Times are getting harder for us at MoneyWeek: so many people seem to be coming round to our way of thinking (double-dip, etc) that we can barely consider ourselves contrarian anymore.
On Tuesday the US Federal Reserve downgraded its expectations for US growth, made moves to ease monetary policy again and appeared to become a firm member of the deflationary camp. Apparently, “the pace of economic recovery is likely to be more modest in the near term than anticipated” and “inflation is likely to be subdued for some time”. Much the same happened here on Wednesday when our own inflation report emerged from the Bank of England. Growth forecasts were cut; we were told that, “it will take many years before bank balance sheets and fiscal positions return to anything like normal”; and Mervyn King also made it clear that he thinks it is only the odd exceptional factor, such as VAT rises, that will keep inflation rates high.
But how much should we really care about the forecasts of our central bankers? We know they were hopeless at forecasting, or even recognising, the banking crisis and its consequent recession. Back in 2008, the Bank said its “central projection was for GDP to be broadly flat over the next year or so”. The economy actually shrank more than 6% in the following months.
We know they’ve been just as useless at predicting its path. Even in May, when it was obvious to almost everyone that the ongoing contraction in bank lending was bad news for growth, the Bank was predicting GDP would expand by a fantastical 3.4% in 2011. That number has now been downgraded to a slightly less optimistic 2.5%. But possibly worst of all, the Bank has constantly underestimated inflation: the consumer price index has been above target in 42 of the last 51 months.
There’s every chance this particular bout of terrible forecasting has been, at least in part, intentional. The last thing the Bank wants is to forecast rising inflation. If it did, under its central inflation control remit, it would then have to raise interest rates at a time when it knows that to do so would push the housing market, and hence consumption, over the edge.
Nonetheless, the more our central bankers get their growth and inflation targets wrong, the less likely the market and general population is to put any store by them. And that could be a major problem. One reason for having inflation targets is to convince people that prices will be stable and stop them doing the things that make sense in a high inflation environment (demanding fast-rising wages, refusing to hold cash, and so on). Right now what inflation there is comes from prices, not wages – we’re importing it from Asia, where consumer prices in China rose 3.3% in July alone, for example.
But if we all stop believing Mervyn King’s forecasts and start to notice the steady erosion of our living standards that comes with stagnant wages and rising import prices, things could rapidly turn nasty. The Bank is now to spend £3.5m on building a new model for forecasting the future of the economy. Let’s hope it works a lot better than the last one.