Charles Bean: Business surveys and monetary policy
Speech by Mr Charles Bean, Deputy Governor (Monetary Policy) of the Bank of England, at
the CBI Industrial Trends Survey 50th Anniversary Reception, Centre Point, London, 24 July
2008.
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Good evening! It is a great pleasure to be asked to say a few words to mark the 50th birthday
of the CBI's Industrial Trends survey. The birthday boy and I have, in fact, been acquainted
with each other for over thirty years - from when I started my professional career in 1975 as
a forecaster in the Treasury. In those days, the quarterly Industrial Trends survey was really
the only game in town as far as business surveys go. Since then, the field has become more
crowded, but the Industrial Trends survey remains a key source of information about
business developments.
To celebrate the survey's birthday, I thought that I might say a few words tonight about the
part played by business surveys, and intelligence about business conditions more generally,
in our setting of Bank Rate each month. Because our interest rate decisions affect UK
economic activity and inflation with a rather long, and sometimes rather variable, lag, there is
nothing much that we can do to affect the current and near-term rate of inflation. That is
already largely baked into the cake. Instead we have to focus on inflation prospects in the
medium term - that is, two years or so ahead. So we therefore need to form a judgement on
where the economy is likely to be heading. But to do that, we need to start by figuring out
where we are now.
The great Danish physicist Niels Bohr is supposed to have observed that "Prediction is very
difficult, especially about the future." But I don't think he realised just how tough economic
forecasting is. Not only is the MPC unsure of the prospects for commodity prices, how the
credit crunch will play out and a myriad of other future events, but we don't even have a
precise picture of the current state of the economy. As a result, controlling the economy has
been likened to driving along a winding road looking only in the rear-view mirror. Indeed, it's
worse than that as we don't even have that good a view of where it has been in the past
either! It is as if the rear window is also a bit misted up.
Our primary signposts are, of course, the official data provided by the Office for National
Statistics for the key macroeconomic variables, such as output, spending, employment,
prices, wages and so on. However, we do not rely on the official data exclusively, for a
number of reasons. First, it takes time for the official data to be collated and published. For
instance, the preliminary estimate of GDP growth in Q2 only appears tomorrow, almost a
month after the quarter ended.
Second, early official estimates are often based on incomplete samples, with missing
information extrapolated from other indicators. As more information accrues over time, so the
data gradually then get revised. And significant revisions can still occur for some years after
the event. For an example, look at Chart 1. This plots the initial and current official estimates
of four-quarter UK GDP growth, as well as the range of the intervening estimates. As you can
see, the picture provided by the mature data sometimes looks quite different to that furnished
by the first estimates. For instance, the initial estimates suggested a sharp slowdown in 1998
in the wake of the Asia and Long-Term Capital Management crises, whereas the current
estimates suggest that the pace of expansion barely eased. For more recent quarters, the
initial and current estimates are closer together, but that may simply reflect the comparative
youth of the latest estimates, as well as the fact that the 2007 Blue Book did not involve a full
balancing of the National Accounts.
Finally, even mature data that has gone through the full revision process may still not give a
fully accurate picture because of the intrinsic difficulty of measuring a particular economic
concept, for instance the value added by the financial sector. In such cases, the ONS are
instead forced to employ proxies, but sometimes these are just not all that good a guide.
The need to form as up-to-date and reliable a picture of the current state of the economy as
possible means that the MPC makes extensive use of business surveys alongside the official
data. That includes not only the quarterly Industrial Trends survey and its monthly sibling, but
also the other, more recent, CBI surveys, such as those covering the distributive trades and
service sectors. The various surveys carried out by other organisations, such as the
Chartered Institute of Purchasing Supply and the British Chambers of Commerce, are also
valuable sources of information for us. Moreover, we have our own network of 12 regional
agencies, whose role is to collect intelligence as to what is happening on the ground.
Collectively, our regional Agents have about 8000 business contacts and they represent an
important additional source of timely information for us.
The uses of the survey data are varied. First, different indicators more often than not seem to
tell different stories and we need to figure out which is the right one. For instance, at the
current juncture, there is a marked discrepancy between the official data on the volume of
retail spending, which points to considerable robustness this year - including whopping
growth of 3.6% in May alone, though that was fully reversed in today's release for June - and
the Distributive Trades survey, which suggests significant weakness (see Chart 2). While the
ONS have suggested that the official data are likely to be better at picking up small retailers
and unconventional shopping channels, such as internet purchases, the conformity of the
picture given by the Distributive Trades survey with other potential indicators of spending,
such as consumer confidence and the Agents reports, have led us to place less weight on
the official data on retail spending for the present.
The surveys will not always provide the best coincident guide, however. For instance, during
the 1999-2002 period, the official data suggested greater swings in manufacturing output
growth than did the Industrial Trends survey (see Chart 3). Now, during this period, we know
that there was a rapid expansion in ICT-related activities, followed by a sharp contraction.
The simple balance of "ups" over "downs" in the Industrial Trends survey could therefore be
expected to have failed to reflect adequately the sharp movements in that sub-sector's
activity. So, for this period, the official data probably gave a better picture of what was going
on.
A second use of surveys is in the application of forward-looking questions to form a view of
the near-term outlook. In that regard, questions on business and consumer confidence, and
on the trend in orders and backlogs, can give some indication of likely trends in output and
spending. The surveys are also useful in forming an assessment of the prospects for capital
spending, as this is an area where statistical models are particularly poor - and I should
know, having spent some of my formative years at the Treasury unsuccessfully trying to build
econometric models to predict investment! Both the CBI and BCC surveys collect information
on investment intentions, and it is also something we ask our Agents to take a view on,
based on their contact interviews (see Chart 4). We look closely at this information when
assessing the outlook for business investment.
