Bank of England (Economic Affairs Committee Report)

Lord Burns Excerpts

Thursday 2nd May 2024 Lords Chamber

[Lord Burns (CB)]

My Lords, I am also grateful to the noble Lord, Lord Bridges, for introducing this debate. I congratulate the noble Lord, Lord Moynihan of Chelsea, on his maiden speech and his entrepreneurial career. I am sure we will hear much more from him on many of the topics we are talking about this afternoon.

This is an important report. The noble Lord, Lord Bridges, set out its conclusions well. In particular, he described how the monetary framework has been severely tested in recent years. I was not a member of the committee when the report was published, but I am pleased to say that I am now once again a member of it.

It is striking. We must bear in mind that the increase in prices over the past three years has been over 20%—more than three times the target at the time. We should not forget that, on the eve of the Russian invasion of Ukraine, inflation was already well above target. It must also be acknowledged that this is a problem shared with many other major countries, although it has been pointed out that some managed to avoid this—certainly to the extent that we have suffered.

I will limit my comments to some of the issues covered in the report where I have some experience. The first relates to economic forecasts. When the noble Lord, Lord Lamont, introduced the inflation target rating in 1992, we knew that maintaining inflation within a narrow range would not be easy. Interest rates have to be set on the prospects for inflation some time ahead. This inevitably means some reliance on judgments about the outlook over the next two years or even more.

I carry many bruises from my own time in the forecasting business. The evidence is clear that making accurate forecasts for inflation over this kind of time horizon is very difficult. The noble Lord, Lord Lawson, often said to me when he was Chancellor that forecasts work well when the economy is behaving well and you do not need them, but they are at their weakest when the economy is subject to volatile circumstances and you need them the most. I think the experience since the Bank of England’s independence is consistent with this. During the great moderation, as we know, the forecasting record was astonishingly good. It is only when we have come to this time of turbulence that we have seen just how bad it can be.

I remain an enthusiastic supporter of trying to create models of economic processes. There is much to be learned from the discipline of testing hypotheses about behaviour against data from the past. But, if events take us outside our historic experience, it has to be said that these relationships will be prone to error. I fear the Covid lockdown was one such experience. So, although I have some sympathy for the forecasters, especially in a world full of people with perfect hindsight, we also need to ask questions about the lessons that should be learned.

I am concerned that, over the years since the MPC was established, an increasing emphasis has been given to model forecasts, and I worry that the MPC has gone too far in this direction. Forecasts must be used with care, and model forecasts should not be the only guide to decisions. They have to be looked at, as several other speakers have said, alongside a range of other indicators: monetary and financial measures, as well as labour market pressures and, crucially, what is happening in other countries and in world markets generally. It is also advisable to spend time understanding the source of errors in the recent past and whether they have clues to the future.

Reading the Bank’s monetary reports, I have a further worry. The forecasts are presented as the forecasts of the MPC itself. It takes collective ownership of the process and the forecasts, but I am not sure how a group of this size with several part-time outside members can do this effectively. Surely it would be better if the forecasts were owned by an executive forecasting team, and the MPC would then take them into account, along with other forecasts, analysis and insights, in making its decisions.

This leads me to the concern in the committee’s report that there might be an absence of challenge, and the issue of intellectual diversity. I would like to see the minutes include contributions from individual members of the MPC, setting out briefly why, on balance, they have reached their decision and the main factors they have considered. We have the votes but not the reasons for the votes set out in a systematic way.

Recently, I have been looking at some of the published minutes of the monthly monetary meetings that took place between the Chancellor and governor in the pre-independence era. One interesting feature there is the extent of the challenge between the main participants—what came to be known as the “Ken and Eddie show”. At the end of those meetings, first the governor and then the Chancellor would summarise the balancing of the factors and their views on whether to change interest rates. There are some useful ideas here about how this could work for members of the MPC, so that we could hear rather more about the balancing process, rather than this astonishing degree of agreement most of the time.

My final group of concerns is around the issue of operational independence versus policy independence. In its initial form in 1997, the emphasis was very much on operational independence, with the Chancellor setting policy through the remit and the inflation target. With the extension and greater complexity of the remit, and with the emergence of QE and QT, this distinction has become, to my mind, much more blurred. For example, once the inflation rate is outside the normal tolerance band, it seems to me that there is an important question of who should decide the speed for aiming to return inflation to its target. For me, this is as much a policy question as it is an operational question. Surely the Chancellor should be more actively involved in this issue than we have observed.

There is a similar issue about governance surrounding QE and QT, and there is a clear role for both, as temporary measures under extreme circumstances, to occur. We saw the success particularly during the international financial crisis. However, since the onset of Covid, it has been done in a way that has been pointed out by several speakers: it has logged up huge mark-to-market losses and higher debt interest costs. We have still had no answer to the questions: “What account was taken of the potential fiscal costs when the decisions were made, who should have been the decision-makers and who should have been bearing the risk?”

The Bank sees QE as a monetary operation and therefore one for it. But the Treasury, of course, provides the Bank with an indemnity for any losses. This suggests to me that this is a policy question as well as an operational matter, and I am surprised that there appears to be no established or regular mechanism between the Bank and the Treasury for looking at the fiscal risks involved in a policy that is as extensive as it has been.

Finally, the Bernanke report set out many criticisms of the forecasting hardware of the Bank and the failure to monitor and maintain some parts of it. Along with the noble Baroness, Lady Lane-Fox, who mentioned this, I find it deeply disappointing that some of the basics of model building and the handling of digital information should be ignored when the model itself is given such a prominent role. I hope that we will see the kind of investment that is needed there if we are to bring that into the modern age.