Our Dull Low-Inflation World Still Needs the Art of Nimble Economic Policy Making
King, Stephen, The Independent (London, England)
If you ever have the time, it's worth logging on to the Bank of England's website and taking a look at the press conference that followed the release of the Bank of England's latest Inflation Report. The key address is www.bankofengland.co.uk and you simply need to click on to the box that takes you through to the webcast. While it may not be the most titillating webcast ever placed on the internet, it certainly provides an interesting overview of the challenges that face economic policymakers not just in the UK, but around the world as a whole.
One of the Bank's biggest difficulties lies in knowing, precisely, what's going on at any moment in time. The Bank clearly distrusts the data it receives from the Office for National Statistics (ONS), not so much because the ONS is error-prone but, rather, because the ONS simply doesn't have enough information available to make a reliable and accurate quick-fire assessment of the economy's performance from one quarter to the next.
For an economy like the UK's, heavily dependent on services, it's not enough to be able to count the number of widgets churned out from one month to the next: information on services, though, comes through only in dribs and drabs. As a result, initial estimates of GDP are best regarded as the first snapshots taken from the camera on a mobile phone rather than the 8 megapixel images that might come from a truly professional camera " at best, therefore, a foggy representation of the truth.
On top of that, the imagery the Bank requires is multi- dimensional whereas the ONS's first estimates are merely two- dimensional. The budding policymaking cameraman has to incorporate more shots from different angles to get a better picture of what is really going on. And those new images take time to put together. One implication of this is that the Bank is likely to make mistakes of interpretation from time to time: it sets policy on the basis of what appears to be happening rather than on the basis of what actually is happening. It's a bit like seeing a wedding day snapshot and concluding that bride and groom are now living happily ever after, perhaps with a baby on the way: only later on do you discover that the groom ran off with the best man before the vows were taken.
Central bankers have to rely on a hypothesis, an approximation of reality that can continuously be tested over a period of time. Currently, for example, the Bank is concerned about the impact of higher oil prices. It knows what oil prices have done up until now, it knows what futures markets are thinking oil prices will do in the future and it also knows that futures markets have been wrong. But even if the Bank had perfect foresight, it would still have a problem: it has to provide a hypothesis of how, exactly, higher oil prices feed through to the broader economy.
An obvious difficulty lies in assessing precisely why oil prices are higher. On one interpretation, higher oil prices stem from supply-side shocks, the kind of thing that happened after the 1973 Yom Kippur war. On another interpretation, they're the result of stronger than expected demand, the result of faster global economic growth. Currently, the second of these interpretations looks to be the better bet. Then there's the question of who, in the world, is delivering strong demand. It's certainly not the usual G7 suspects: Britain's European trading partners are still very weak, despite some slightly better business surveys in recent months. The US consumer is playing a role, but the biggest increases in demand for commodities are coming from countries like China. And while they may be contributing to higher global energy and other raw materials prices, they're also putting downward pressure on global wage levels. …