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The Monetary Policy Committee forecasting Bank of England
REVIEW OF THE MONETARY POLICY
COMMITTEE’S FORECASTING CAPABILITY
Report by David Stockton
Presented to the Court of the Bank of England
A review of the MPC’s forecasting capability
This report was prepared at the request of the Court of the Bank of England. I was asked by the
Court to focus my review on the forecasting capabilities, the forecasting processes, the forecast-
related analysis, and the forecasting performance of the Monetary Policy Committee (MPC). In
preparing this review, I studied the materials provided to the MPC in the development of the
forecast, and I attended the key meetings held by the staff and MPC during the production of the
forecast for the August Inflation Report. Understandably, I did not attend the meeting at which the
MPC reached its policy decision. For this review, I interviewed all of the current members of the
MPC and all former members who served on the Committee over the period since 2007. Similarly, I
interviewed many members of the staff of the Bank of England. Outside of the Bank, I consulted
with individuals from the academic community, financial institutions, private consulting firms, and
official institutions. I also reviewed external studies of the forecasting record of the Bank of England.
And, I consulted previous reports commissioned by the Court that reviewed the policy process and
forecasting apparatus employed by the MPC.
I gathered most of the information for this report during two separate visits totaling about nine
weeks on-site at the Bank. During this time, I received full cooperation from Bank management and
staff and benefited greatly from their candor and insights. Likewise, I received a great deal of
thoughtful feedback on and analysis of the Bank’s forecasting performance and procedures from
individuals outside the Bank, who were uniformly generous with their time.
In conducting my analysis and presenting some options for change, I took as given the existing
monetary policy framework embedded in the laws governing the Bank of England and the Monetary
Policy Committee. I did not consider issues surrounding the inflation target, the composition of the
MPC, or the frequency of MPC meetings or Inflation Reports. An examination of actual policy
decisions was also beyond the remit of my report.
Needless to say, the past five years have been exceedingly challenging for economic forecasters.
The advanced economies experienced a major financial shock that caused steep declines in output
around the world. In the United Kingdom, the financial shock was accompanied by a substantial
depreciation of the sterling exchange rate. More recently, the banking and sovereign debt crisis in
the euro area has had repercussions for trade and financial markets that have likely impaired the
performance of the UK economy. The extent to which any of these key developments were
foreseeable and the degree to which they have influenced economic outcomes remain an active
area of debate within the economics profession. But the fact of the matter is that, on the whole,
neither official nor private sector forecasters anticipated the size or timing of the shocks that hit the
global economy in recent years. Likewise, the propagation of these shocks into economic activity
and inflation was widely underestimated in magnitude and duration.
However, the observation that forecasting errors were widespread during this period does not
obviate serious introspection on the part of economic forecasters and policy making institutions
about what went wrong and what lessons might be learned to limit the probabilities of making
similar errors in the future. That obligation is especially pressing for central banks; the forecasts of
central banks provide key underpinnings to policy decisions that can have profound consequences
for economic outcomes. That process of introspection is under way at the Bank of England. This
report aims to make a further contribution to the internal and external dialogue surrounding the
Bank’s forecast—its development, its accuracy, its role in the monetary policy process, and its
communication to the broader public.
Fundamentally, the forecast process and the associated forecasting tools employed by the Bank in
support of its monetary policy decision making are sound. MPC deliberations about the forecast are
focused on the important issues and the debate and discussion is rigorous. That said, the shocks and
stresses experienced by the UK economy in recent years have revealed some weaknesses in the
forecasting and policy processes that may have been difficult to detect or were of little consequence
during more tranquil times. In this review, in addition to noting some considerable strengths, I point
out some of the weak points in the processes, not all of which are unique to the Bank of England. A
period of nine weeks of study is too short to develop a full understanding of exactly what lies behind
all of the forecasting procedures, tools, and meetings that are currently in place. But, I do feel that I
gained sufficient exposure and insight to offer a range of options for changes to the forecasting
process that have at least the potential to improve its support of monetary policy decision making. I
set out my high-level conclusions in an Executive Summary, and I present the options for change in
more detail in the final section of this report, discussing their pros and cons. Some of the options for
changing the forecasting process would be significant and consequential, and as such, would require
thorough deliberation by the Bank and by the members of the MPC before their undertaking.
Others concern matters of internal organization and could be implemented at the discretion of Bank
management, with advice and counsel from the staff.
One obvious difficulty that I encountered in developing the options for change outlined in this report
is that I simply do not have sufficient information and insight to judge all of the costs and benefits
that will need to be weighed in deciding how to move forward. Most notably, some of the options
that I put forward would likely require additional resources. I have little perspective to offer on how
the benefits of additional resources would stack up against other pressing claims on the public
purse. Similarly, some of the resources might be garnered by a reallocation of effort within the
Bank—but again, I feel unqualified to assess the shadow costs associated with alternative
distributions of the Bank’s limited resources. As a consequence, the approach that I took in
developing options for change was to put forward only those options that I viewed as likely to
surmount a reasonable benefit-cost test or those where that calculation might be a close enough call
so as to at least warrant serious consideration. I did not put forward any options where I felt the
benefit-cost test would clearly not be met.
The Court will need to consider how to move forward with the observations and options for change
that are outlined in this report. In doing so, the Court should know that there are no flaws in the
process, as it currently exists, so serious that urgent action is required. Many of the options will
require careful deliberation and consultation to consider whether they should be implemented.
And, if a decision is taken to go forward, some time for planning will be needed before
implementation. Of course, allowing time and space for such deliberation and planning should not
be seen as an opportunity to “kick the ball into the long grass” if I understand correctly the meaning
of the phrase. The Court should expect the Bank to confront the issues raised in this report and to
make appropriate adjustments when warranted.
As this report will lay out, there is scope for making changes to the forecasting processes and
procedures that I believe offer the potential for improvement in forecast accuracy, transparency to
the public, and the effectiveness of monetary policy decisions. But that potential for improvement
should not be read as an indictment of the current forecast process of the Bank of England and the
MPC. During my stint at the Bank, I encountered serious people grappling with serious issues. The
members of the MPC engage each other and the staff in vigorous debate and discussion of policy-
relevant issues. And the staff work exceptionally hard to support the MPC in the conduct of policy.
That differences of opinion exist as to how best to execute the mission of the Bank should come as
little surprise in an institution populated with many economists. However, whatever those
differences, policy makers and staff clearly share a strong common commitment to public service in
support of the mission of the Bank of England.
Executive summary ................................................................................................................................. 5
Section 1: The functions served by a central bank forecast and forecast process ............................... 11
Section 2: The performance of the MPC’s forecasts since 2008 .......................................................... 14
Section 3: The forecast process at the Bank of England ....................................................................... 29
Section 4: An evaluation of the forecast process of the MPC .............................................................. 34
Section 5: Options for consideration .................................................................................................... 45
Annex: Terms of reference for the Review ........................................................................................... 59
1.   The Bank of England and the Monetary Policy Committee (MPC) have been well served by
the forecast process that has been in place since the MPC was established in 1997. The
analytical apparatus that supports the forecast compares favorably with that employed at
other major central banks; the MPC’s deliberative process is impressive in its rigor and
energy; and, the MPC and the Bank provide considerable information to the public about
their view of the outlook for the economy.
2.   But there are reasons why a thorough examination of the forecast process might be
warranted at this juncture. First, forecasting tools and monetary policy processes have been
put through a severe “stress test” by the events of the past five years. Those events have
revealed some vulnerabilities in both economic models and in deliberative processes that
were not readily apparent in more tranquil times. Second, some other central banks have
pushed farther forward with actions to make their economic forecasts and the policy
expectations accompanying those forecasts more transparent to the public. In addition to
enhancing transparency and accountability, those efforts have, in some cases at least, likely
increased the effectiveness of monetary policy. In light of these developments, the Bank and
the MPC may benefit from a reassessment of the current organization and communication of
the economic and policy outlook.
3.   As set out in Section 1 of this report, the forecast process at a central bank can serve three
functions: to present and analyze the macroeconomic outlook; to provide a vehicle for
considering monetary policy tactics and strategies; and to communicate the outlook for the
economy and for monetary policy to the public. Section 2 considers the first of these
functions, and asks how the MPC’s forecasts have performed. Sections 3 and 4 examine and
evaluate the forecast processes at the Bank. In those sections, I raise a number of issues that
are worthy of consideration by the Bank, and which give rise to a number of options for
change. Those options, and their key benefits and costs, are presented in Section 5.
The forecast performance of the MPC
4.   The MPC’s recent forecast performance has been noticeably worse than prior to the crisis,
and marginally worse than that of outside forecasters. The forecast errors of the MPC have
been characterized by persistent over-prediction of output growth and persistent under-
prediction of CPI inflation. The Bank has set out a narrative to explain those errors. The
explanations of the over-prediction of the growth in real output center on tighter-than-
expected credit conditions, surprisingly weak productivity, downward pressure on real
incomes from the increase in global commodity prices, and adverse developments within the
rest of the world affecting volumes of net trade. As for inflation forecast errors, the Bank
narrative leans heavily on higher-than-expected prices for oil and other commodities, a
larger and more rapid than expected pass through of the depreciation of the sterling
exchange rate into consumer prices, and increases in the value added tax rate. In broad
terms, I find these explanations to be persuasive. But the narrative offered by the Bank may
not fully explain the serial persistence of their recent errors; that persistence could simply
reflect a string of bad luck, but it also could reflect some inertia imparted by the forecast
process or point to problems with the paradigm underlying the Bank’s forecasts.
Furthermore, the lack of systematic, detailed quantitative analysis undertaken by the Bank to
interrogate its forecast errors makes assessing the completeness and balance of their
explanations for those errors difficult. There should be no illusions that the Bank could
develop a single and complete “accounting” of its forecast errors. Our knowledge of how
large modern economies operate, and thus our ability to identify with any precision the
“sources” of our forecast errors, evolves only slowly (and as the crisis revealed, the evolution
of knowledge in the economics profession has not always been reliably in the forward
direction). That said, I suggest that the Bank and the MPC need to introspect more deeply
and more systematically about the lessons that can be gleaned from episodes of large
The forecast process at the Bank
5.    Staff at the Bank play a central role in supporting the production of the MPC’s forecasts. The
material they produce is of high quality, and staff are energetic and committed to the
mission of the Bank. But there are some challenges for the Bank in this area. First, there
may be too few incentives and opportunities for staff to seriously challenge the MPC about
some of the key issues surrounding the forecast. Management of the Bank have recognized
this issue and put in place vehicles to better allow staff to surface alternative views. But
more work may be necessary. Second, staff lack experience, both absolutely and relative to
members of the MPC, in part reflecting their rapid rotation through positions within the
Bank. Surmounting these challenges would require some structural changes—most
significantly, if the Bank were to consider the production of a staff forecast as a key input
into the forecast process of the MPC. In addition to requiring additional resources, that,
along with other options aimed at cultivating and embracing a more assertive and
experienced staff, would likely require some cultural changes at the Bank.
6.    Turning to the tools employed in the development of the forecast, staff use a wide array of
statistical and econometric models that compare favorably to those used by central banks
elsewhere. But there is always additional work to be done. The financial crisis exposed
virtually all major macro models as being woefully ill-equipped to understand the
implications of this type of event, and the Bank’s current forecast model—Compass—has
very limited financial detail. The Bank will need to decide whether to enrich the financial
specifications of its central model, or, if the costs in terms of increased model complexity of
that are deemed too high, to ensure it devotes adequate attention to further developing,
monitoring, and reporting on satellite models to address this issue.
