MNI INTERVIEW: BOE Needs To Update Forecasts For New Scenarios

The Bank of England this month published rate paths for different economic scenarios after long internal debate but may struggle to keep delivering them until it updates its forecasting processes, former BOE economist and Oxford Professor Michael McMahon told MNI.

While there were differing views inside the Bank over the pros and cons of publishing internal, rules-based rate paths, in line with recommendations in the 2023 review of its communications and forecasts by Ben Bernanke, McMahon noted that the bigger challenge highlighted by the former Federal Reserve head was the inadequacies of the Bank’s IT and forecasting processes.

"I would have done nothing on the external communication side until I had sorted out all of that stuff,” McMahon noted in an interview, “The risk was always that you start doing one thing because you just want to get something external out there and say, look, we're responding. And then suddenly you go, oh, we have a new set of forecast processes that can't do that. So we're going to have to change again.”

Nonetheless, he added, having made their rules-based rate paths public, “hopefully they will realise that the sky has not fallen in and that, actually, we can continue to go forward with this.” 

The Bank published two alternative scenarios with endogenous rate paths at its Nov 6 meeting, one with more persistent inflation and the other with weaker demand than the central forecast. The different scenarios published will reflect “the distinguishing feature of the debate at the time,” according to McMahon, with the main question this month being whether disinflation would continue.

The three forecasts “broadly encompass the nine members of the committee,” he said. (See MNI POLICY:  BOE Needs Scenario Rate Paths - Top Economists)

NARRATIVE

MPC members also outlined their individual views for the first time in the minutes, with their comments putting different weights on different scenarios.

These show variation between MPC members’ thinking on either side of the Bank’s five-four vote to hold rates, McMahon said. “The paragraphs tell us there are many roads to those paths.”

“I like them as both a disciplining device for the policy makers, but also a communication device,” he said.

“The key was to put narrative at the heart of not just the communication, but narrative should be at the heart of the policy process,” he added.

Such narrative is absent from alternative central bank communication tools, such as the Federal Reserve’s dot plots, McMahon said. (See MNI POLICY:  Perceptions Gap Between BOE Projections And MPC)

“The dot plots give you numbers, but no narrative. I believe all communication, I believe all policy making, I believe all thinking on these things should be narrative driven.”

RATE PROJECTIONS

For each scenario, the Bank published three endogenous rate paths under different policy rules and a rate path under an optimum policy projection. So long as the differences between the market rate path and the rule-based BOE rate paths are fairly narrow these will provide little news, McMahon said.

“I think that most of the time these will be a fairly boring thing," he said, "The one thing I would hope, is that we don't start agonising over 20 to 35, even up to 40 basis points of difference in these rules, because they are inherently uncertain.” 

“I would imagine that if they had done this exercise and found that there's a 200-basis-point difference, unless they really wanted to talk about it, they probably wouldn't have introduced them at that time,” he added.

“These rules are not super precisely estimated. They are not prescriptive. They are supposed to be descriptive.”

“Going forward with Bank of England Monetary Policy Reports, I would imagine there are many times when it just lingers in the background … Here are what three or four endogenous rules and the market curve look like. They all look basically the same, but like I say, I can imagine a future where the Bank has taken a markedly different view of the economy, and then these become a sort of quantification of the implications of that. And that is where I imagine the real excitement around these will be.”