Economic forecasting, inflation and the 21st century bankers' ramp

The question of inflation has again been on my mind. Not the usual concern about how inflation is being used as a stealth tax but a more technical concern. One reflected in this quote from a short piece by Andrew Sentence, a member of the Bank of England’s Monetary Policy Committee (MPC):

Bank's inflation forecasts have consistently underestimated the upside impact from rising global energy and commodity prices and persistently overstated the downward pressure on inflation from spare capacity in the UK economy.

Put simply, since 2007 the Bank of England has consistently got its inflation forecasts wrong and the error has nearly always been to underestimate the rate. And while this may seem to be a technical consideration, we should recognise that the result of this under-estimation has been a monetary strategy predicated on the expectation of deflation during a period when, in fact, inflation rates were rising. There is no doubt in my mind that this error – compounded over time – is damaging our economy.

But why do we make the error? I am not minded to consider that it is some form of dark conspiracy intended to manipulate the economy in the interests of a corrupted banking system (although at times it does seem that way). Perhaps it lies in that quote from Andrew Sentence – we are wedded to the idea of recession representing idle capacity. Of great machines standing unused, waiting for glimmers of hope – those legendary green shoots – before surging once again into action.

Yet the truth is that – even in manufacturing and distribution – businesses simply do not hold large amounts of spare capacity. Just-in-time processes, outsourcing and a more flexible labour market (domestically and internationally) have made that unnecessary. Just look at the rate of job creation in the productive sector since growth began again in the UK:

…the UK economy has returned to growth more strongly than most expected. UK GDP has grown by 2.8pc over the past year – ahead of the pace of recovery in the early stages of the previous two recoveries.

Employment has risen by around 350,000 since early 2010. And manufacturing industry has recorded the strongest growth since 1994, supported by strong global growth and a competitive exchange rate.

All of which is, of course, contributing to inflation. Indeed when we look at the world market prices for primary commodities – wheat, oil, gas, copper, coffee – we see buoyant, rising prices driven by growing international demand. And this is driving inflation. Unless of course you’re Paul Krugman – who may be a Nobel Prize winning economist but believes that rising commodity prices are a signal of deflation!

It seems to me that economic forecasting – whether it be growth, inflation or employment – has become less reliable because it is stuck with models created to describe a pre-internet, manufacturing economy rather than today’s more flexible and responsive business environment. None of this suits the banks – who are bothered about all those, now unsecured, property loans on their books rather than about the real economy. And sadly – as we’ve seen in the UK, in the USA and tragically in Ireland – our political masters are so in hock to the banks (in order to keep all those expensive public services going) they’ll damage the real productive economy rather than allow the truth about banks, government and property to come out into the open.

…so maybe it really is a bankers’ ramp?

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