Economists, huh? Central bankers took credit for that period of seemingly never-ending growth – the period known as NICE, and then when things went pear- shaped they said: “Well it wasn’t my fault.” Alan Greenspan was the worst. The maestro happily took plaudits for keeping inflation down and growth up, but where was his humility when things went wrong? And then there’s the Bank of England. Sure, weren’t they clever during the NICE decade. But now they are about as accurate at forecasting inflation as airport authorities are at predicting bad weather.
It is just that the criticisms are unfair, and in a speech last night, the Bank of England’s arch dove Adam Posen helped to explain why.
First of all, critics want it both ways. First they say central bankers take too much credit for things. And secondly, they want to know why the Bank of England has been so bad at predicting inflation recently.
The truth is, however, that in his book, The Age of Turbulence, Alan Greenspan said that he had been given too much credit for creating the NICE decade – and that his role in that period has been greatly exaggerated.
Secondly, Alan Greenspan never really did know. When he said: “If you think I am making myself clear, then that probably means you have misunderstood me.” What he was in effect saying is that the markets hate it when he says “I don’t know,” so instead he says: “I don’t know, but in such a complicated way that no one understands me.”
Central bankers really aren’t as clever as we are led to believe.
And that applies now as regards getting inflation right.
In a speech yesterday Adam Posen summed up his reason for believing inflation will fall. And he pretty much made the arguments we have made here enough times. Two factors have pushed inflation over target: the cheap pound and the hike in VAT. CPIY inflation, that’s inflation after deducting the effect of indirect taxes such as VAT, was just 1.5 per cent in the year to November.
Next year, inflation will go up because VAT will go up. But it seems probable the pound will strengthen against the euro and the dollar, which will at least compensate for some of the effects of rising VAT. If Capital Economics is right, and commodity prices fall sharply next year or in 2012, then the prognosis for inflation over the medium term is actually very good.
So why does the Bank of England keep getting it wrong? Mr Posen said: “I think both the Bank of England and the public gained an exaggerated confidence over the NICE decade of 1997-2007 about just how finely the MPC could both forecast and control inflation. We can still control inflation over the medium-term, but the degree of extreme predictability seen then was due not just to the good policy regime, but was also partly due to good luck in terms of the absence of major shocks, and thus was misleading.”
In other words, getting inflation predictions right is very difficult.
And that’s the problem. Mr Posen talked about humility moving forward, and admitting to uncertainties.
There are two snags.
For one thing, markets hate it when central bankers say they don’t know, and much prefer it when they seem to know the answer, even if really they are guessing.
For another thing, central bankers are paid rather well, maybe too well if they are going to get humble and say things like “Not sure about that.”
So, in the interests of protecting their salaries, central bankers might be far better off if they blind us all with mumbo-jumbo, and make things so complicated that anyone who claims to understand must clearly be a charlatan.
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