There has been lots of comment in the media on the criticisms that former chair of the US Federal Reserve and economics Nobel prize winner, Ben Bernanke, has made of the Bank of England's forecasting techniques. He undertook a review of these methods at the invitation of the Bank because so much concern has been raised about how poor their forecasting has been, particularly since the Covid crisis.
In general, observers have suggested that Bernanke must have been thorough because he has made twelve recommendations for what people think to be significant reforms within the Bank. Bank of England boss, Andrew Bailey, has already said that he will act upon them. That, however, to me is the surest sign that Bernanke has missed his target. If he had suggested anything that would have created real change Bailey might have resisted his recommendations a lot more obviously.
A long time ago a wise person taught me that I should, when reading reports of this nature, not consider what is said within them, but what is left unsaid, meaning that an issue has been ignored. It is in this light that I have read the report.
Before noting those exceptions let me make it clear that I am unsurprised that he has said that (and I am summarising his twelve, heavily overlapping, recommendations when noting these issues):
- The Bank's methodologies are out of date.
- The Bank's technology is outmoded.
- The Bank is over-reliant on data analysis.
- The Bank has structures that do not encourage the promotion of expertise.
- There has been resistance to change within the Bank.
- Critical thinking that challenges the Bank's forecasting has been discouraged, even in the Monetary Policy Committee.
- The Bank's systems are orientated to processing normality, and not exceptions to the norm.
- There is a bias against narrative explanation of the Bank's opinions and forecasts.
- Its reporting methods might be familiar due to their habitual use but they are not necessarily useful.
I stress, this is not how Bernanke puts things; I offer these as reasonable interpretations of what he says. To me they say that the Bank:
- Is outmoded in its thinking.
- Has failed to invest despite the enormous resources available to it.
- Requires compliant obsequiousness from its staff.
- Does not encourage critical thinking.
- Hides behind opacity.
- Lacks creativity.
- Most of all, is seeking to reinforce what it thinks it knows rather than what might actually be happening.
Again, I stress he did not say that: it is what I think he means.
That said, there are, in my opinion, major failings in what Bernanke has done. For example, has not questioned the basis of the economic approach adopted by the bank, which is based on what is described as dynamic stochastic general equilibrium modelling (DGSE). This is unsurprising. Bernanke is deeply invested in this economic method methodology, as all central bankers are. However, the model is profoundly unsound. There are a number of reasons.
Firstly, the model is based upon microeconomic foundations. It assumes that the model of decision-making that is appropriate for individuals, households and companies is also appropriate for the state. To put this another way, the household analogy is built into it from the outset. The result is an inherent logic that the government is just another player within the economy when it is nothing of the sort. It role is not only normally the inverse of all other actors within the economy, it also sets the rule for everyone else.
There is another problem arising from the use of microeconomic foundations. Many of the crass assumptions within microeconomics, including that markets can produce optimal outcomes and that they can clear supply and demand, are implicit in DGSE modelling, quite inappropriately. You cannot build sound economic forecast on the basis of nonsense. Bernanke does not say this.
Secondly, although it is claimed that these mathematical models can handle uncertainty, I do not think that is true. They can only handle risk, which is probabilistic. I am not convinced that they can handle uncertainty, to which probability cannot be attached, although it happens, nonetheless. This is why they were quite unable to handle the global financial crisis of 2008 and the Covid crisis. Those events simply did not exist within the range of forecast probabilities. Bernanke does not point this out.
Third, these models assume that there is such a thing as equilibrium, i.e. an optimal economic outcome to which we can aspire. There is no evidence that such a state as ever been achieved. In that case, why it is appropriate to assume that this is the basis for forecasting is very hard to explain. Bernanke offers no such explanation.
Fourth, as Steve Keen has explained, relentlessly, models of this sort are based upon the assumption of a barter economy where there is no role for money. Any adaptations within the model to include the role of money are necessarily a fudge. Why the Bank is using such a model to control monetary policy is hard to explain.
