The Bank of England forecast mystery
The Bank of England’s forecast for UK growth over the coming years is remarkably bullish compared with other forecasters.
Michael Saunders of Citigroup illustrates just how bullish in this chart:
The Bank of England is forecasting significantly higher growth than the IMF, the National Institute of Economic and Social Research and City economists.
In this month’s Inflation Report the Bank doesn’t really explain this optimistic forecast. But it does say:
“By end of the second year of the forecast, the risks of growth being above or below its historical average rate are broadly equal.”
So the Bank seems to be assuming that growth will pretty much snap back to trend. But as Michael Saunders points out, the Bank of England’s forecast for 2014 - 2.9% - is actually above the UK’s historic trend, which he estimates at 2.3% over the past 20 years and 2.4% over the past 50 years.
Is the Bank actually expecting lower growth then? If so, this would lead to another policy problem according to Saunders:
“If the MPC actually did project that growth will be in line with its ‘historical average’ (ie 2.3-2.4%) then presumably they would not expect the output gap to close and they would project sub-target inflation over the medium-term.”
What he is saying is that if the Bank expects the UK to return only to its long term trend rate of growth it should, logically, also expect inflation to be lower than the 2 per cent target over the next two years. Why? Because there is a surplus of unemployed resources in the economy (jobless workers and unused factory capacity) thanks to the recession. And this surplus should continue to act as a drag on price rises until these resources are put back to work. A growth spurt would accomplish that. But mere trend growth leaves a gap. Therefore the Bank should be filling it with more quantitative easing.
In one sense this logic chopping is ridiculous. Everyone knows that these growth forecasts – even those of the Bank of England – are highly speculative, so drawing exact monetary policy prescriptions from them makes no sense.
But in another sense it does matter. What financial markets expect from the Bank is intellectual consistency so they can plan their trades. It’s not good for confidence if they suspect that consistency is lacking.Tagged in: citigroup, growth, inflation, Michael Saunders, trend
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