7.    I also examine the MPC’s forecast process and deliberations. The process that I observed has
considerable coherence and integrity. I found the MPC’s discussions and debates to be
vigorous, analytical, and well informed, with MPC members engaging in productive
discussions of the key issues driving the outlook. I observed no deep structural problems
with the process currently in place.
8.         Nonetheless, there are some issues concerning the process that deserve further
examination. The forecast process of the MPC, organized as it is around reaching a “best
collective judgment,” has some considerable strengths. Policy makers struggle together with
difficult economic issues in an effort to reach consensus on the forecast. Beyond the
deliberative value of that collective effort, the resulting consensus forecast has the virtue of
simplifying the message of the MPC. Nevertheless, the financial crisis highlighted just how
wrong the consensus view can be at times. There could be potential gains from encouraging
and considering more fully views that diverge from the consensus. The current focus on best
collective judgment may round off differences of view that, if brought into sharper focus,
could help the MPC better understand the vulnerabilities in its outlook for the economy and
its policies. Surfacing those differences more visibly and systematically could also provide
valuable perspective to the public about key areas of dispute in the policy debate.
9.         As a practical matter, virtually all regular economic forecasting exercises exhibit a degree of
inertia, and that is the case with the forecast of the MPC. Some of that inertia is procedural;
the starting point for a forecast round relies heavily on a staff update of the MPC’s previous
forecast for incoming data and news. But some of the inertia exhibited by forecasts simply
reflects the slowness with which forecasters spot deeper structural problems with the stories
underlying their forecasts. In the MPC’s forecasting process, there are few mechanisms
capable of acting as a trigger for a fundamental reassessment of the outlook. Some of the
options presented in this review are intended to create more “speed bumps” in the forecast
process that might disrupt its natural inertia—for example, the possible development of a
staff forecast and an even greater engagement with external researchers and scholars.
The forecast and monetary policy decisions
10.        The forecast process, as it is currently organized, is an under-developed vehicle for
undertaking and discussing analysis of how the outlook bears on monetary policy options
and strategies. The forecast is conditioned on a simple assumption that Bank Rate follows
market expectations. This raises some practical problems in terms of producing an internally
consistent, forward-looking set of projections. But more importantly, the overall policy
process could be improved by introducing analysis that more directly connects the central
forecast and its accompanying risks to policy options and strategies.
11.        Although it is beyond the specific remit of this review1, a forecast-related issue that will need
attention not too far in the future is the interaction of the forecast process, the monetary
policy process, and the financial stability policy process. The crisis made clear that the
development of the economic forecast and the conduct of monetary policy could likely
benefit from the intelligence gathered and the analysis prepared as part of the efforts to
monitor and respond to emerging financial stability concerns. Likewise, understanding
vulnerabilities to the financial system is likely to be closely linked in many instances to the
outlook for the domestic and global economies. Considering the best mechanisms for
promoting productive integration of these efforts should likely be high on the agenda in the
period immediately ahead.
The full terms of reference for the Review are set out in the Annex, p.59.
12.   The Bank of England was among the early pioneers in developing and promoting central bank
transparency, and many practices that are now considered routine at other central banks
had their origin at the Bank. But some central banks have pushed farther forward in
increasing the quality of their transparency and communications, and the Bank may wish to
take stock of its communications strategy in light of its own considerable experiences and
13.   The fan charts remain a valuable tool in communicating the probabilistic nature of a forecast
exercise. But some amendments to the fan charts—such as reducing the gradations within
the charts, and producing cumulative density functions—deserve consideration. In addition
to possible changes to the charts themselves, the use of alternative scenarios could help to
illustrate how sensitive the forecast is to different critical judgments.
14.   One common view expressed by outside forecasters is that the MPC provides too little detail
in support of their forecasts, making it difficult for observers to understand the key drivers of
the forecasts, and to audit and interrogate the forecasts over time. The Bank and the MPC
may wish to consider developing an efficient vehicle for providing more quantitative texture
to its forecast. The options might range from providing a full forecast of the expenditure and
income components behind the consensus forecast to providing forecasts of some of the key
analytical variables underpinning the forecast, such as the output gap, household saving rate,
15.   Another area worth some exploration by the Bank would be to report some summary of the
individual forecasts of the MPC. While this could risk detracting from the central message of
the forecast, it would provide greater transparency as to the range of views held by MPC
members. The value of that information might be especially large when risks were mounting
sharply and different views were emerging among members of the Committee.
16.   Finally turning to policy communications, some central banks have taken large steps toward
greater transparency by offering explicit guidance about the expected path of the policy rate.
That provides both greater transparency, and another tool for the central bank to influence
financial conditions. It remains too early to declare those efforts a success. As a
consequence, the MPC may wish to study these innovations before deciding whether to
move in this direction, and, if so, how.
17.   In Section 5, I offer an array of options for making adjustments to the forecasting process
that respond to many of the issues raised by my evaluation. These are options for further
consideration rather than firm recommendations, and, in Section 5, I set out the rationale for
each option. In addition, I present issues that would need to be considered before making a
decision about whether to adopt that option, including, importantly, some of the drawbacks
or costs associated with each of these options. But below, I simply set out the options
themselves, grouped into three functional areas: 1) options related to improving forecast
capabilities, process, and organization; 2) options that could raise the support offered by the
forecast process to the conduct of monetary policy; and 3) options to enhance the forecast
as a device for communication, transparency, and accountability.
18.   An over-arching theme that cuts across many of the options offered below is the objective of
increasing the number of “entry points,” both internally and externally, for alternative points
of view about economic developments and their relation to the forecast and to policy. I
doubt that the implementation of any or all of these options six years ago would have
materially increased the probability that the Bank of England, or any other central bank,
could have fully foreseen the intensity of the impending financial crisis. But given the
experience of the past six years, the greater objective should be to make changes, when
warranted, that improve the efficiency, robustness, and transparency of forecasting and
policy processes. By doing so, the Bank could increase the probability of detecting and
responding in a timely manner to emerging economic and financial developments.
Options related to forecast capabilities, process, and organization
1.    Further expand efforts to increase the detail with which the financial sector is incorporated
into the forecast and the models that support the forecast.
2.    Support even greater engagement with the academic community on forecast technology.
3.    Hold four “special issues” meetings each year that would be used to explore topics relevant,
directly or indirectly, to the forecast but that need greater attention than can be devoted
under the meeting constraints of the forecast round. To create time for MPC members to
attend, these meetings could replace four pre-MPC meetings.
4.    Produce a staff forecast and present that forecast to the MPC prior to each Inflation Report.
5.    At some point in the forecast process, canvass individual MPC members for their forecasts of
real GDP growth and inflation.
6.    Develop richer and more systematic internal processes for evaluating outturns against the
7.    To promote a more assertive and experienced staff, increase the participation and influence
of specialists within the Monetary Analysis Directorate of the Bank in the forecast process.
8.    To the extent possible, consider increasing the number of staff allowed to witness forecast
9.    Contemplate encouraging longer tenure in positions and less rotation.
Options related to better integration of the forecast and monetary policy analysis
10.   Analysis of monetary policy options and strategies could be included routinely in the
background materials and briefings prepared by the staff for every forecast round.
11.   Consider creating a forecast with an extended horizon beyond the current three-year
period—a horizon of sufficient length to allow consideration of the development and likely
unwinding of major economic and financial imbalances.
Options for improving communication and transparency of the forecast
12.   Consider publishing some alternative scenarios.
13.   Provide greater detail about the consensus forecast.
14.   Expand the forecast evaluation exercise currently published in the Inflation Report to include
a fuller discussion of how outturns have differed from expectations.
15.   Consider publishing a summary of the individual forecasts of the MPC members as a
supplement to the fan charts in the Inflation Report.
16.   Consider increasing communication about the outlook for policy as part of the forecast
17.   Consider publishing a vote by MPC members on the forecast in addition to a vote on the
18.   Outsource to a reputable and impartial research organization the responsibility to organize
once- or twice-a-year meetings of the MPC with leading researchers and scholars, focused on
difficult or controversial issues. This outside group would set an agenda based on what they
think the MPC should hear, including views that would challenge prevailing conventional
wisdom at the Bank.
19.   Consider changes to the fan charts. The Bank could reduce the fine gradations of the fan
chart and add a line for the mean and/or modal forecast. And, some consideration should be
given to moving away from a continuous quarterly projection and providing projections for
half years or years.
20.   Consider the creation and publication of cumulative density functions for inflation, the
growth rate of real GDP, and the level of real GDP for a couple or few specified dates.
21.   Publish the supplementary data with the quarterly detail and the probability distribution
parameters underlying the fan charts at the time of the release of the Inflation Report rather
Section 1: The functions served by a central bank forecast and forecast process
Section 1: The functions served by a central bank forecast and forecast
19.   The forecast produced by a central bank can serve several mutually supporting functions.
This is not to say every central bank produces a forecast that serves all possible functions;
that is not the case. But understanding these functions provides a useful point of departure
for assessing the forecasting framework and procedures currently employed by the Bank of
England and the Monetary Policy Committee. In brief, I see three key functions being served
by a central bank forecast: 1) to present to policy makers an economic outlook and
associated risks, and to do so in a structured process designed to encourage focus on and
debate of the key issues and vulnerabilities surrounding that outlook; 2) to provide a vehicle
for considering monetary policy strategies and tactics that best respond to the expected
economic environment and the associated risks; and, 3) to communicate that economic
outlook and its implications for monetary policy to the public in a manner that promotes
1.1 Presenting the economic outlook and associated risks
20.   The first function noted above focuses on the development of the economic forecast and its
discussion by policymakers. There are two important components to this function, which
can be stated in simple terms as “numbers” and “analysis.” Much external attention to the
forecasting enterprise is often focused on the numbers. And, indeed, the numbers are
relevant and important. Some of the numbers involve a “point” forecast, where the point
forecast might be a modal forecast—the most likely outcome, or a mean forecast—a
weighted average of all possible outcomes. But most policymakers at central banks would
likely agree that point forecasts alone provide insufficient information on which to take
decisions. The risks surrounding the point estimates and how those risks are changing over
time are also relevant considerations to policy decisions. In effect, forecasts of greatest
value to policy makers can best be thought of as probability distributions, which embed not
only a point forecast, but also ranges of outcomes with varying probabilities. At the risk of
some oversimplification, the size of those risks can be characterized by the variance of the
distribution of outcomes (how wide the distribution is) and the balance of the risks
associated with the outcome can be characterized by the skew of the distribution (how
probability mass is distributed above and below the mode).
21.   Of course, a good forecast process extends well beyond the production of point estimates
and probability distributions for a few key variables. A central bank forecast process should
also provide a vehicle for policymakers to discuss and debate the factors shaping the
economic outlook. A good forecast process is likely to involve filtering much high-frequency
information to gain some purchase on where the economy has been recently and where it
might be headed in the near future. The incoming information is also important because it
provides clues as to whether developments are evolving in the manner previously expected,
and if not, whether there are more serious challenges emerging about the basic story
underlying the forecast. Because there is always considerable uncertainty about the
interpretation of this incoming information, a good policy process should encourage policy
makers to challenge their own views and those of their colleagues in a constructive effort to
understand often-conflicting data.
22.   As one looks further out on the horizon, the incoming data become less determinative of the
outlook, and the forecast is typically guided by the broader economic forces thought to be
operating on the economy. For most central bank forecasts, the manner in which those
broader economic forces manifest themselves in the outlooks for activity and inflation is
captured by an economic model or a collection of economic models. The models provide
intellectual frameworks that enforce discipline on discussion and debate. In general, models
used in the forecasting process should be forced to confront the data and should provide
policy makers with reasonable assurance that the models are capable of replicating the types
of dynamic responses to shocks that have been observed historically. Of course, all models
are gross simplifications of a very complex and evolving reality, and any model’s ability to
provide accurate forecasts over long forecast intervals is severely limited.