Fifth, if, instead of an equilibrium state being modelled there is instead a model that presumes that the status quo prevails (which Bernanke implies to be the case), then the model has built within it an assumption of reversion to the norm. That would be great if that norm was what everyone desired, but very clearly the norm within the economy in which we all live at present is not working. That means that the model is inherently in conflict with society - and what is happening in the real world.
Sixth, the most massive macroeconomic externality, in the form of climate change, is effectively ignored within this model, because that is what its microeconomic foundation necessitates. This fact pretty much undermines just about everything the Bank does.
I could go on, but I think that my reservations are now clear. I am, of course, aware of that I am generalising, but I also know that in almost every model of this sort where adaptation is introduced to try to accommodate the criticisms made, the assumption is that the exception from the model's requirements is contrary to economic well-being i.e. the model always tries to make prediction that resort to its implicit over-riding assumption that pure market economies must exist, fundamentally free of government interference. The reality that a central bank exists to implement government policy is in fact contrary to the implicit assumptions in the models that presume that no such thing should happen.
Bernanke mentions none of this. As a result what he says will fail us.
But that was also guaranteed for another reason. It would appear from the commentary that he has provided that he spoke to no one, at least of consequence, outside the Bank when undertaking his work. In other words, he has made recommendations for reform of the way in which the Bank works without ever once considering the opinion, or needs, of the Bank's stakeholders, whether they be the government, other politicians, society at large, or business of all sizes. His comments do, therefore, represent the ultimate statement of central banker arrogance. In the opinion of central bankers, nothing but their view matters. Bernanke did not say this, but whether he recognises it or not, it is clear that he thinks it.
Bernanke was always the wrong person for this job. He was a central banker marking another central banker's homework, without ever questioning the assumptions on which the central bank worked. This investigation was doomed from the outset as a consequence.
And these are the people that Rachael Reeves is placing her faith in to run the economy when a Labour government is in office.
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Thank for being the voice of reason, in a holistic and broad churched kind of way.
Richard Werner points out for the 8 axioms necessary for equilibrium to apply there is a probability of less than 1%.
see at 45min10s https://tube.childrenshealthdefense.eu/w/da49083e-9742-4b11-bc68-53dcb585d3b9
Steve Keen with his system dynamics monetary model Minsky can derive everything from macro-economic definitions, no equilibrium or micro-foundations needed. It can model the 2008 GFC.
Emergent Macroeconomics: Deriving Minsky’s Financial Instability Hypothesis Directly from Macroeconomic Definitions
https://www.tandfonline.com/doi/full/10.1080/09538259.2020.1810887
Minsky open source
https://sourceforge.net/p/minsky/home/Home/
As Albert Einstein once said “We can’t solve problems by using the same kind of thinking we used when we created them.”
The amount of money a sovereign government can put on the table created from nothing makes it a big player. This is simply not bring recognised by Neoclassical/Neoliberal economists. Rather government is still being regarded as being a wrecker of so-called equilibrium for having this power and this is downright perversely out-dated as well as being evil.
“being” not “bring”
If forecasters at the Met Office want to know what the weather is like they do not pore over their models, they look out the window; this would be a good start for the BoE.
It is the Mile End Economists’ approach – only by asking a large swathe of individuals what they ARE doing and what are they GOING to do can you have any idea of the trajectory of the economy. In this sense it IS all about micro being aggregated up to macro…. but (as you observe) “government” is different, it adjusts the sails and the wheel to counter the winds and tides to steer the correct course. (Please forgive the sailing analogy… the season fast approaches!!)
On models; George Box said “all models are wrong but some are useful”. No doubt the BoE model could be improved – in particular it its treatment of money – but whatever model you use it needs to be calibrated to real life… which feeds into the paragraph above – get out there and ask people what is happening! “My model says X, reality is Y…. what is wrong with my model?”…. rather than “My model says X, so the reality is or will become X”
I would not be too critical of Ben Bernanke; within his (narrow) mandate he was about as harsh as he could be in the world of “Central Banker speak”. But your point – “getting the economy running nicely” (which is what the BoE is trying to do) begs the question “nicely for whom?”.
