Bank of England threat – to central banks

  • The Bank of England has outlined the economic consequences of Brexit
  • It has failed to apply a ‘plausibility test’ to its results
  • This actually helps hard-line Brexiteers, as well as those who would erode central bank independence

Yesterday (28th November, 2018), the Bank of England published a report called ‘EU withdrawal scenarios and monetary and financial stability’. The report was requested by the House of Commons Treasury Committee. Its publication received substantial attention because in its worst outcome (the disorderly no deal no transition scenario) the Bank estimates that the impact on the UK economy could be worse than the 2008 Great Recession, and therefore the worst downturn since the Great Depression of the 1930s.

It is not the Bank’s fault that journalists fasten on to the most spectacular part of the report, which will make for the biggest news. Certainly, the worst possible outcomes, where everything that can go wrong, goes wrong, make for wonderful headlines, to wit:

  • A fall in GDP relative to the May 2016 trend of 10½% by 2023; but relative to the November 2018 projection, a fall of ‘only’ 7¾%.
  • Unemployment between 5¾% and 7½% by 2023.
  • Inflation between 4¼% and 6½% by 2023.
  • House prices falling by up to one-third.
  • And all this necessitating a Bank Rate of around 5½%.

No doubt this is exactly what comes out of the Bank’s models, once these have been fed the relevant inputs. And, to be fair, the text of the report is replete with statements that these are not forecasts, with warnings of uncertainties and of forecasting difficulties and the unlikelihood of the worst-case outcomes stressed.

Possibly the only surprising point is that the Bank’s Financial Policy Committee (FPC) “judges that the UK banking system is strong enough to serve UK households and businesses even in a disorderly Brexit.” But perhaps that is not surprising at all – any other conclusion would mean acknowledging that the FPC has failed in its task.

Even as a Remainer (someone who hopes that, somehow, the United Kingdom could remain in the EU or at least the EEA), it is difficult to avoid being dismayed by the Bank report. The Bank’s forecasters have not covered themselves with glory in recent years. They forecast a recession if the 2016 referendum resulted in a vote for Brexit. It did – no recession. In August 2013, Governor Carney promised that monetary policy would remain unchanged until unemployment fell below 7%, something he forecast would take three years. In fact, it only took six months. And so on.

Every forecaster knows that any ‘automatic’ result derived by equations or numbers, whether in a model, a linear regression or anything else, needs to pass some form of plausibility test. A disorderly no deal no transition Brexit would probably be bad and would probably be compounded by the lack of future trade agreement with the EU. But it is very difficult – not least in light of the Bank’s own faith in the banking system – to accept that it would be worse than 2008.

By failing to apply the plausibility test, the Bank has committed two mistakes:

First, it has given further ammunition to those who would like to see a no deal Brexit. They will (in fact, they already are) accuse the Bank of exaggerating again, and urge voters, MPs and everyone else to dismiss the entire report as another attempt at ‘Project Fear’.

Second, it has giving further ammunition to those who feel that central banks’ independence needs to be curtailed.

The Bank has, it seems, forgotten the fable of the boy who cried wolf. Repeated predictions of blood-curdling outcomes are in themselves subject to the law of diminishing returns. More seriously, the Bank, as an institution that in the public mind is now firmly identified with Remain, should be doubly, if not trebly, careful of what it says on the subject.  It has a duty to offer its opinion and advice, but it is (alas) no longer viewed by much of the population as a neutral voice.  As such, those that disagree will say ‘Well they would say that, wouldn’t they?’.

To overcome this, it is not only a plausibility check that the Bank needs to apply but a political ‘red rag to a bull’ check.  Once you are no longer seen as a neutral outsider to a debate, those who disagree with you will not listen or be persuaded by your argument – if anything it will harden their views against you.

Most seriously of all, when an institution that is known to be hostile to Brexit predicts such a disastrous outcome, it calls into question whether the Bank is able any more to distinguish between what it expects to happen, and what it secretly wants to happen in order to prove all those stupid Brexiteers wrong.

Governor Carney has done the Bank, and by extension the cause of all central banks and central bank independence, no favours with this lurid and apocalyptic warning.