Economic Trends: Politics, Economics and Fact

The Treasury and the Bank of England have embarked on another scaremongering campaign to tell us us how dire life will be if we leave the EU with a WTO deal.

The Treasury forecasts that our incomes will drop by 10.7 per cent over the next fifteen years. The Bank of England has joined in with dire warnings on incomes, property prices, the exchange rate, and inflation.

Economic forecasting is a notoriously hazardous trade. But there is an insatiable demand for it and so, there will always be some kind of supply. Forecasts of the next period’s outcome are often best estimated as being the same as the present period. But economists produce estimates from different complicated models, claiming great precision and often to more than one decimal place. Sometimes they go beyond a one-year out forecast – as far as five or ten or even fifteen years in the recent examples and those that followed the referendum. For these forecasts the consumer needs a very good sense of humour. Even the best-intentioned economic forecasts should be treated with caution.  Moreover, it should not be forgotten that in ‘normal’ times the Bank of England’s forecasting record was not good. Such forecasts should certainly be treated with scepticism when the producers have some case to make. They should be ignored when the producers are endeavouring to frighten the consumer.

The facts are that the British economy has, over the last two hundred years or so, grown on trend at between 2 and 3 per cent. Occasionally, it has slipped a bit below for a short spell and perhaps risen a bit above for a few years. That 2 or so per cent on trend held over all manner of economic and exchange-rate regimes and through huge structural changes in the economy. At the same time the economy has always moved with some ebb and flow, a clear rhythm. It was once called the trade cycle but more recently the business cycle. From one peak or trough in activity to another took around 5-7 years. In the upswing of the cycle the growth rate would be a bit above the trend rate and in the downswing a bit below trend rate. The downswing became thought of as the recessionary phase in the cycle. Some recessions were deeper than others. What triggered a sharp contraction (which was rare) was generally misguided economic policy, usually monetary but possibly fiscal policy. If the Bank of England concentrates on its mandate of delivering monetary and financial stability the economy can then be left to deliver whatever it is that it is capable of.

But the Governor says that the exchange rate will collapse and bring about inflation. Leaving aside how anyone can predict where a price will move to, given all the unknowables, it is the inflation bit that is interesting. The mandate of the Bank is to deliver monetary/price stability – specifically inflation of about 2 per cent. Presumably, having accepted the job of Governor meant believing that he had the means to deliver on the mandate even if we had a flexible exchange rate. The previous Governor made it clear he did when he said you could have whatever inflation rate you wanted. So why the scare-mongering now?

These elements raise another more serious question, that of central bank independence. Central bank independence is a fragile plant. At base it means that politicians will leave the Bank alone to carry out its clearly defined work. And the Bank should resist any attempt at pressure from the politicians. It should also stay well clear of any political programme. By all means carry out work in preparation for all manner of possibilities that could arise and keep the results in readiness for action if anything approaching the predicted path begins to emerge. That would simply be part of its job but it should not be part of a political programme.

 

Professor Forrest Capie

Forrest Capie is Professor Emeritus of Economic History at the Cass Business School at City University and was editor of the Economic History Review between 1993 and 1999. His recent publications include Monetary History of the UK (Routledge, 2015) and The Bank of England, 1950s to 1979 (Cambridge, 2012) and for Politeia he was co-author of Banking on Recovery: Towards an accountable, stable financial sector (2016).

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