Big questions not quickly solved but at a start we must get diversity (Trade Unionists, small business owners, public servants, pensioners, non-workers etc.) it its Policy making committees and governance more broadly.
I think we might agree that we both want ‘the economics of walking about’ to be represented in the decision making processes.
A very fair and good summary. If you were going to ask three expert groups for advice on forecasting, there are three sets (and three specialisms, I will not term them ‘disciplines’), nobody with any judgement would choose.
1) Economists
2) Bankers
3) British weather forecasters
“Again, I stress he did not say that: it is what I think he means.”
So you are making it up then. Classic “strawman” approach, which is very typical of you.
If you do not know that this is how the world works you are really naive
Can this ruling by the European Court of Human Rights in regard to global warming’s effect on the weather have any relevance to the use of money in an economy? Afterall since money like the weather is always with us government regulation or rather misregulation of money can have severely adverse effects on some of us. Indeed lack of government spending on tackling global warming will affect all of us.
https://www.theguardian.com/law/2024/apr/13/swiss-climate-ruling-global-impact-european-court-human-rights
Not under this Government or even a Labour Government currently, I would suggest. Neither party has weather or climate change as a priority right now.
Not even with the news of flooding affecting crop yields and the dire warnings of the summer to come affecting the UK’s food production.
Certainly the Tories are looking to ‘do away with Human Rights’ using this position as a justification to pretty much ignore anything that comes out of Europe; and I don’t think Starmer would change his stance from that ‘centrist’ position either (Labour isn’t exactly in ‘opposition’ over this) in order to ‘attract disgruntled Tory voters to the red side’ so this ‘EU weather warning’ will be ignored. At the end of the day, they will both end up doing nothing as, as is noted in this article:
“legal experts warned the UK’s Brexit trade agreement with the EU “could be terminated” if the UK quit the ECHR.”
https://www.euronews.com/2023/03/13/uk-citizens-will-lose-the-most-if-country-exits-european-convention-on-human-rights-warns-
The typical Government status quo of the last 15 years will prevail: Shout about it a lot, use it distract from their failings to further disenfranchise migrants, women, and disabled through fomentation of public outrage and dissent, and in the end do nothing unless someone can figure out ‘how will we pay for it?’
These politicians. They know the cost of everything and the value of nothing.
I am reminded of the Police/MI5/MI6 security announcement that they had found no evidence of corruption involving this Tory Government, wealthy Russians or the Russian State.
When those deeply suspicious of Johnson and the Brexity Tory party continued to press, the Police/MI5/MI6 were eventually forced to claim that they had never found any evidence because they had never investigated the matter.
Off the scale dishonesty.
“Firstly, the model is based upon microeconomic foundations.”
Bit like developing/defining the control algorithms for a national power system – based on a model of household elec demand (which is stochastic by the way).
In the real world – this approach would last about 10 minutes. In the real world demand is statistical – that is how it is treated.
I’m kinda surprised the pointy heads in the BoE have not caught up.
My first reaction on reading that list is that it could probably be applied equally to any branch of Government or the Civil Service. Have we always been lions led by donkeys?
Hi Richard
This post caused me quite a bit of amusement. I particularly liked this :
“Bank of England boss, Andrew Bailey, has already said that he will act upon them. That, however, to me is the surest sign that Bernanke has missed his target”
I think it is absolutely spot on. The establishment never allows real criticism, or would act upon it.
This by Clive Parry:
“Big questions not quickly solved but at a start we must get diversity (Trade Unionists, small business owners, public servants, pensioners, non-workers etc.) it its Policy making committees and governance more broadly.”
and your own post, towards the end:
“In other words, he has made recommendations for reform of the way in which the Bank works without ever once considering the opinion, or needs, of the Bank’s stakeholders, whether they be the government, other politicians, society at large, or business of all sizes”
point out the obvious failings in this “report”.
regards
Any sensible examination of the world we live in would demonstrate that the world is not in equilibrium, still less stable; using any measure you may care to use in any rigorously examined area of human life, geopolitics, economics or even climate.
