Bank of England commits to ‘once in a generation’ reform after Bernanke review

The review, launched last summer, was led by Ben Bernanke, who chaired the Federal Reserve between 2006 and 2014.

Apr 12, 2024 - 19:26
Bank of England commits to ‘once in a generation’ reform after Bernanke review

The review, launched last summer, was led by Ben Bernanke, who chaired the Federal Reserve between 2006 and 2014.

The Bank of England has committed to a “once in a generation” review of its forecasts and communications after Ben Bernanke’s review found some major shortcomings with its current operations.

The changes will likely see major investments in the Bank’s backroom operations as well as a much larger role for scenario-based analyses in its economic projections.

The commitment comes after this afternoon’s publication of the Bernanke review, which found several major problems with the Bank’s approach over the last few years.

The review, led by the former Fed chair, was launched last summer after the Bank of England’s forecasts repeatedly failed to get to grips with the surge in inflation following the Russian invasion of Ukraine.

In the months that followed, the Bank’s communications also received heavy criticism as policymakers were forced to hike interest rates further and faster than they had previously signalled.

The review’s recommendations were summarised in three main points:

  • Building and maintaining a high quality infrastructure for forecasting and analysis.
  • Providing a forecast process that better supports the MPC’s decision-making.
  • Using the forecast to communicate the MPC’s outlook and policy rationale to the public.

Bernanke said the “most serious problems” found during the review were in the Bank’s forecasting infrastructure. Some key software was out of date, while important functionality was also missing.

Bernanke said there had been “material under-investment” in core infrastructure. Too often, Bank staff were unable to address the problems with the models because they were spending more time creating the quarterly forecasts.

Regarding the forecasts themselves, Bernanke noted that the Bank’s projections over the past few years had performed in line with other central banks and independent forecasters.

“Unusually large forecasting errors by the Bank during that period were probably inevitable,” the review said given the number of shocks the global economy has faced.

Nevertheless, Bernanke said there were lessons to be learnt, particularly when it came to communicating uncertainty. Currently, the Bank publishes two forecasts, one based on market expectations for interest rates and the other based on a constant Bank Rate.

Given the greater degree of geopolitical and economic uncertainty, Bernanke suggested that the Bank make “expanded use of alternative scenarios” in order to explore the potential impact of different macro possibilities and domestic policy choices.

Greater use of scenarios would make the Bank’s communication clearer, too, Bernanke argued.

The use of scenarios would provide the public with “additional useful information about the rationales for policy choices, the risks to the forecast, and the robustness of the MPC’s policy plans in the face of uncertainty about key aspects of the economy’s state and structure,” the report said.

However, the review stopped short of recommending that the Bank of England publish its own rate projection. Instead, it said the central forecast, based on the market path, should be “de-emphasised”.

The Bank should be “exceptionally clear” about where it disagrees with the market path.

This would help avoid situations where the Bank ends up misleading the public in order to send a signal to the market, like in November 2022 when it forecasted the longest recession in history based on a very unlikely market path for interest rates.

Bernanke also said that the Bank’s fan charts “should be eliminated”. Fan charts use a distribution of probabilities to signal uncertainty around the forecast, but the charts have become increasingly wide, reflecting growing uncertainty about the future.

“The forecasting and policy challenges faced by the Bank of England in recent years were hardly unique,” Ben Bernanke said.

“The Bank, like other central banks and policy institutions, will be working to draw the appropriate lessons from this experience,” he continued.

In response to the report, the Bank said it would initiate a “substantial upgrade programme” with changes introduced in a phased manner.

The Bank committed to reconsidering the role of the central projection as well as how use of alternative scenarios could augment its forecasts.

Scenario-based analyses are likely to replace fan charts, but it is unclear what form this will take. The Bank said the use of scenarios will require “careful consideration”, noting other strategies were also available.

Andrew Bailey, governor of the Bank, welcomed the review. “This is a once in a generation opportunity to update our approach to forecasting, and ensure it is fit for our more uncertain world”.