View is better from the ivory tower
Saturday 15 August 1998
It is not just manufacturers who favour this work-creation scheme for their own ranks, but also many members of the economics commentariat who ought to know better. The objection to appointing people who supposedly have more real-world experience than the out-of-touch egg-heads in Threadneedle Street goes beyond the obvious one that you should not let the drunks run the brewery. After all, industry loves a boom; it is the busts they object to.
Rather, it is a question of how to form judgments on the state of the economy, present and future. The objection from the Bank's critics in the "real world" is that the MPC has set interest rates too high given the strength of the pound. They argue that the nine experts - save for their new heroine DeAnne Julius - are over-estimating both the current strength of the economy and the inflationary dangers. The cost of borrowing should be on its way down by now, say employers, unions and plenty of City pundits. With so many critics, whose objections have dominated the reporting of the Committee's decisions, it would be easy to believe that Gordon Brown has appointed too many mad professors and should replace some with straight-thinking business folk, pronto.
No wonder the Bank has commissioned some opinion pollsters to find out exactly what popular misconceptions it is up against. For the easy conclusion is utterly wrong. The practical experience of people in industry is a terrible guide to the level of interest rates needed for the economy as a whole to grow at a pace consistent with the inflation target. For one thing, manufacturers naturally want to see rates set at a level to suit their businesses. This level is lower for manufacturing than for the whole economy because industry is the weakest sector. The policy decision has to weigh manufacturing, services and construction together.
For another, non-experts are more likely to misread the available evidence on the economy. While there is no doubt growth is slowing markedly now, the official figures are nothing like as gloomy as the comment. "Real world" people place far too much emphasis on anecdote on the grounds that it is a more up-to-date economic thermometer. Well maybe, but the timely anecdotal evidence is usually wildly inaccurate. It is no advantage to take the temperature faster if the reading is wrong.
The past week has provided an excellent example of this. The loss of jobs, for various reasons, at Siemens, BOC and elsewhere has been used widely as proof of the imminence of recession. Yet the creation of 500 jobs by the Pru got scarcely a mention. As a rule of thumb, it takes 1,000 new jobs to generate the same attention as 100 job losses. The only way to assess the true net effect of all the corporate decisions on the level of employment is to wait for the official statistics, and these show that unemployment is still falling despite redundancies in manufacturing.
Similarly, many of the Bank's critics quarrel with its inflation forecast on the grounds of the unworldliness of the team of economists who crank through the numbers each quarter. The update in Wednesday's Inflation Report again predicted that inflation would be threatening to bust target next year - the result of a combination of monetary policy that was too lax up to about a year ago and the likelihood that the pound will fall much lower. Many of the "real world" critics simply refuse to believe inflation will go up at all, extrapolating from current conditions where the strong pound is making imports cheap and competition on the high street is keeping a lid on the prices of certain goods.
Most industrialists will have no truck with fancy computer models of the economy that attempt to forecast the future, but there is absolutely no reason to believe their experience in a particular business would make them any better than the Bank's profs at economic forecasting. The future is simply not the same as the past.
These pitfalls are identified in a new book* by Alan Blinder, an American professor of economics who served as vice-chairman of the US Federal Reserve Board. He writes: "You can get your information about the economy from admittedly fallible statistical relationships, or you can ask your uncle. ... I fear there may be altogether too much uncle-asking."
There is no better way to make interest-rate judgements than to rely on a combination of official figures - always more reliable than the alternative - and on theoretical models of the economy. No matter how flawed, they are better than anybody's gut instincts.
Professor Blinder adds that a good central bank will always set people grumbling precisely because it is trying to influence the future and not the present. It is too late to do anything about today's inflation rate. Today's job is keeping inflation on course over an 18-month to two-year horizon because that is how long it takes inflation to respond to changes in the pace of activity. This is why inflation rises as growth slows as every cycle peaks, and why inflation is low even as growth belts away after every trough. For the more excitable, the economy lurches from miracle to stagflation, but it is the normal pattern. A good central bank will end up seeming too hawkish and then too doveish. "A successful stabilisation policy based on pre-emptive strikes will appear to be misguided and may therefore leave the central bank open to severe criticism," writes Professor Blinder.
He warns that few central banks actually find themselves in the happy position of being criticised for the right reasons. "Decision-making by committee may contribute to systematic policy errors ... by inducing the central bank to maintain its policy stance too long." But, equally, committees guard against horrendous mistakes. If they are wrong, they are usually not too far wrong.
This is the case in the UK now. The Bank's critics are fooling themselves if they believe that any sensible method of setting interest rates - even the former method of leaving it up to good old Ken Clarke - would have produced a level very different from today's 7.5 per cent. Likewise, the last quarter-point increase, or even the next, will not turn out to have been a matter of life or death for manufacturing. Such small steps simply do not have a big impact on the economy; it takes the whole series of small steps to make a difference.
The critics are not fools; these are pretty obvious points. Rather, they are lobbyists for their own interests, which in the short run would be better served by an economy growing too fast for the MPC to be confident of hitting the inflation target. The payback of low and stable inflation is too far away for exporters currently in the stranglehold of a strong exchange rate. But this is precisely why the MPC should consist of experts rather than representatives of sectors of the economy. The view is far better from the ivory tower.
*"Central Banking in Theory and Practice", Alan Blinder, MIT Press, $14.95
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