Then we turn to the economics and banking professionals; and find they are, frankly selling a particularly foul and toxic snake oil. Minsky shot their fox long ago, but here they remain, blundering uselessly in the dark; with, it seems no end to their well funded impudence, ignorance …… and tenure.
“Stochastic”and “equilibrium” are largely mutually exclusive. If we imagine a pendulum clock it can be maintained to keep excellent time by regular servicing and compensatory measures to allow for thermal and pressure variations. This equilibrium can be maintained provided there are no stochastic influences. For example if our clock is located in an earthquake zone and although it will over a long time look like equilibrium applies as it keeps time, when the major earthquake hits who knows whether the clock can be restored to its equilibrium steady state. Stochastic shocks by their nature are unpredictable but you can estimate the likelihood that one may occur such as volcanoes erupting in Iceland. You can adjust society to cope with the inherent risks but it should be obvious that a universal equilibrium is not possible in such a geologically diverse world and similarly, I suggest it is not possible to establish an equilibrium in such an economically diverse world subjected to stochastics! It reminds me of all the steady state astronomers in the middle of the last century who were vehemently opposed to the reality of an expanding universe. It couldn’t possibly have started from a “Big Bang” and yet current thinking is the expansion is still accelerating. The sooner we are rid of these recalcitrant economists the better.
Agreed
But I think you’re also agreeing these morris cannot really be stochastic
Actually the Bondi-Hoyle-Gold model is consistent with an expanding universe. What it has difficulty accounting for is the microwave background radiation.
While agreeing with all you say, I remind you there is no Nobel Prize for economics. Going along with the pretence there is is surrendering to being gaslit, helping lend credence to an entirely false reality, one created solely for the purpose of deifying the wealthy. It helps ensure future generations of schoolkids, if there are any, are brought up in a world where they learn in history of the great Alfred Nobel and his six Nobel Prizes, physics, chemistry, medicine/physiology, literature, peace and economics, and if you tried to suggest to them that there were only ever five and that the sixth was the invention of the Swedish central bank, any mention of it having long been dropped from the history books and any related syllabus, they’d think you mad. Giving all your heard-earned to the wealthy is normal and natural, they’d think, and they’d know that because science told them so, science elevated by its association with Nobel at that. We witness before us the rewriting of history to suit a malevolent minority. It should be abhorred, not encouraged by participation.
I seem to remember being taught in primary school in the 50s that there were five Nobel prizes. There was even a jingle, which I am doing my best to recall, that was supposed to help you remember what they are. I was quite surprised when I first came across the notion of a Nobel prize for economics because I didn’t think there was one!
You are right
It’s called one, but like most things in economics, is not what it claims to be
I’d almost got used to the brink of failure model where businesses and public services are pushed right to the brink of failure but kept running. Rationalisation, stripping back staff levels whilst maximising profits.
We seem to have gone beyond that now. I read an article in the Grauniad about the Post Office
https://www.theguardian.com/commentisfree/2024/apr/08/quit-royal-mail-falling-apart
which would seem to point out that it is now a zombie service. Not being kept just alive but being kept dead.
Then I listened to George Monbiot and his rivers of shit piece
https://x.com/DoubleDownNews/status/1772993830297415977
where ‘our’ water companies have moved over from being just alive to being dead but still pumping money to their puppet masters.
These are deeply unhelpful/unhealthy models being used to serve anyone but the public. These are the economic models that, like those of the BoE, are designed only to the benefit of a very few people.
The state should be rooting out these dodgy abusive models not choosing to be part of them.
“It’s difficult to get a man to understand something, when his salary depends upon his not understanding it” – Upton Sinclair
When you only have one blunt tool, which can only tackle one kind of inflation, and that’s the only justification of your ‘independence’.. you have to be very careful about what you understand.
So the Bank off England needs some money to update its forecasting model. Does it have money of its own or will it go to the government to Bailey it out?