23.   Because our knowledge is, in fact, so limited, one key objective of a central bank forecast
process should be to focus policymakers’ attention on the key issues and vulnerabilities
surrounding the economic outlook. In other words, while the process is about the
development of a coherent story for the outlook, it should also work to understand the many
ways in which that story might be wrong.
1.2 The forecast as a vehicle for considering policy strategy
24.   This leads to a second function that can be served by a central bank forecast process—its use
as a device for discussing monetary policy tactics and strategies. Even when policy
instruments are held fixed in the forecast process, as at the Bank of England and some other
central banks, the resulting forecast can convey useful information about the economic
outlook and the likely direction in which policy will need to be moved in order to achieve
25.   But the process can alternatively involve greater integration of the setting of an expected
path for policy within the development of the economic forecast. In particular, the path of
policy can be endogenized in the forecast process—an approach taken by some other central
banks. For example, forecasts can be developed that incorporate a policy rule that adjusts
policy instruments in response to changes in other variables or that incorporate some type of
“optimal” policy. Using this approach, a policy path is determined simultaneously with the
forecast of other economic variables. Especially for a committee where policy preferences
may vary within the context of the broader policy remit, the consideration of economic
outcomes and policy paths from a variety of rules and “optimal” policy configurations can be
a valuable input into policy discussions and decisions. Although most policy makers would
be very unlikely to take the prescriptions from such rules literally, such analysis can help
provide a guide to making the link between the forecast and the policy decision at hand.
That link can be further enriched by considering analysis that takes account of the
uncertainties in the outlook and their implications for the conduct of policy—uncertainty
about the structure of the economy, uncertainty about the nature of the disturbances
affecting the economy, and uncertainty about the way in which various policy actions might
operate on the economy. This analysis could also lead more naturally to useful discussions
among policymakers as to what constitutes preferred or desirable outcomes for inflation and
1.3 Communicating the macroeconomic and policy outlook
26.   The third purpose served by a central bank forecast is its use as a communications devise
with the public. The forecast, especially of the variables that are primary and ancillary policy
objectives, is a central element of accountability to the public. The forecast and the analysis
offered in support of the forecast should provide for as transparent an engagement as
possible with the public, allowing the public to better understand the central bank’s thinking
about the evolving outlook and the factors that might cause that outlook to change.
Transparency about the forecast also provides an opportunity for those outside the central
bank to critique the analysis of the central bank. That feedback can be helpful to the central
bank in gaining alternative perspectives on difficult issues of economic analysis. Finally, a
central bank forecast should offer sufficient information to allow the public and market
participants to infer the likely path of policy and how that path might change in response to
evolving economic circumstances. That information can enhance the effectiveness of policy
by better aligning private expectations with those of the central bank.
27.   This brief description of functions is undoubtedly incomplete, but it does provide some
useful benchmarks for an assessment of the Bank of England’s forecast process. In the next
section, I focus on the “numbers” aspect of forecast performance. In Sections 3 and 4, I
describe and evaluate the “analysis” and “communications” aspects of the forecast, and their
relation to forecast process and policy-related deliberations.
Section 2: The performance of the MPC’s forecasts since 2008
28.        As part of the remit for this review, I was asked to examine the performance of the MPC’s
projections for the growth of real GDP and inflation since 2008. My examination of the
forecast performance of the MPC encompasses three elements: some statistics related to
the forecast performance of the MPC and a comparison with outside forecasters; a
presentation of the narrative offered by the Bank of their forecast errors; and a discussion of
that narrative and some broader observations on the forecast evaluation process at the
2.1 The MPC’s forecasts for GDP growth
29.        The MPC stresses that the nature of its forecast is a distribution of possible outcomes rather
than a point forecast. So one way to gauge the success of the MPC’s record—and the one
the MPC prefers—is to compare the distribution of actual outturns to the previously
forecasted distributions. Chart 1 shows the proportion of outturns for four-quarter GDP
growth that have fallen in each quintile of the forecasted probability distributions at the one-
year and two-year horizons over the period since the financial crisis began in the middle of
Chart 1: Distribution of GDP growth since August 2007 across quintiles of the distribution
forecasted by the MPC(a)
The center of forecasts made prior to 2011Q3 have been adjusted upward by 0.3pp to reflect backdated
methodological changes in GDP measurement introduced in that quarter.
30.        Were the MPC to have accurately forecast the distribution of outturns, then in large samples
outturns would be expected to lie within each quintile 20 percent of the time2. Instead,
outcomes in the period since the crisis commenced have been concentrated in the lowest
One caveat is that the forecast distribution is conditioned on the market-implied path for financial market
variables available at the time of the forecast, while the GDP outturns are a product of the actual path
followed by financial market variables.
quintile, meaning growth has consistently been weaker than the MPC forecast both one-year
ahead and two-years ahead.
31.     Five years is, of course, a relatively short sample period. In Chart 2, the analysis is extended
to cover the full period for which MPC forecasts are available. As is shown, over the full
sample, the outturns have been more evenly distributed relative to the MPC’s forecast.
Nonetheless, the MPC’s significant over-prediction of growth since 2008 means that, even
over that longer period, more than 30 percent of outturns for one-year ahead GDP growth
have fallen in the lowest quintile of the forecast distributions, compared with the 20 percent
that might have been expected on average.
Chart 2: Distribution of GDP growth since February 1999 across quintiles of the distribution
32.     To gain some perspective on this performance, a comparison of the MPC’s forecast record
with that of other forecasters over the same period is instructive. For this exercise, it is
necessary to focus on the MPC’s central projections, because that tends to be the only
forecast provided by others. I consider both the mode of the MPC’s forecast distributions
and also the mean of those distributions. For purposes of this review, I label the difference
between the outturn and the central projection an “error,” though I recognize that others
may wish to label them low-probability outcomes.
33.        Chart 3 shows outturns for year-on-year growth of real GDP, the mean and mode of the
MPC’s forecast distribution of real GDP growth one year prior, and the average of around 25
other forecasts made one year previously, as collected by Consensus Economics survey of
forecasters.3 Chart 4 shows the forecasts made at the beginning of each year for calendar
year GDP growth the following year—in essence, the two-year ahead forecast—which is the
longest horizon over which Consensus forecasts are provided.
Chart 3: Central forecasts for annual GDP growth made
one year prior to the outturn
Sources: Consensus Economics and Bank of England
Chart 4: Central forecasts for calendar year average
GDP growth made at the beginning of the previous year
One technical matter that makes these and subsequent forecast comparisons imprecise is that the MPC
conditions their forecast on the market-implied path for the Bank rate, while external forecasters are
presenting, in general, an unconditional forecast—one that incorporates their best guess for the path of Bank
34.      A number of points are apparent from these comparisons. First, neither the MPC nor
external forecasters anticipated the deep recession which began in 2008 following the onset
of the global financial crisis. Second, once the recovery began in the second half of 2009,
both the MPC and, on average, external forecasters were overly optimistic that it would
continue. As with the MPC, external forecasters did not predict the significant weakening in
growth over 2011, or that the economy would return to technical recession.
35.      However, despite those qualitative similarities, the MPC has over-predicted growth by more
than the average of external forecasters. The MPC’s modal and mean projections have
consistently been above those of the average of external forecasts over this period. Table 1
compares the forecasting errors of the mode and the mean of the MPC forecast and that of
Consensus for one-year ahead forecasts. The table confirms that, since the crisis
commenced, the MPC have made somewhat larger forecast errors for growth than the
average errors of external forecasters, though the differences are not striking.
Table 1: Comparison of MPC GDP growth forecast and Consensus forecast made 1-year prior
Root Mean Square Errors                Average absolute errors                       Average errors
MPC          MPC                      MPC          MPC                       MPC            MPC
mode         mean      Consensus      mode         mean       Consensus      mode           mean         Consensus
forecast     forecast                 forecast     forecast                  forecast       forecast
Whole period        2.41         2.40         2.26         1.66         1.68         1.54         0.52          0.34              0.15
Pre-crisis          1.31         1.32         1.38         1.01         1.02         1.01        -0.56          -0.63             -0.74
Crisis              3.54         3.50         3.21         2.71         2.74         2.40         2.27          1.91              1.61
Sources: Consensus Economics and Bank calculations.
A positive number signifies the forecast was higher than the outturn
2007Q3 is used as the widely recognized starting period of the crisis. This differs slightly from the remit of the review which
refers to forecasts &quot;since 2008.&quot;
It should be noted that methodological changes in the 2011 ONS Blue Book resulted in upward back revisions to historical
estimates of GDP growth. This increased the incidence of forecasts underpredicting GDP growth.
36.      To supplement this analysis, I also looked at the recent forecast records of the European
Central Bank (ECB) and the Federal Reserve. A direct comparison of forecast records is
fraught with difficulties, as one is looking at different economies, with different volatilities,
and different shocks. But Charts 5 and 6 show the difference between the central forecasts
of the participants of the FOMC—the deliberative body of the Federal Reserve— and the ECB
relative to the outturns; that difference is also shown for the MPC. The major takeaway from
this exercise is that, as in the United Kingdom, neither the ECB nor the Federal Reserve
anticipated the deep contraction in activity that occurred in 2008 and into 2009. The
forecast errors of the ECB and the Fed have been less marked in the period since the global
recession receded, but drawing any firm inference from that observation would be
Chart 5: The performance of FOMC and
MPC forecasts of annual GDP growth(a)(b)
MPC modal forecasts; For the FOMC: Semi-annual forecasts from
1999 to 2007 and reported to Congress. From 2008 onwards, midpoint
of the central tendency published in the Summary of Economic Projections.
Observations are the difference between Q4-on-Q4 growth rates and
those forecast one year prior.
Chart 6: The performance of ECB and MPC forecasts
of annual GDP growth(a)(b)
MPC modal forecasts; Center of interval forecast provided by ECB.
Observations are the difference between calendar year average
growth rates and those forecast one year prior.
37.     In summary, the MPC has persistently over-predicted growth since the onset of the financial
crisis. It is not surprising that the MPC did not foresee the onset and intensity of the
recession over 2008 and 2009—other forecasters of the UK economy made similar errors
during that period, and both the ECB and the Fed also failed to anticipate the depth of the
impending recessions in their economies. In the period since the global recession, most UK
forecasts have tended to over-predict growth. However, the MPC has predicted stronger
growth than other forecasters, on average, since that period—and therefore has made
somewhat larger forecast errors than others.
2.2 The causes of the MPC’s forecast errors for the growth of real GDP
38.    In evaluating the MPC’s forecast performance, it is useful to consider the possible reasons
that have been offered to explain why the economy evolved differently than the MPC’s
central projections. In what follows, I report the broad narrative that has emerged at the
Bank concerning the reasons for recent forecast errors. In developing this narrative, I have
used information available from the staff in Monetary Analysis (MA), in Inflation Reports, and
in various speeches given by MPC members. In the conclusion of this section, I discuss the
plausibility of these explanations.
39.    Based on material made available to me by the Bank to assist in the preparation of this
review, among the expenditure components, the largest contributors to the weakness in
GDP growth relative to the MPC’s forecasts made in 2008 have been, in order of their
contribution to the forecast errors, household consumption and private sector investment.
External trade has also provided a smaller contribution to real GDP growth than was
expected in 2008, despite the weaker demand for imports that is likely to have resulted from
weaker domestic demand. The contribution of government spending to growth has been
broadly in line with forecasts made at the start of the recession.
