David Worsfold
The recent appearance of Bank of England governor Mark Carney before the Treasury Select Committee cast some long shadows over the value of economic forecasts, even those from central banks.
He and his colleagues were attempting to explain why their gloomy post-Brexit vote forecasts appear to have been wide of the current reality: “We didn’t think the economy would go into recession… we were towards the top end of forecasters at the time. We should have been higher, in retrospect. We might understand that no forecast is perfect, but that is not what [everyone] hears. We need to do a better job of explaining what a forecast is and what the different scenarios are for the economy”, the governor told MPs.
This statement might seem rather surprising to those who followed the Bank of England’s immediate pre- and post-Brexit vote statements. The overwhelming impression the Bank created was one of gloom with the economy moving sharply into reverse. Ask most people today, even many in the City who scrutinise central bank statements with great care, what they thought the Bank was predicting six to nine months ago and most will say an economy going into reverse if not recession. Some will say they thought the Bank was being too gloomy and didn’t buy into the negativity but they will still find themselves acknowledging that the general thrust of the forecasts was downwards.
There was a distinct negative shift in sentiment after the EU referendum in June. Some will argue that the Bank – Carney in particular – contributed to that while others will, more generously, say it merely reflected a wider consensus. There are, of course, those who accuse Carney of playing politics and using his forecasts in advance of the referendum to influence public opinion but that is a debate for another time and place.
Certainly, whatever the underlying data in the forecasts said, the spin put on those figures was negative. If it is partly about the way you interpret and build a story around forecasting data, it is also about the underlying reliability of the data, said Gertjan Vlieghe, a member of the interest rate-setting Monetary Policy Committee at the same Select Committee session.
“I am never confident of any forecast,” said Vlieghe, as he cautioned against "unrealistic expectations" of perfect predictions.
He said economic models can never be perfectly accurate regardless of how much data and analysis the economists put into them, adding that forecasts look at probabilities of certain outcomes rather than produce definitive predictions of future economic activity. “It is still going to be the case that there are large forecast errors. We are probably not going to forecast the next financial crisis, nor are we going to forecast the next recession – models are just not that good."
This dampening down of expectations of the accuracy and certainty of economic forecasts seems to be something of a theme with the Bank of England at the moment as a few weeks before its chief economist, Andrew Haldane, said criticism of economists was “fair cop” after they failed to predict the financial crisis and were wrong about the impact of the Brexit vote.
He likened their collective failures to the famous weather forecast by Michael Fish in October 1987 when he dismissed suggestions that the southern UK was about to be hit by a hurricane. That night devastating winds swept in off the Atlantic Ocean. This, said Haldane, caused a crisis of confidence in the reliability of weather forecasts which it has taken years – if not decades – for meteorologists to recover from. It sparked a search for new sources of data and tools to analysis it, a phase that, he suggested, economists might have to embark on if they are to win back the confidence of people who need quality forecasts to run their businesses and manage huge investment portfolios effectively.
Haldane didn’t completely run up the white flag, however: “Right now there is a very interesting disconnect between what we read in the papers about the degree of political and policy uncertainty, which by any historical metric is at high levels, and what we have seen from the economy and financial markets, which have actually been remarkably placid. That disconnect cannot last forever. There will need to be a reconciliation between the two ... Maybe some of the scarier stories politically will be seen to be just that – scare stories”.
The difficulty of producing accurate economic predictions will not come as a surprise to chief investment officers as they have struggled to cope with increasingly unpredictable volatility since the 2007-08 financial crisis. Now they have to factor in the Bank of England taking a step back from the mirage of certainty it had tried to create around its forecasts.
Perhaps the great mid-20th century American economist John Kenneth Galbraith was right:
“The only function of economic forecasting is to make astrology look respectable”.
Or, in other words, in the long term, we’re all wrong.