Other forward-looking questions can also prove valuable. For instance, at the current
juncture, with CPI inflation well above our 2% target, we need to judge how much further it
will rise and for how long that might persist. Past experience gives us some guide as to the
speed at which higher commodity prices pass down the supply chain and the extent to which
those movements are amplified or attenuated by movements in other costs and prices. But
the questions on pricing intentions contained in the business surveys represent a valuable
additional source of information on near-term inflation pressures.
A third use of surveys is in helping the MPC diagnose the causes of recent developments.
Here, the quarterly Industrial Trends survey stands out as particularly useful because it has a
rich set of questions that explore companies concerns. For example, it has questions about
the factors limiting investment, exports, and output. Responses to those sorts of questions
can, for instance, help us work out how businesses have been affected by the recent
depreciation of sterling, and the tightening in credit conditions.
A fourth use of the surveys is in providing measures of variables for which there is no official
counterpart. In particular, the amount of economic slack in the economy is a key determinant
of inflationary pressures. We have official indicators of slack in the labour market -
unemployment, vacancies and the like - which is one factor determining pay growth. But we
have no official measures of the amount of slack within businesses, which potentially affects
pricing pressures. Business surveys such as the Industrial Trends survey do, however, ask
how intensively firms are working their capital (see Chart 5). And the MPC draws on this
information in forming a judgement about the overall margin of spare resources in the
economy.
A fifth, and perhaps less obvious, use of survey information is in refining our picture of the
past. I noted earlier that the official data tends to get revised for some while after it is first
released. But it turns out that there are some systematic patterns in the historical revision
process. Moreover, for some series, we have found a tendency for revisions to be in the
direction of reducing the discrepancy with the corresponding survey information. So rather
than just taking the latest vintage of official data at face value, we can employ statistical
techniques to exploit this information in order to refine our assessment of the past.
Inflation
An example of this approach, drawn from our May Report, is shown in Chart 6. This
shows our assessment of the range of possible final outturns for four-quarter GDP growth
rates for the past six years. The current vintage of official GDP growth data is shown by the
green line. The centre of the darkest purple band of the fan reflects our view of the most
likely path once the revisions process is complete - a "backcast", if you like. The fan around
this path indicates the uncertainty around this projection, with a 9 in 10 chance of the
eventual outturn lying somewhere inside it. The width of this fan is based on the historical
experience of data revisions. The fan becomes progressively narrower the further back in
time one goes, reflecting the reduced incidence of revisions for more distant periods. For the
recent past, the most likely path for the mature estimates of growth lies above the current
vintage of data, reflecting our judgement that the business surveys and the past history of
revisions together make it somewhat more likely that the official estimates for this period will
in future be revised up, rather than down.
I hope that this gives you a sense of the use we make of business surveys, and business
intelligence more generally, in making our regular assessment of the state of the economy
each month, before taking our decision on the appropriate level of Bank Rate. The timeliness
of this information is particularly important at the current juncture, when the economic climate
is changing rapidly. The global and UK economies have been subject to two large shocks of
uncertain magnitude, duration and impact. The first is the continuing de-leveraging in the
banking system and the attendant squeeze on the terms and availability of credit. The
second is the fairly relentless rise in commodity prices, especially that of oil, driven in part by
the robust growth in demand in the emerging economies. These two shocks both depress
output growth, though they have divergent effects on inflation.
In our May Inflation Report, our central expectation was for four-quarter GDP growth to slow
markedly through this year, reflecting both subdued real income growth and tighter credit
supply (see Chart 7, which also includes the same backcast information as Chart 6). It was
then expected to gradually recover through 2009 as credit conditions slowly improved. The
corresponding projection for CPI inflation is shown in Chart 8 (note that no uncertainty is
shown for the past, as the data for CPI inflation are rarely revised). Our central projection
was for inflation to continue to rise during the second half of this year to a peak close to 4%
and then - assuming that oil prices stabilised - to fall back towards the 2% target as the
growing margin of spare capacity in the economy held back pay and price increases. Since
May, inflation has turned out higher than expected and oil prices have risen further,
notwithstanding some moderation in the past week or so. But the news on activity has not
been very good either, with some distinctly downbeat business surveys, including
yesterday's Industrial Trends survey, further weakening in the housing market and continued
fragility in the financial sector. All this points to a worse near-term prospect for both growth
and inflation. The net impact of this on the outlook for inflation in the medium term is less
clear, though for our considered view on that, you will have to wait until our August Inflation
Report is published in a couple of weeks time.
Moreover, there are considerable risks surrounding the central outlook. A particular risk on
the upside is that the extended period of elevated inflation leads to an acceleration in pay
and causes inflation expectations to rise. That could lead the higher inflation to become
embedded. But on the downside, there is a risk that the credit crunch leads to a deeper and
more prolonged slowdown, leading to greater slack in the economy and causing inflation to
undershoot our target.
In setting policy, we have been trying to balance off these risks against each other. In making
that judgement, the more accurate a picture we have of the economy, the better. So the
Industrial Trends survey, as well as the other business surveys, will continue to be a crucial
input into forming that picture. Let me therefore conclude by wishing Many Happy Returns to
the Industrial Trends survey on the occasion of its 50th birthday. We hope that you and your
younger siblings will continue to flourish in the years ahead. Thank you!