40.    Of course, this examination of expenditure components does not address at a deeper level
the reasons why growth in real GDP has been weaker than the MPC expected. The principal
candidate explanations offered by the Bank are: tighter-than-expected credit conditions;
downward pressure on real incomes from increases in global commodity prices; surprising
weakness in labor productivity; less support than expected from international trade; and the
widespread effects on UK activity from the continuing strains in the euro area.
2.2.1 The tightening in credit conditions
41.    The Bank believes that a major driver of the recession of 2008/2009 was the effects of the
sharp tightening in credit conditions that occurred in the wake of the severe financial
turbulence in autumn of 2008 and the associated fallout on UK and overseas banks. And
continued restrictions in the availability of credit may also have been responsible for some of
the weakness in activity since then. One indicator of that restriction in credit supply is the
spread between Bank Rate and the average effective interest rate paid by firms and
households. This spread increased by several percentage points relative to its level in 2007,
and the growth of lending volumes effectively came to a halt in late 2008.
42.    The contraction in private sector credit coincided with a process of balance sheet adjustment
by households and businesses that has likely weighed on real GDP growth throughout the
period in question. In contrast to the period of strong credit growth that occurred in the ten
years prior to the recession, the ratio of total debt to GDP has been flat since 2008. Within
that total, private sector leverage has been falling as households and firms save a higher
proportion of their income, while government borrowing has increased.
43.       The financial crisis, and the sharp tightening in credit conditions that resulted from it, was
not foreseen by the MPC or by other forecasters. That was probably responsible, in large
part, for the MPC not predicting the dramatic fall in GDP in 2008 and 2009.
44.       Regarding the period since then, there is some evidence that the MPC has been overly
optimistic regarding the pace at which the banking system would stabilize and credit
conditions would normalize. Throughout the period since the recession, the MPC has
generally been predicting a gradual improvement in credit conditions as the most likely
outcome4, which was expected to provide some boost to growth as private sector borrowing
picked up in response. Instead, credit conditions have remained tighter for longer, not least
as challenges facing several euro area countries weigh on asset prices and bank funding
2.2.2 Influences from—and trade with—the rest of the world
45.       A second drag on the growth of real GDP has been the price and quantity of the UK’s trade
with the rest of the world. In particular the very sizeable increase in global commodity prices
put significant and unexpected downward pressure on real household incomes, and upward
pressure on non-energy companies’ costs, over much of the period. The damper this likely
placed on domestic spending, most notably consumption, is a recurring theme of the
narrative that the MPC puts forward for its forecasting errors.
46.       In addition, the volume of trade with the rest of the world has disappointed. Following the
depreciation of sterling in 2008, the MPC forecast a somewhat quicker and more significant
improvement in net trade than was subsequently experienced. Four years later, it seems
increasingly likely that the ultimate boost to net trade will be smaller than suggested by
historical movements in the exchange rate. Moreover, world activity has been weaker than
the MPC had expected—especially in the euro area, further weighing on UK GDP growth.
47.       The Bank believes that events in the euro area may also have weighed on UK growth through
other channels beyond simply reduced demand for UK exports. Continued uncertainty over
the resolution of the challenges facing the euro area may have increased strains facing some
UK banks, given their exposure to the euro area, and so may be partly responsible for the
continued restrictions to the supply of bank credit discussed above. More generally, euro-
area concerns are judged to have increased the degree of macroeconomic uncertainty facing
UK households and firms, reducing their willingness to spend. Such channels are difficult to
quantify, but are thought by the MPC to have likely contributed to its over-prediction of
growth over this period.
See, for example, the August 2010 Inflation Report, p43, and the November 2010 Inflation Report, p43.
2.2.3 Weakness in productivity
48.     A third drag on economic activity cited by the Bank has been persistent weakness in
productivity, which has been an additional weight on real incomes. A fall in productivity is to
be expected when output declines; following a drop in demand, firms tend to operate for a
period with a significant amount of spare capacity of both capital and labor, which is reduced
over time as either demand recovers or firms reduce capacity. The experience of previous
UK recessions, and the cyclical behavior of productivity in some other developed economies,
was consistent with this pattern.
49.     The fall in labor productivity in the UK in 2008 and 2009 was, however, particularly sharp.
The pace and extent to which productivity would recover became a key judgment for the
MPC to make when assembling its forecasts; the path of productivity influences the incomes
of households and businesses, and the sustainable level of output in the economy overall.
50.     As set out in various Inflation Reports following the 2008/2009 recession, the MPC’s central
judgment was that some appreciable proportion of the decline in productivity, and so in the
supply capacity of the economy, was likely to persist.5 Nonetheless, firms were judged likely
to be operating with a significant margin of spare capacity. Implicit in these judgments was
an assumption that damage to the potential output of the economy had been smaller than
the fall in output per head. And so some rebound in the level of real GDP toward its pre-
recession trend could be expected, implying a period of above-trend GDP growth.
51.     With the passage of time, the hit to labor productivity is proving to be more persistent than
the MPC initially assumed. Output per worker has still not even recovered its level in 2007.
Moreover, business surveys imply little spare capacity within firms. Weak productivity has
been reflected in persistently weak wage growth.
52.     Several explanations have been put forward for the persistent weakness in productivity
growth, including that: there is more spare capacity within firms than surveys suggest, and
thus productivity will eventually recover; that the reduction in credit availability has had a
significant impact on the supply side of the economy, perhaps by slowing the necessary
reallocation of resources within the economy; that low real wages and high financing costs
have resulted in a substitution of labor for capital; and that output and productivity were
unsustainably high before the recession. As yet, no consensus has been reached on this
2.3 The performance of the MPC’s forecast of inflation
53.     A similar exercise to that above can be employed to examine the MPC’s forecasts for
inflation since 2008, comparing them to the subsequent outturns for inflation, and to other
contemporaneous outside forecasts. Chart 7 shows the proportion of outturns for four-
quarter inflation that have fallen in each quintile of the forecast probability distributions at
the one-year and two-year horizons over the period since the financial crisis began in mid-
See, for example, the February 2010 Inflation Report, pages 44-45, and the May 2010 Inflation Report, pages
2007. Again, were the MPC to have accurately forecast the distribution of outcomes, then
outturns might be expected to lie within each quintile on roughly 20 percent of occasions6.
Instead, outturns have been highly concentrated in the highest quintile of the forecasted
distribution; inflation has frequently turned out significantly higher than the MPC forecast.
Chart 7: Distribution of inflation since August 2007 across quintiles of the distribution forecasted
54.       Extending the chart back to cover the all available MPC forecasts shows a more even
distribution of outcomes relative to the distribution projected by the MPC (Chart 8). But
even over this longer period, inflation has been concentrated in the upper quintile—around
40 percent of outturns having fallen in that quintile, rather than the expected 20 percent.
With the caveat that the forecast distribution is conditioned on the market-implied path for financial market
variables available at the time of the forecast, while the inflation outturns are a product of the actual path
Chart 8: Distribution of inflation since February 1999 across quintiles of the distribution
forecasted by the MPC
55.     Chart 9 shows the year-on-year outturns of inflation relative to both the mean and mode of
the MPC’s forecast distribution one year previously, and the consensus average of external
forecasts made one year previously. Neither the MPC nor external forecasters foresaw the
inflation spike in 2008, nor did either group anticipate the sustained period of above-target
inflation which began in late 2009. Table 2 compares the forecasting errors of the mode and
the mean of the MPC forecast and that of Consensus for one-year ahead inflation forecasts.
Both prior to the crisis and in the period since then, the MPC’s root mean squared error
when forecasting inflation one year ahead is a little higher than that of the Consensus
average forecast. But for both the MPC and the Consensus, errors have been significantly
larger over the past five years than prior to the crisis.
Chart 9: Central forecasts for annual CPI inflation made
Table 2: Comparison of MPC inflation forecasts and Consensus forecast made 1-year prior
Root Mean Square Errors                 Average absolute errors                     Average errors
MPC      MPC                          MPC         MPC                          MPC        MPC
mode      mean     Consensus          mode        mean       Consensus         mode        mean       Consensus
forecast forecast                     forecast    forecast                     forecast   forecast
Whole period       1.21      1.16       1.07             0.86        0.85         0.76            -0.59      -0.54        -0.57
Pre-crisis         0.46      0.46       0.40             0.38        0.39         0.32            -0.14      -0.11        -0.12
Crisis             1.80      1.72       1.60             1.54        1.50         1.40            -1.22      -1.15        -1.22
A positive number signifies the MPC&#39;s forecast was higher than the outturn.
refers to forecasts &quot;since 2008&quot;.
56.      Chart 10 shows the forecasts made at the beginning of each year for calendar year inflation
the following year (that being the longest horizon over which Consensus forecasts are
provided). At this horizon the MPC’s forecast has more clearly underperformed the
Consensus. In particular, at both the beginning of 2009 and the beginning of 2010, the MPC
anticipated that inflation would fall significantly below the 2 percent target in the following
year. In contrast, other forecasters, on average, predicted that inflation would be close to
the target. Given that inflation was in fact significantly above the target in both 2010 and
2011, the MPC made larger forecast errors than external forecasters.
Chart 10: Central forecasts for calendar year average
inflation made at the beginning of the previous year
57.      For completeness, Charts 11 and 12 display the inflation forecast errors of the Federal
Reserve, the ECB and the MPC. The inflation shocks to these three economies are probably
even more idiosyncratic to their individual economies than the financially driven shocks to
demand and output, most especially so because the United Kingdom experienced a
substantial depreciation of the sterling exchange rate. So a direct comparison of forecast
performance is even more problematic. About all that can be said is that the ECB and the
Federal Reserve also experienced some upside surprise to their inflation forecasts.
Chart 11: The performance of FOMC and
MPC forecasts of inflation(a)(b)
MPC modal forecasts; For the FOMC: Semi-annual forecasts
produced from 1979 to 2007 and reported to Congress. From
2008 onwards, midpoint of the central tendency published in the
Summary of Economic Projections.
Observations are the difference between Q4-on-Q4 growth rates
and those forecast one year prior.
Chart 12: The performance of ECB and
inflation rates and those forecast one year prior.
2.4 The narrative of the MPC’s forecast errors of inflation
58.     As with the analysis of the forecast errors for real GDP, what follows is the broad narrative
that has emerged at the Bank as to the sources of the inflation forecast errors. Again, I
report, as best I can, the Bank’s stories about the inflation surprises.
59.     In explaining the unexpected strength of inflation over recent years, the Inflation Report and
speeches given by some MPC members have tended to distinguish between the effects of
“external” price shocks (specifically the effects of energy prices and import prices) and
domestic influences on price inflation.
60.     One external cost shock that has undoubtedly had a substantial effect on inflation since 2007
has been large swings in energy prices, most notably the price of oil. Overall, the price of oil
has risen by more than half since 2007. This and other energy price increases have put
upward pressure on inflation—directly through higher petrol and utility costs and indirectly
through effects on input costs in the production of other consumer goods and services.
61.     Unexpected changes in the price of oil have clearly been responsible for some of the MPC’s
inflation forecast errors over this period. Throughout the period (and prior to it), the MPC
has assumed that oil prices would follow the path implied by futures prices, though the MPC
has, at times, indicated that it thought risks to its central forecast were skewed because of
the possibility of further oil price rises. Those futures prices did not predict the large rises in
oil prices during 2008, their subsequent plunge following the global recession, or their steady
and significant recovery during 2010 and 2011.
