The inflationary outbreak observed between 2021 and 2023 generated criticism of central banks for failing to predict and react in advance to the acceleration in prices.
It is in this context that, after strong pressure from the English Parliament, the Board of the Bank of England determined that there would be an external audit regarding the economic forecasting processes and the communication of monetary policy.
The person chosen to conduct this analysis was Ben Bernanke, the former president of the Fed. It is worth noting that the BoE has always been a reference for inflation targeting regimes, recognized for its high technical capacity.
After nine months, the audit led by Bernanke produced a report with a critical analysis of existing internal processes and recommendations for changes. Bernanke’s team analyzed documents and models, interviewed directors and employees, and held meetings with other central banks and private institutions. Bernanke even participated in meetings of the BoE’s Monetary Policy Committee.
In this way, the Review became not only of interest to the BoE, but also a reference for other central banks.
The analysis of the process of preparing economic forecasts and the monetary policy communication strategy resulted in the following notes and recommendations:
(1) Flaws in econometric models and software.
Bernanke showed that there were problems such as outdated parameters and a deficient database.
Recommendations: Rework the current BoE projection model. In practice, Bernanke seems to suggest starting everything from scratch. Improve the database construction process; preparation and updating of econometric models; expand teams dedicated to research and development of forecasting models.
(2) Deficiency in the use of forecasting models.
Bernanke pointed out an anchoring bias in previous projections, insufficient efforts to recognize structural changes in models, and the excessive use of human intervention in the projection process.
Recommendations: Efforts to evaluate the performance of models, seeking to identify recent deviations in projections and why they are occurring. In other words, not just using models to make projections, but also making backtests on a recurring basis. There are also suggestions for using the BoE’s expert teams more efficiently.
Suggestion that the Monetary Policy Committee give weight not only to the base scenario, but also analyze alternative scenarios in detail.
(3) Deficiency in communicating monetary policy.
The main point of attention would be the excessive focus on base-case projections as a basis for monetary policy decisions and communications.
Recommendations: Publish and use alternative scenarios more widely. Highlight in the communication the underlying hypotheses considered as standard when preparing the projections and, when applicable, highlight that the Monetary Policy Committee considers other hypotheses to be more likely.
The audit also suggested a simplification of BoE communications in order to remove the excessive weight given to the quantitative projections of the base scenario. Delete the projection confidence interval graph (fan chart), due to its technical deficiencies and ineffectiveness as a communication tool. Alternative scenarios would take the place as an instrument to indicate the Committee’s uncertainty and balance of risks.
Finally, we return to the original question: whether the BoE can be held responsible for errors in its projections.
Comparing with the performance of other central banks, the study concluded that the BoE was no different from the others. If it weren’t for the flaws in the process of preparing the projections, the BoE could have had external audit approval.
After its results were published on April 12, the “Bernanke Audit” received a response from the BoE on the same day. The executives and staff of the BoE thanked the recommendations and recognized opportunities for improvement.
The answer begins by highlighting the main positive point of the report: the BoE achieved the same performance in its projections as other central banks and private institutions. Furthermore, it was a period of great shocks, which effectively clears him of the accusation regarding his economic projections.
Regarding data and modeling infrastructure failures, the response points out that an investment plan in data infrastructure has already been initiated since 2023.
The BoE’s response also pays special attention to recommendations about removing weight from base-case projections. The bank argues that the process worked very well for decades, but that structural changes and substantial shocks in recent years have hampered the success of the approach that had proven robust until then.
The BoE recognizes that Bernanke’s recommendations are appropriate and should serve as guidance for change. In the communication strategy, the institution seems to agree with the replacement of fan charts for publishing alternative scenarios.
The document establishes a strategic plan to implement improvements. The evolution of the BoE, which was at the forefront in many aspects in the construction of inflation targeting regimes, will certainly be a source of inspiration and reference for other central banks. Changes are coming and a progress report on the implementation of the initiatives will be published at the end of the year.
The recommendations of the “Bernanke Audit” should also be carefully evaluated by other central banks, developed and emerging. Even for the Central Bank of Brazil, recognized for using an excellent process, several points raised by the study can spark debates about potential improvements.
Marcelo Cirne de Toledo is the chief economist at Bradesco Asset Management.
Marcelo Cirne de Toledo
Tags: Monetary policy postcovid period Bank Englands Bernanke audit
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