How the former Fed boss could shake up the Bank of England

LONDON — The Bank of England will release a much-anticipated study Friday from former Federal Reserve Chairman Ben Bernanke that could lead to significant changes to its monetary policy.

The study was launched last summer to assess the Bank’s difficulties in accurately forecasting the huge global rise in inflation that followed Russia’s invasion of Ukraine. This led to the BoE being too slow to raise interest rates and subsequently having to raise its main bank rate to 5.25%, its highest level in 15 years.

With inflation now falling faster than the MPC predicted, some economists have argued that the Bank is making the same mistake in the opposite direction – now delaying cutting rates even as the economy stagnates.

In a research note published Tuesday, Goldman Sachs suggested that Bernanke’s recommendations would focus on two key areas. The first concerns how the Bank of England communicates the uncertainty surrounding its central forecasts.

“We expect Bernanke to recommend that the fan chart play a less significant role or be eliminated altogether, while also suggesting that the Bank use alternative scenarios more widely,” said Goldman economists Jari Stehn and James Moberly.

“We believe that scenario analysis would more clearly communicate the conditionality of forecasts, help express uncertainty, and better represent the range of views within the Committee.”

The fan chart is the Bank’s long-standing method of presenting the probability distribution that forms the basis of its inflation forecasts.

“That said, some of the information that the scenarios would contain is already captured by the MPC’s judgment on risk asymmetry and in communications from MPC members,” Stehn added.

German Bank also advocated that this be a central point of Bernanke’s assessment. Senior economist Sanjay Raja suggested in a note last week that he might recommend a scenario-based approach during exogenous shocks.

A central issue for the Bank of England and other major central banks around the world in the wake of the Covid-19 pandemic was quantifying the upside risks to inflation forecasts from disruptions in the supply chain. global supply, whether due to lockdowns and resulting demand bottlenecks, or to war. in Ukraine.

Fan charts have been blamed for the MPC’s inability to keep up with these inflationary pressures, and Raja predicts that they will “probably be abandoned in the future.”

“A possible recommendation from the Bernanke review could be for the MPC to adopt scenario-based analyzes in periods where exogenous shocks increase uncertainty around the Bank’s central projections,” he said.

“Using alternative scenarios would also more formally reflect the different views within the committee (i.e. hawkish and dovish risks, as reflected in the current composition of the MPC).”

A change in the conditioning trajectory of interest rates

The second area of ​​focus, Goldman notes, will likely be the path shaping interest rates. The Bank currently publishes two forecasts for GDP, the unemployment rate and inflation – one based on the implied path of market interest rates and the other assuming constant interest rates.

This differs from the European Central Bank, which produces a single forecast based on the market’s implied movement for interest rates, and the Fed, which presents a “dot plot” through which each member plots its policy direction, inflation, real inflation. GDP and employment.

“While it cannot be ruled out that Bernanke could recommend that the MPC adopt a dot plot or publish a committee forecast for the policy rate, we believe this is less likely. The downside of giving a policy rate forecast would be that it could be misinterpreted as a commitment to a particular rate path,” Stehn noted.

“That said, if the MPC were to move from conditioning on the path of market-implied rates to a forward-looking policy path, this would represent a more significant change in the policy framework than the use of scenarios.”

Deutsche Bank’s Raja suggested that Bernanke might recommend sticking to a set of conditional assumptions and publishing a collective projection of GDP, unemployment rate and inflation.

“This could include an endogenous view of rate expectations, replacing the market yield curve with a preferred interest rate profile,” Raja said.

“The main benefit would be to avoid marked changes in BoE projections due to market interpretation of policy expectations or global spillovers that impact market prices as a cycle approaches Relying on an internal conditioning path of interest rates could be less volatile and could avoid the “tail wagging the dog” scenario.

Streamline communication

Another aim of the review, according to Deutsche Bank, could be to streamline the Bank of England’s communication, to reduce the documents, statements and projections to digest at each meeting – and, therefore, strengthen the message main MPC from meeting to meeting.

Raja said this could be achieved by making “fewer and fewer adjustments” to the policy statement, aligning the process more closely with the conciseness and consistency of policy statements from the Fed and ECB. This, in turn, will allow the market to more easily interpret and isolate “new news.”

Although the use of scenario-based analysis or endogenous interest rate developments could improve transparency around the Bank of England’s policy outlook “at the margins”, Raja doubted it would “change the gives” for the markets or for the near future. long-term trajectory of monetary policy.

Bernanke’s recommendations will not be implemented immediately. New BOE Deputy Governor Clare Lombardelli has been tasked with leading implementation when she takes office in July.

“Moreover, the MPC remains independent and ultimately all votes and decisions of MPC members will remain independent,” Raja said.

“The Bernanke Review will therefore reset how the Bank conducts its forecast cycles and, more importantly, how it communicates its projections (and decisions) to the general public.”