62.     A second external cost pressure that the Bank believes has been responsible for some
portion of its inflation forecast errors has been increases in non-oil import prices. Non-oil
import prices rose by a cumulative 25 percent in sterling terms between the middle of 2007
and the end of 2011. These increases occurred in the wake of the roughly 25 percent decline
in the sterling effective exchange rate in the two years beginning mid-2007. This fall in
sterling was not anticipated and thus was not factored into the MPC’s central projection in
advance—the MPC conditions its forecasts on the path for sterling implied by interest rate
differentials between the United Kingdom and other countries7. Higher import prices also
reflected unexpected upward pressure from a global increase in the price of non-energy
commodities which began in mid-2009.
63.     Movements in exchange rates and world commodity prices take time to affect consumer
price inflation, as prices are gradually adjusted throughout the supply chain. Moreover,
some of the effect of these changes can be absorbed via lower wages or lower price mark-
ups. Therefore the MPC was faced with a judgment concerning the extent and timing of the
pass through of a weaker exchange rate and higher world commodity prices into consumer
prices. Immediately following the depreciation, the MPC’s central case embodied the view
that only a small amount of the adjustment to higher imported costs would come through
In fact, the MPC assumes the exchange rate follows a path half way between that implied by interest rate
differentials and a constant path.
higher consumer prices. The MPC judged it most likely that firms would accept a lower price
mark-up or reduce wage costs. To be sure, there is a body of academic literature that
supported this judgment based on the more recent experiences of developed economies,8
though that view is not unanimously accepted by economists.
64.     The MPC now judges that it underestimated the effects of sterling’s depreciation on
consumer prices, and that this contributed to their inflation forecasting errors since 2008.9
In 2008, the rate of inflation of goods (which are relatively import intensive) increased
significantly, relative to both its historical average and the equivalent rate of inflation of
goods in the euro area. Meanwhile the rate of inflation of (less import intensive) services
was not weak enough to offset the effect on aggregate inflation10. This suggests that a larger
proportion of the necessary adjustment to the higher level of import prices occurred through
higher consumer prices, likely raising inflation by significantly more than the MPC had
anticipated immediately after the depreciation. The MPC’s views on pass-through appear to
have shifted in response to the accumulating evidence that the effects have been larger than
it initially projected.
65.     Inflation is also influenced by domestic factors, including, in particular, indirect taxes. During
the period since 2008, there have been three changes in the rate of Value-Added Tax (VAT).
The standard rate of VAT was reduced by 2.5 percentage points in December 2008, increased
by 2.5 percentage points in January 2010, and raised by a further 2.5 percentage points in
January 2011. The MPC’s convention is to condition their forecast on publically announced
fiscal measures. Therefore these VAT changes will only have been factored into their
forecasts once announced; by staff estimates, each change would have resulted in forecast
errors of between &#189; and 1&#189; percentage points on annual inflation relative to forecasts made
prior to the announcements. If those estimates are in the right ballpark, the VAT effects
likely contributed significantly to some of the upside forecasting errors—for example for the
inflation forecasts for 2011 made before the most recent VAT increase was announced in
66.     The Bank believes that the influence of other domestic sources of inflation pressures have
been small and largely offsetting. Throughout the period, the MPC has anticipated that
domestic wage growth would be weak, given the influence of elevated unemployment and
weak demand. Wage growth has indeed been low throughout the period.
67.     Growth in companies’ unit labor costs—that is, their labor costs per unit of output
produced—has been considerably stronger than the growth of wages themselves over much
of this period, owing to the influence of the weaker than anticipated productivity growth
discussed above. But this appears to have been offset, to some degree, by downward
For a comprehensive review of the literature available at the time see Mishkin, F S (2008), ‘Exchange rate
pass-through and monetary policy’, Norges Bank Conference on Monetary Policy
See, for example, the Box on pages 48-49 of the August 2010 Inflation Report, which suggested that higher-
than-expected exchange rate pass-through was responsible for &#189; to 1-1/2 percentage points of the year-ahead
inflation forecast error in mid-2010.
See the Box on pages 34-35 of the February 2011 Inflation Report for further ex-post analysis on the effect
of the exchange rate on UK inflation.
pressure on inflation from a reduction in businesses’ profit margins, perhaps as a result of
persistent weakness in demand. Overall, the MPC finds little evidence that stronger-than-
expected domestic inflationary pressure has been responsible for the MPC’s persistent over-
prediction of inflation.
2.5 A summary analysis
68.   On the whole, the forecast performance of the MPC over the past five years has been
noticeably worse than its performance prior to the crisis and marginally worse than that of
the average of outside forecasters. The failure to anticipate the crisis and its accompanying
fallout for activity is not surprising—other forecasters in the United Kingdom and those at
other major central banks made similar forecast errors. The series of predominantly one-
sided errors subsequent to the crisis, in both the forecasts for growth of real GDP and
inflation—persistent over-predictions of growth and persistent under-predictions of
inflation—raise more difficult questions. Here again the forecast record of the MPC relative
to that of the average of outside forecasters is marginally worse.
69.   On the whole, I find the Bank narrative for its forecast errors of recent years reasonably
persuasive, assuming that I have stitched it together correctly. But that narrative leaves
open the question of whether the serial persistence of the MPC’s recent errors represents
only a string of bad luck, points to some slowness in responding to these errors as they
became apparent, or reflects a deeper flaw in the analytical framework of the MPC. And, the
lack of more detailed quantitative support for the narrative makes it quite difficult to assess
its balance and completeness.
70.   There should be no illusions that it will be possible for the Bank to construct a fully coherent
and holistic “accounting” of all of its forecasting errors. Our knowledge of how large modern
economies operate is incomplete, as is aptly demonstrated by the lack of any consensus
within and outside the Bank as to the causes of weak activity and elevated inflation in the
United Kingdom. Nonetheless, the Bank and the MPC will need to make an effort to prevent
the well-worked and standard list of reasons that have been developed to explain its errors
from becoming the Bank’s “catechism of forecast errors”. As will be discussed later in this
review, that effort is likely to require more internal work, study, and analysis about this most
recent episode than has occurred to date. And, it is likely to require the Bank to open that
analysis to greater public scrutiny to encourage a broader and more productive dialogue
about its forecast both in the past and going forward.
71.   As I noted in the previous section, statistics on forecast accuracy form only part of the basis
for assessing the contribution of a forecast process at a central bank to the conduct of
monetary policy. The forecast process and accompanying analysis should also be judged on
the extent to which policy makers are forced to confront key issues, to explore their
implications for the economic outlook, and to shape an appropriate policy response. The
next two sections describe and assess the forecast process in place at the Bank of England.
Section 3: The forecast process at the Bank of England
72.     In this section, I begin with a brief description of the forecast process in place at the Bank of
England. I then turn to the organization of the forecast process. I conclude with a
comparison of the forecast outputs provided by the MPC with those of other central banks.
3.1 A brief description of the process
73.     The basic objective of the MPC’s forecasting process is to produce probability distributions
for future GDP growth and inflation. These distributions are illustrated several ways in the
quarterly Inflation Reports, the most prominent being fan charts showing probability bands
for the growth of real GDP and CPI inflation. The central, darkest band in each fan chart
encompasses the central ten percent of probability distribution and the modal forecast of
the MPC’s distribution; the relative width of the bands above and below the modal forecast
represents the Committee’s judgment of the skew of the likely outcomes (in the absence of
any skew, these bands represent 5 percent of the distribution); the absolute width of the fan
charts is determined by the MPC’s judgment of the general uncertainty surrounding the
forecast. Some numbers and parameters underlying these fan charts are published a week
after the release of the Inflation Report.
74.     The conditioning assumption for monetary policy underlying the forecast is an important
element of the forecast process. There are many different approaches that can be taken to
setting the policy path that conditions the forecast. In the MPC’s forecast, Bank Rate is
assumed to follow the path implied by financial markets over the three-year forecast
horizon,11 and the stock of asset purchases is assumed to remain in line with the most recent
decision. If the majority of the probability mass is one side or the other of the inflation
target in the medium term, market participants have typically taken a qualitative signal that
the MPC does not view the market-implied path for policy as being consistent with achieving
75.     To produce the forecast presented in each quarterly Inflation Report, staff work on the
forecast for around six weeks, with the MPC engaged with the process for a period extending
over nearly four weeks. Table 3 shows the key milestones during the MPC’s “forecast
round”. The process begins when the staff receive the Quarterly National Accounts data
release. At around the same time, and as part of the MPC’s regular monthly process, staff
present to the MPC a thorough analysis of the incoming financial and economic information
on the UK and global economies, reports from the Bank’s agents on economic conditions
around the country, and a briefing on outside economic analysis. The members of the MPC
actively engage staff in a discussion of the information that has been presented.
The Inflation Reports also contain fan charts conditioned on Bank Rate remaining unchanged. But most of
the discussion of the projections is focused on the distributions conditioned on market expectations of interest
Table 3: A stylized timeline of MPC forecast production
Time until                   Milestone                                        Description
6 weeks             Quarterly National             The most detailed quarterly release of GDP expenditure
Accounts data release          components and income. Allows the staff to begin to update the
preceding forecast in earnest.
5&#189; weeks            Pre-MPC presentations*         Set of presentations given to the MPC each month ahead of their
regular policy meetings. Provides data reports and flags new
5 weeks             MPC policy meeting*            Regular monthly policy meeting and decision.
4 weeks             Benchmark Meeting              The staff present the new “Benchmark” forecast to the MPC. It
embodies their processing of the data, any new staff judgments
which have been imposed, and any reassessment of past
(Committee or staff) judgments.
3 weeks             Key Issue meetings             The MPC are given presentations on, and opportunities to discuss,
the key risks surrounding the Benchmark forecast for GDP growth
1&#189; weeks            Pre-MPC presentations*         Set of presentations given to the MPC each month ahead of their
analysis not already covered in the forecast process.
1&#189; to               Draft meetings                 The staff present updated versions of the forecast, incorporating
1 week(s)                                          feedback from the MPC along with the latest data.
6 days              MPC policy meeting*            Regular monthly policy meeting and decision.
6 days              Sign off                       The Committee signs off the forecast following their policy
0 days              Inflation Report
*Meetings in blue are not strictly part of the forecast process, but are relevant nonetheless.
76.        In the next step of the process, the staff update the MPC’s previous forecast. The staff layer
onto the previous forecast several assessments: 1) the effect of the data news; 2) the
implications of any new analysis; and 3) staff reassessment of past forecast judgments. This
is presented to the MPC as a “benchmark forecast”, and importantly, is an update of the
MPC’s previous forecast rather than an independent assessment of the outlook made by the
staff. The staff subsequently present some key risks to the outlook for GDP growth and
inflation in two “key issues” meetings. These key issues meetings usually contain alternative
forecasts for GDP and inflation based on alternative assumptions.
77.        There then follows an iterative process (via a series of “Draft” meetings) through which the
MPC make adjustments to the staff update, based on their reading of the incoming economic
and financial information and any reassessments that they have made of the outlook and its
determinants. In principle, the MPC is not constrained by past judgments embedded in
earlier forecasts and, at times, has made sizeable adjustments to its forecast.
78.       The MPC refer to the final fan charts published in their Inflation Report as being a reflection
of their “best collective judgment”. In each meeting, individual MPC members are given an
opportunity to voice their opinions on the issue under discussion. As the forecast round
progresses Committee members provide input on the overall positioning of the fan charts. In
the process of reaching “best collective judgment”, members of the MPC do not typically
provide individual quantitative assessments of either the point forecasts or the position of
the fans. Individual MPC members are asked at the Draft meeting and again before the final
sign-off if they are in reasonable accord with the fan charts for real GDP growth and inflation.
But no formal votes are taken on the final fan charts.
