After the Bank of England failed to predict the recent rise in inflation, the governor of the central bank has admitted that there are “very important lessons” to be learned when setting monetary policies.
Andrew Bailey, along with other members of BoE’s Monetary Policy Committee told the House of Commons Treasury Select Committee on Tuesday that its own forecasting model did not produce accurate results and that the committee has reduced its role in setting interest rates.
“We are not following the model because of asymmetrical effects [in BoE’s view on the path of inflation]. . . The governor stated that we have made a conscious choice to ignore [the predictions of the model].
He said the inflationwould likely fall more slowly than predicted by the model from the March rate of 10.1 percent to the BoE target of 2 percent.
Bailey stated that the BoE should now focus on “how to operate monetary policies in the face very large shocks”. Bailey added: “We have to take action and bring inflation down.”
The BoE’s forecasting model assumes that the inflation rate will fall as fast as it appears. However, the MPC has been tweaking its results in order to counter this assumption.
Officials now say that they believe wages and prices are likely to continue rising faster than central predictions of the model.
The MPC believes that there is a 50% chance of it not falling below the target.
Bailey refused to comment on whether interest rates would continue to rise after the BoE increased them to 4.5 percent this month. He said: “I cannot tell you if we are at or near the peak but I can say that we are nearer the peak.”
The MPC, which votes independently to set interest rates, also made similar comments about the difficulty of forecasting inflation.
Huw Pill, chief economist at the Bank of England, said that the economic models were not able to deal with recent shocks in energy and food costs because they were built on periods where such shocks did not occur.
He said that MPC couldn’t rely on past episodes of high-inflation in the 1970s or 1980s, because so many other factors had changed.
Catherine Mann, a member of the MPC who is not a committee member, stated that she voted higher than the majority because she thought the inflation would lead to higher wages and encourage companies to increase prices.