements. Bernanke will also look at the merits of explicitly stripping out a staff forecast, distinguishing it from the MPC’s judgement, MNI understands.

One thing that does not appear to be in the running is a Fed-style “dot plot” with individual MPC members setting out their own point-based rate paths, whether anonymously or not. Bernanke is no enthusiast for this approach, which reflects the idiosyncrasies of the Fed system, with its powerful regional presidents, the basis for whose forecasts sometimes lack transparency.