79.       There is scope, in principle, for MPC members to ask for alternative forecasts to be
quantified in the Inflation Report should their views differ considerably from that of the
“best collective judgment”. In the early 2000s, a separate table12 was occasionally included
quantifying how different assumptions would affect the inflation forecast. But that device
has not been employed for over a decade, even though there have been times when some
MPC members took public positions at a variance with the published fan charts. For a
number of the current and former MPC members that I interviewed for this report, the
implicit hurdle for using such a device is viewed as high; most thought that they have
sufficient opportunities to expand on their personal differences in speeches and in other
3.2 The organization of the forecast effort
80.       The responsibility for assembling the benchmark forecast, presenting key issues, and making
adjustments to the forecast in response to directives from the MPC falls principally on the
Forecast Team in the Conjunctural Assessment and Projections Division within the Monetary
Analysis (MA) Directorate of the Bank. But inputs and analyses relevant to the forecast
process are provided by other divisions as well. For example, the forecasts for overseas
activity and inflation, estimates of structural unemployment, and forecasts of key financial
conditions are provided by the relevant specialist teams in other divisions, as are the
forecasts for the near-term outlook for inflation. Moreover, the Bank’s network of regional
agents provides substantive surveys and anecdotal information from regional businesses to
provide further perspective on economic developments beyond national statistics.
81.       As would be expected, the staff use a wide array of econometric and statistical tools in
support of the forecasting effort. The central model used by staff for processing news and
judgments is known as Compass, which is a Dynamic Stochastic General Equilibrium (DSGE)
model with a relatively parsimonious 16 variables at its core. Compass replaced its more
complex predecessor (BEQM) in November 2011. Although Compass is the central
forecasting model, Bank staff develop, track, and utilize a large suite of models to support
See, for example, Table 6B on page 57 of the February 2000 Inflation Report.
the forecast and to inform key judgments that must be made in the forecast process.
Indeed, new software, designed specifically for the purpose, allows for the incorporation of
insights from the suite of models into Compass.
3.3 A comparison with other central banks
82.   Table 4 provides a summary of the key features of the forecasts of other central banks and
how those features compare with the forecast of the MPC. As the table reveals, there are as
many differences as similarities in the forecast setups of the major central banks. There is
considerable congruence in the forecast procedures of the Norgesbank and Riksbank, and
both banks are characterized by their analytically sophisticated frameworks. That, of course,
does not imply that those frameworks can or should be grafted onto different institutional
and committee structures, which may offer other compelling advantages of their own. But
the table makes clear that there is not one single model for forecast development and
presentation that prevails among the major central banks. One nearly uniform feature of the
published forecasts is that they are “owned” by the policy makers and not their staffs (the
one major exception is the ECB). This seems as it generally should be—policy actions ought
to be conditioned on the views of the policy makers.
83.   A detailed study of the evolution, motivation, and experience of these other central banks
with their respective frameworks is beyond the remit of this report. Instead, I offer a few
broad thoughts on how the MPC’s framework stacks up against those of other central banks.
When it comes to characterizing the uncertainty surrounding the economic outlook, I would
place the MPC near the front of the pack. The fan charts for inflation and real GDP growth
explicitly place the outlook in a probabilistic setting, which communicates clearly the fact
that predictions about the future are more than a series of point estimates. In terms of
forecast detail—most notably, the components of expenditure, labor costs, alternative prices
measures, and some measure of the output gap or labor utilization—the MPC is perhaps a
little further back in the pack. Many central banks provide qualitative descriptions of these
variables, as is the practice of the MPC, but some also provide quantitative forecasts for
some or all of those variables. As for the policy path used in the forecast, the practice of
conditioning the forecast on the market-implied path of Bank Rate is not unique to the MPC;
the ECB follows a similar procedure, and a couple of others condition their forecasts on an
unchanged policy rate. But a number of the central banks listed in the table now condition
their forecast on a published endogenous path for the policy rate, and therefore the MPC has
now fallen farther back in the pack, at least in terms of transparency. I should note that
determining whether greater transparency about the path of policy rates improves the
effectiveness of monetary policy remains an unsettled issue at this point.
84.   In the next section, I offer an evaluation of the forecast process described above. I also
discuss some of the accompanying issues that inform the options for consideration offered in
the final section of the report.
Table 4: Key features of international central bank forecasts
European                        Reserve Bank        Reserve                                                             Federal Open
Bank of          Bank of        Central                           of New           Bank of                            Swiss National                      Market
England          Canada          Bank        Norgesbank          Zealand           Australia         Riksbank             Bank         Bank of Japan    Committee
Forecast ownership
Ownership of forecast                      Policymakers     Policymakers        Staff      Policymakers      Policymakers      Policymakers      Policymakers        Policymakers    Policymakers    Policymakers
Range of policymakers’ views
quantified?                                     No               No              No             No                No                 No                 No                No              Yes            Yes
Point forecasts                                Yes(1)            Yes             No             Yes               Yes               No                  Yes               Yes             No             No
Interval                                        No               No              Yes            No                No                Yes                 No                No              Yes            Yes
Fan charts                                      Yes              Yes             No             Yes               No                No                  Yes               No             Yes(2)          No
Alternative scenarios quantified                No               No              No            Yes(3)             No                No                 Yes(4)             No              No             No
GDP growth                                      Yes              Yes             Yes            Yes               Yes               Yes                Yes                No              Yes            Yes
Components of GDP                               No               Yes             Yes            Yes               Yes               No                 Yes                No              No             No
Unemployment                                    No               No              No             Yes               Yes                No                Yes                No              No             Yes
output gap/potential output                     No               Yes             No             Yes               Yes                No                Yes                No              No             No
Wages/labor costs                               No               No              No             Yes               Yes               No(5)              Yes                No              No             No
CPI inflation                                   Yes              Yes             Yes            Yes               Yes               Yes                Yes                Yes             No             Yes
Narrower measure of inflation(6)                No               Yes             No             Yes               No                Yes                Yes                No              Yes            Yes
Conditioning assumptions for policy
Unchanged policy rate                           Yes              No              No             No                No               Yes(7)               No               Yes(8)           No             No
Market-implied path                             Yes              No              Yes            No                No                No                  No                No              No             No
Endogenous policy(9) assumed, not
published                                       No               Yes             No             No                No                 No                 No                No              Yes            No
Endogenous policy(9) assumed,
published                                       No               No              No             Yes               Yes                No                Yes                No              No             Yes
Forecasts per year                               4                4               4              3                 4                 4                   6                 4               4              4
Point forecasts made available with a week lag.
Rather than continuous fans, the BoJ publish distributions around forecasts for discrete points in time.
The Norgesbank presents alternative profiles for the key policy rate on the basis of qualitatively different scenarios.
The Riksbank presents alternative forecasts for key variables on the basis of quantified different scenarios.
An average wage forecast of around 3.5% is referred to in the text of the most recent Statement on Monetary Policy, but not in tables or charts.
E.g. inflation excluding energy and/or indirect taxes and/or food.
In the past the RBA has used qualitatively different paths for the policy rate when unchanged was considered less realistic.    .
Recent SNB forecasts have been conditioned on the expectation that the exchange rate will depreciate.
For example a simple policy rule, or monetary policy considered consistent with the policymakers&#39; objectives.
Section 4: An evaluation of the forecast process of the MPC
85.    As noted in the Introduction, my review of the forecast process of the MPC involved two
main avenues of information gathering. First, I reviewed the materials prepared by the staff
for the MPC as part of the forecast process; this included a set of standard materials
circulated during each forecast round, as well as special notes and briefings provided to the
MPC for the May and August forecasts. I also attended the main meetings held by the staff
and MPC for the preparation of the August Inflation Report. As a second avenue, I
interviewed all current members of the MPC, all former members who served on the
Committee during the period under study, members of the Bank’s staff, academics, financial
market participants, and outside forecasters. My review encompasses both information that
I observed directly during my stay at the Bank and information that was reported to me by
others. In what follows, I have tried to carefully distinguish between those two sources of
information because I can only directly vouch for my own observations on the process. As
for the views of others, I have reported only sentiments expressed with sufficient frequency
that they were not likely to represent the idiosyncratic views of one individual.
4.1 Forecast capabilities and process
4.1.1 The staff forecasting capabilities and organization
86.    The staff of the Bank of England play a central role in supporting the development of the
MPC’s forecast for growth of real GDP and inflation. The staff provide considerable analysis
to the MPC during the forecast round in the form of written notes and oral presentations. I
found that material to be of a very high quality—thorough, analytically sound, and focused
on the key issues confronting the MPC. The staff presentations appeared to serve well the
purpose of provoking discussion among the policymakers on relevant issues.
87.    In this process, the staff are, for the most part, assisting in the preparation of the MPC’s
forecast, rather than directly challenging the MPC on the major issues (though that
reportedly occurs from time to time). Some former MPC members and some staff members
suggested that there were too few incentives for staff to seriously challenge the MPC on
major forecast issues. Senior management of the Bank has already recognized this as a
possible problem and has moved to create some vehicles to better allow staff to surface
alternative views related to the forecast. The Chief Economist hosts a special “Challenges”
meeting between forecasting rounds at which staff can present work that offers alternative
views on various aspects of the forecast. Those meetings are well attended by staff, clearly
indicating that they view this effort as providing a vehicle for influencing the discussion on
important policy-relevant topics. Within MA, there is a less formal but very active web-
based forum named “Thinkspace” that offers staff an opportunity to offer up thoughts,
evidence, and early-stage analysis on a wide variety of economic issues and policy-oriented
topics, including views at variance with those of Bank executives and the MPC. These are
creative attempts by the Bank to promote a more assertive staff that will be better
positioned to engage and challenge the MPC on major forecast and policy issues.
88.    One factor that makes that engagement difficult for the staff is their relative lack of
experience compared with that of the members of the MPC, many of whom have been
involved for many years in the forecasting enterprise. Tenures on the Forecast Team are
relatively short, with the average experience being less than two years. Rapid movement by
staff around various positions in MA (and by many reports throughout the Bank) is viewed by
staff as a key to advancement; and, no doubt, exposing staff to many aspects of Bank
business is useful in developing the future leadership of the institution. But that rapid
turnover does create some difficulties in developing a staff with enough experience and
analytical depth on forecast-related issues to challenge members of the MPC in a
89.    The difficulties that the Bank faces in retaining a high-quality forecasting staff go well beyond
the internal churning that occurs among positions. I found staff in MA to be intelligent and
energetic, and the Bank faces fierce competition for their services from firms in the private
sector, and particularly in the City, that can offer much better pay.
Staff forecasting tools
90.    Turning to the tools employed in the development of the forecast, the staff use a wide array
of statistical and econometric models that compare favorably to those used by central banks
elsewhere. As noted above, the staff employ Compass, a DSGE model, as the central model
around which the forecast is organized. But the analysis provided by that model is
supplemented with considerable statistical machinery that processes the incoming high-
frequency data on activity and inflation when constructing the near-term projection. And
staff inside and outside the Forecast Team provide insights offered from reduced-form
equations, partial equilibrium models, and other research. As noted above, an innovative
feature of the Bank’s modeling efforts has been the development of software that they hope
will allow alternative specifications of key economic relationships to be integrated into
Compass. This would enable the staff to assess the sensitivity of the forecast to alternative
model specifications about which the data sometimes offer only weak guidance. The staff
and policy makers are keenly aware of the limitations of econometric models, and they are
intelligent producers and consumers, respectively, of model output. In that regard, while
DSGE models have shown some promise in forecasting and policy settings, they have some
drawbacks as well—as do all macro models. So staff and policy makers will need to remain
alert to those shortcomings, make adjustments when needed, and be prepared to consider
shifting to alternative models when evolving knowledge or accumulating experience suggests
that is warranted. Indeed, Bank staff have done just that in the past. All told, the staff’s
approach to modeling and forecast development follows closely the criteria that I laid out in
Section 1 for an effective forecast process at a central bank.
91.    Of course, there is always additional work to be done. The financial crisis and its aftermath
exposed most large-scale macroeconomic models as woefully ill-equipped to deal with the
implications of this type of shock. How to adjust our models and our forecasting frameworks
to better account for the impact of financial disturbances is, understandably, an active area
of research. Compass, as it currently stands, and in common with the majority of DSGE
models being used for policy purposes, has limited financial detail. And because the central
model used in a forecast process can be important in framing the types of questions that get
asked and answered, staff should give strategic consideration to expanding some of the
financial dimensions of Compass. Modelers always face difficult tradeoffs between simplicity
and completeness. Indeed, an important motivation for shifting to Compass from a previous,
very complicated model (BEQM) was to achieve considerable simplifications that would free
up unproductive use of staff time without sacrificing, and likely gaining, analytical coherence.
Moreover, the Bank has developed a considerable analytical apparatus that models financial
sector behavior outside of the confines of Compass. So a decision about whether to enrich
the financial specifications of Compass would need to be set against the costs of greater
complexity. If those costs are deemed too high, staff will need to ensure adequate
attention is given to further developing, monitoring, and reporting on satellite models that
incorporate the key linkages between financial conditions and economic activity and
92.    Compass has now been in active use by the staff as input into the forecast for nearly a year.
However, interested parties outside the Bank have little to no understanding of the model
and its key features. Bank staff made, in my view, a sensible decision that the first priority
should be to get the new model into action to alleviate the very heavy costs of running its
predecessor. But with that transition moving along, effort should soon be devoted to
documenting for public consumption the new model’s specification and key properties—as
had been done for previous large-scale models in use at the Bank.
93.    Some consideration of staff organization to support the production of the forecast is
probably warranted. The Forecast Team is the most visible conduit of forecast-related
analysis to the MPC. In putting together the Benchmark forecast, the Forecast Team gathers
inputs from economists in other divisions in MA. While that process works reasonably well,
it is not seamless. Some economists outside the Forecast Team expressed the view that their
work did not get the attention or have the influence on the forecast that it should have had.
And some current and former members of the Forecast Team indicated that, in some cases,
the work of the “specialists” in other divisions was not as influential as those economists
might wish because it was not aimed squarely enough on the issues of greatest interest to
the MPC, or perhaps not delivered in a form easy to incorporate in the central forecast. This
is not a major problem, and senior management within MA recognize the issue and have put
in place a number of initiatives to address it. But my general observation is that the full
human capital that exists in MA is not being exploited to the maximum benefit of the Bank
and the MPC.
4.1.2 The MPC forecast process and deliberations
Best collective judgment
94.    During my visit, I witnessed a deliberative process that has considerable coherence and
integrity. The discussions and debates were vigorous, analytical, and reflected an awareness
of both the data and the anecdotes. There was broad participation by the members of the
MPC, with the encouragement of the Chair. Some of the key virtues of “best collective
judgment” were on display. MPC members engaged each other in a productive discussion of
the key issues driving the outlook. They made considerable effort to come to a common
understanding of some difficult outstanding economic issues of relevance to the forecast.
And, when that was not possible, remaining differences were respected. I observed no deep
structural problems with the process currently in place, though I recognize that witnessing a
single forecast round can provide only limited perspective.
95.    Nevertheless, despite its considerable strengths, there are some aspects of a forecast
process organized around best collective judgment that deserve further thought and perhaps
re-examination. By its nature, reaching a collective judgment is intended to round off
differences in views; the objective of the process is to emphasize consensus among
policymakers rather than individual assessments. That has the virtue of simplifying the
message of the MPC with little loss of transparency when a reasonable consensus among
policymakers actually exists. But the financial crisis highlighted the potential value of
encouraging and taking account of views that diverge, perhaps widely, from the consensus.
In these circumstances, a focus on best collective judgment may convey more conformity of
opinion than actually exists and could obscure differences that, if more visibly and
quantitatively surfaced, would provide valuable perspective to the policy makers and
96.    In general, there is a risk of some murkiness around the “ownership” of the forecasts arrived
at by best collective judgment. In principle, one might infer that the fan charts are owned by
the members of the MPC who do not dissent from the current majority view on policy. But
dissents at the policy meeting could reflect differences in policy preferences rather than
differences about the forecast; for example, dissenting members might have different views
about how quickly inflation should be returned to target. Individual members of the MPC
are queried directly at several meetings about their comfort with the fan charts, but they are
not necessarily asked to explicitly indicate where their outlook stands relative to that of the
collective judgment fans (though, of course, MPC members are free to offer that
information). This lack of specificity is likely helpful in allowing the nine members of the MPC
to reach consensus. But without a more formal canvassing of the outlooks of individual
members, there is some possibility that the fans do not always accurately capture the
centre of gravity of the MPC members. Moreover, those MPC members that do not
subscribe to the best collective judgment behind the fans are not required to specify just
how large their differences are with the fans.
97.    Some former MPC members that I interviewed reported that they encountered difficulties
getting divergent points of view to be seriously considered in the forecasting process. As
expressed to me, the problem was one of breaking strongly held “house views” on key issues
relevant to the forecast. Some examples provided were the magnitude and duration of the
effects of financial shocks on aggregate demand, the effects of house prices on consumer
spending, and the effects on aggregate prices of relative price shocks, such as changes in oil
prices. As noted above, for a brief period in the early 2000s, some MPC members requested
an additional table be included in the Inflation Report to illustrate the consequences of their
alternative judgments about key aspects of the forecast. More recently, the public surfacing
of such differences has relied on the initiative of the individual MPC members that have held
Forecast scrutiny and evaluation
98.    In a similar vein, some former policy makers, academics, and market participants take the
view that the Bank would benefit from greater exposure to and consideration of outside
views. This is not to imply that members of the MPC do not solicit the views of those outside
the Bank. The Bank hosts a twice-yearly Monetary Policy Roundtable (MPR)—a large
meeting with outside economic practitioners and academics. Moreover, most MPC
members have considerable individual contact with businesses, academics, market
participants, and other members of the public to gather information and exchange views.
But neither the large MPR gatherings nor the individual interactions with external contacts
force the same degree of engagement on issues as occurs internally. As one person noted, a
broader “ventilation” of the key maintained hypotheses underlying the MPC’s forecast
would be valuable to the Committee.
99.    The structure of the forecast process can impart inertia to the forecast. As noted above, the
benchmark forecast prepared by the staff for the MPC basically takes as its starting point the
previous forecast and updates that forecast for incoming information and any new analysis
that might bear on the outlook. To be sure, the MPC has the discretion to reconsider the
forecast each round with a blank slate, but the process lends itself more naturally to
incremental adjustment. Moreover, there are few institutional or procedural mechanisms
that would act as a trigger for a more fundamental reassessment of the outlook.
100.   The MPC includes an assessment of its forecast record each August in a Box in the Inflation
Report. This material is interesting and helpful. In addition to reporting how output growth
and inflation outturns have compared with the probability distributions underlying the fan
charts, the box offers some speculations about the reasons for that dispersion of outturns.
But that analysis is relatively narrow in scope, given its focus on forecast performance over
the previous year and given the lack of detail the Bank makes available about its forecast
and, therefore, about its forecast performance. As a consequence, the August Box feels
insufficient to the task of addressing the question of how to interpret the dramatic events of
the past five years and the extent to which those events may be still be reverberating
through the economy in unexpected ways. Was the basic paradigm the Bank was using to
think about the outlook seriously flawed? Or did the surprise simply result from an
incredibly large, low-probability shock? Or was it a combination of those factors? Similar
deep questions could be raised about the outlook for inflation and the serially correlated
errors evident in that aspect of the forecast. Some greater struggle with past forecast
errors could shed light on areas where thinking and forecasts might need adjustment going
101.   The current forecast of the MPC has a three-year horizon. One motivation for that forecast
period is that it was deemed sufficiently long to allow, in normal circumstances, for the
return of inflation to its target. However, the events of the past five years demonstrate that
large shocks to activity and prices mean that the economy could take more than three years
to return to something resembling equilibrium. In such circumstances, the Committee might
find it useful to consider the paths for output and inflation over a longer forecast period and
to consider some of the policy tradeoffs and choices that it could face during the transition
period. Moreover, the Committee may find it useful to communicate to the public the
nature of some of those tradeoffs
102.   There are other benefits to a longer forecast interval. At least one of the chief factors
underlying the severity of the financial crisis and its effect on the major economies was the
unwinding of significant imbalances that had built up over a period of time. A three-year
forecast interval does not force policy makers to grapple with the implications of the
unwinding of those types of imbalances (even if they have been correctly identified). To be
clear, I am not suggesting adding one or two more years, but rather adding perhaps five to
ten years to the forecast horizon. To be sure, a forecast with a horizon of that length is
better viewed as a calibrated construction rather than a statistical prediction. But longer-
term forecasts can be a helpful part of the input to policy deliberations.
103.   Finally, I offer one additional observation on the MPC forecast process that was shared by
some policy makers and staff as well. The forecast process, as it is currently constructed,
carries the very heavy burden of being both the principal vehicle for delivering
macroeconomic analysis to the MPC and also the principal forum for the discussion of that
analysis. At a conceptual level, this would seem only natural; the forecast should encompass
all of the macro analysis relevant to the outlook. But as a practical matter, the forecast
process operates under binding time constraints, and the meetings are structured to
efficiently consider the key issues and to then reach decisions. At times, this can lead some
issues that are important and controversial—but not clearly key to the decision at the
current meeting—to be excluded from the agenda. Other fora for analysis and research to
be presented to the MPC do exist—for example “special project” teams and “research away
days”—but demands on Committee members’ time means that they are not always able to
attend these meetings. The time constraints on the Bank’s decision makers are severe, but
some consideration of alternative avenues for presenting relevant macroeconomic analysis
to them may well be warranted.
4.2 The forecast and monetary policy decisions
104.   As the remit for this report makes clear, one of the key functions of the economic forecast of
a central bank is to provide an assessment of the most likely outcomes and the risks around
those outcomes as a guide to the appropriate setting of monetary policy. Despite the heavy
burden borne by the forecast as a vehicle for many aspects of macroeconomic analysis, the
current forecast process at the Bank seems under-developed as a vehicle for delivering
analysis of how the forecast and its risks directly bear on monetary policy strategies.
105.   There are likely to be some circumstances when the MPC faces difficult tradeoffs when
setting policy. For example, some shocks might lead to inflation moving above target but
output falling below the productive potential of the economy. On such occasions, the
Committee is likely to find it useful to discuss alternative strategies for monetary policy and
the effects of different policy choices on the paths for output and inflation. And such
discussions have reportedly occurred from time to time. But as a routine matter of process,
Bank Rate is held fixed along the market-implied path while the most likely trajectory for the
economy and the risks around it are discussed. That limits the extent to which the
Committee is able to debate the economic implications of alternative monetary policy
strategies during the forecast round.
106.   There are also some more technical problems created by the current process. As noted
above, the forecast is conditioned on an assumption that the policy rate follows current
market expectations. This creates some challenges when using the Compass model (and
would be a challenge when using many types of forward-looking models). The model
necessarily incorporates a policy “rule” that governs how agents within the model expect the
central bank to respond to evolving economic circumstances. But the policy prescriptions of
the model’s rule using the MPC’s forecast is unlikely to deliver, except by chance, the path of
rates expected by market participants. As a consequence, when the market-based path of
policy rates is forced on the model, the model-based forecast must be constructed on the
assumption that there are a series of unanticipated policy “shocks”—that is, policy makers
do not behave in the manner expected by the private sector. This is not a fatal problem for
the forecast process, but is not the most natural starting point for policy deliberations.
107.   One could envision a process in which policy makers articulate an objective function—for
example, preferences over the deviation of inflation from target and output from potential—
and ask, given the forecast, what policy path would maximize that objective function—a so-
called “optimal policy”. Similarly, as a routine part of the policy and forecast process, policy
makers might wish to consult the prescriptions of a variety of simple policy rules with
desirable properties, many of which are commonly employed at central banks, in the
academic literature, and in many forecasting models. No doubt, there are significant limits
to the contribution made by exercises that endogenize policy variables, and most policy
makers would view the results as but one of many types of input to the policy process. But
having some systematic and routine analysis of policy strategy during the forecast process
would seem likely to be of some value to the MPC.
108.   The staff currently produce a quarterly note on monetary policy strategies that is circulated
to the MPC. But that note is not a formal part of the MPC’s forecast and policy process and
is produced on a schedule that is not coordinated with development of the Inflation Report
forecasts or the meetings of the MPC. My sense is that the staff have the analytical
capabilities and the capacity to incorporate some of this material into the forecast process,
should the MPC make the request.
109.   Some former MPC members and staff suggested that the sharp separation of policy
deliberations from the forecast process creates some unproductive incentives for MPC
members. They reported that at times, some MPC members had argued in favor of changing
forecast assumptions or setting particular parameter values primarily in order to push the
forecast in a direction that would ultimately support their policy position rather than out of
conviction about those specific choices. Those discussions were viewed as consuming
valuable time in the forecast process, with little fundamental return to the participants. I
should note that I did not detect any such behavior in the meetings that I attended.
110.   Finally, although it is beyond the specific remit of my review, I should flag a forecast-related
issue that will need attention not too far in the future—the interaction of the forecast
process, the monetary policy process, and the financial stability policy process. Because the
new institutional structure for financial stability policy, including the advent of the Financial
Policy Committee, is in its infancy, it would be premature to make any firm judgments about
how these policy functions should interact. But the crisis made clear that the development
of the economic forecast and the conduct of monetary policy could likely benefit from the
intelligence gathered and the analysis prepared as part of the efforts to monitor and respond
to emerging financial stability concerns. Likewise, understanding vulnerabilities to the
financial system is likely to be closely linked in many instances to the outlook for the
domestic and global economies. Effective interaction among these activities will almost
certainly be vital to their collective success. Considering the best mechanisms for promoting
productive integration of these efforts should likely be high on the agenda in the period
4.3 Forecast communication and transparency
111.   The Bank of England was among the early pioneers in developing and promoting central bank
transparency. The discipline of the Inflation Report, the manner of information conveyed by
the fan charts, and the quality of analysis that stood behind this apparatus set a high bar for
other major central banks. The Bank continues to provide an impressive amount of
information to the public about the outlook for the economy and the current environment
for policy. When the Inflation Report becomes available, the Governor and other internal
members of the MPC hold a press conference to explain the major issues surrounding the
outlook for the economy and to answer questions from the press. Members of the MPC
provide testimony to committees of Parliament and make speeches on the outlook, broad
economic issues, and their individual policy positions. Economic analysis developed by the
staff appears in research papers and in the Bank’s Quarterly Bulletin.
112.   Many practices that are now considered routine had their origins at the Bank of England or
gained greater traction because they had been adopted by the Bank. But, as time has
progressed, some central banks have pushed farther forward in increasing the quality of
their communications and transparency. The Bank may wish to take stock of its
communications strategy in light of its own considerable experiences and the experiences
offered by other central banks employing different approaches.
4.3.1 Communicating risks and uncertainties
113.   The fan charts remain a valuable tool in communicating the idea that the forecasts should be
thought of as probability distributions, not the single-minded development of a series of
point estimates. However, some amendments to the fan charts and some additional
vehicles to convey uncertainty deserve consideration. Some people inside and outside the
Bank view the very fine gradations in the fan charts as suggesting a greater sense of
precision of the uncertainties than is likely justified. Moreover, instead of the continuous
quarterly forecast currently presented in the Inflation Report, not much would be lost by
moving to annual year-over-year changes or changes on a fourth-quarter-to-fourth-quarter
basis. Reporting, for example, 70 and 90 percent confidence intervals along with the
forecast mean and/or mode at an annual frequency might be sufficient detail for most
audiences and in most circumstances. Although it would not reduce perceived precision by
much, additional perspective on the uncertainties surrounding the forecast could be
conveyed by transforming the information in the fan charts into cumulative density
functions at specified dates.
114.   In some cases, the Bank could find it helpful to communicate more information concerning
the implications of a particular risk to the outlook. At times, the MPC may be forced to make
a key judgment in the forecast about an economic development over which it has little
conviction but which has important consequences. In those situations, the use of alternative
scenarios could help illustrate how sensitive the forecast is to different key judgments.
This would both alert the public to these risks in the forecast and communicate the Bank’s
thinking on the dimensions of the uncertainties that they pose to economic developments.
Moreover, there could be times when MPC members hold different views about key aspects
of the forecast. Alternative simulations could address those differences and indicate their
quantitative consequences.
115.   The MPC has recently encountered difficulties in dealing with the risks posed by economic
and political developments in the euro area in the context of the fan charts. The MPC has
argued that it is unable to quantify the risks surrounding extreme outcomes associated with
developments in the euro area, and thus excludes those outcomes from the fan charts.
Some outside observers expressed skepticism about the MPC’s inability to quantify these
risks and indicated that they themselves are forced to do so, however imprecisely. Others
more sympathetic to the MPC’s predicament saw the situation as highlighting some of the
limitations of the fan charts as the principal device for communicating risks and suggested
that the Bank should do more to communicate the consequences of a more significant
economic or financial disturbance in the euro area. I readily admit that I see no simple
solutions in this instance. Judgments about possible outcomes are as much about politics as
they are about economics, and there could be considerable unintended financial
consequences if the Bank of England were seen as placing moving odds on the dissolution of
4.3.2 Communicating forecast detail
116.   One common view expressed by outside forecasters and market participants was that the
MPC provided too little detail in support of their forecast. The lack of detail makes it
difficult for outside observers to fully understand the key drivers of the MPC forecast. It
also makes it difficult to audit and interrogate the forecast over time. As a consequence, the
MPC was failing to provide valuable information that could better inform the public’s
understanding of the outlook. Moreover, the MPC was also missing the opportunity for
scrutiny and feedback that might help sharpen its own thinking about key issues in the
forecast. The Office of Budget Responsibility (OBR) was often offered as a model example of
forecast transparency, though when pushed some outsiders conceded that greater forecast
detail was more central to the fiscal policy analysis conducted by the OBR and probably
easier to arrive at with a three-person committee.
4.3.3 Communicating divergent points of view
117.   Another area worth some exploration by the Bank would be to report, either in full detail
or using summary statistics, the individual forecasts of the members of the MPC. Summary
information of individual committee members is made available by the Federal Reserve and
the Bank of Japan. While this information could risk detracting from the central message of
the forecast, it would provide greater transparency as to the range of views held by
members of the MPC as well as the location of the centre of gravity of those forecasts. The
value of that information might be especially large when risks were mounting and sharply
different views about critical issues were emerging among members of the MPC. In those
circumstances, fan charts based on best collective judgment could provide an incomplete or
misleading picture of the degree of consensus, or lack thereof, among the policy makers.
Outside decision makers might benefit from a clearer understanding of the extent of and
reasons behind the different views held by policy makers.
4.3.4 Communicating about policy
118.   Turning to policy communications, some central banks have taken large steps toward greater
transparency by offering explicit guidance about the expected path of the policy rate. Some,
like the Norgesbank and the Riksbank, provide that information in the form of specific
probability distributions similar to those provided for other key forecast variables. Others,
like the Federal Reserve, offer information from individual policy makers on the date of the
first tightening of policy and on the distribution of interest rate expectations of those
members over the forecast period. In addition to providing greater transparency to the
forecasts of those institutions, guidance about the future path of rates provides those central
banks with another policy tool to influence financial conditions.
119.   More explicit guidance about the expected path of policy could generate other benefits. The
necessary internal deliberations to arrive at the policy path would facilitate greater
discussion among members of the MPC of preferred outcomes for inflation and output and
enable easier consideration of the associated tradeoffs when they arise. Moreover, if the
Bank wished to move in the direction of alternative scenarios, those scenarios would likely
be more plausible and useful if the policy interest rate were endogenized.
120.   Of course, there are some advantages to not being a “first mover” in the endeavor to provide
more information about policy expectations. The efforts by other central banks to provide
interest rate forecasts are generally in their infancy—for the Federal Reserve, specific
interest rate forecasts have only been available since January of this year. It remains too
early to declare these efforts a success. The MPC may wish to take advantage of the
opportunities to learn from these recent innovations before deciding whether to move in
this direction and, if so, how.
Section 5: Options for consideration
121.   In this final Section of the review, I offer a wide array of options for making adjustments to
the forecasting process, most of which follow from the evaluation presented in Section 4. I
have grouped these options into three functional areas: 1) options related to improving
forecast capabilities, process, and organization; 2) options that could raise the support
offered by the forecast process to the conduct of monetary policy; and 3) options to enhance
the forecast as a device for communications, transparency, and accountability. For each
option, I put forward a rationale for why the Bank might consider making such a change, and
I highlight some issues—and potential costs—that the Bank might take into account before
making that change. There are many characteristics in addition to functionality by which
these options could have been categorized and ordered—ease of implementation, resource
cost, urgency, consequence, and no doubt others. Faced with that daunting matrix of
possibilities, I have opted for simplicity here and categorized the options by functionality
and, within functionality, by no special order of consequence. That said, I have done my best
to indicate the considerations surrounding the decisions that would need to be taken and to
provide some perspective on the potential consequence of those decisions.
122.   One over-arching theme that cuts across many of the options offered below is the objective
of increasing the number of “entry points”, both internally and externally, for alternative
points of view about economic developments and their relation to the forecast and to policy.
I doubt that the implementation of any or all of these options six years ago would have
could have fully foreseen the intensity of the impending financial crisis. But more questions
about the financial shock and its implications for the trajectory of output and inflation might
have been raised earlier and with greater effect if more avenues were open to considering
divergent points of view. In any event, this review should be more about looking forward
than looking back. Given the experience of the past five years, the greater objective should
be to make changes, when warranted, that improve the efficiency, robustness, and
transparency of forecasting and policy processes.
Option 1: Further expand efforts to increase the detail with which the financial sector is
incorporated into the forecast and the models that support the forecast.
123.   Rationale: The financial crisis and its aftermath made abundantly clear that nearly all of the
major models used in forecasting and policy analysis inside and outside central banks were
woefully inadequate to the task of anticipating financial disturbances and projecting their
propagation into activity and inflation. So enhancing the financial apparatus included in our
forecasting models would seem to be an uncontroversial and obvious direction in which to
proceed. Such efforts will be quite complex, and how to proceed is far from clear.
Nevertheless, experience warns that continued focus on this effort should not be allowed to
flag. The credit crunch in the early 1990s in the United States spurred vast amounts of
research, much of it done at central banks and at official international institutions and much
of it documenting the importance of the credit channel. Yet a decade later, that research
had left little imprint on most macroeconomic models in use at policy making institutions.
That should not be the case ten years hence.
124.   Issues to consider: This effort will take time and resources, and as with all research
endeavors the payoff is not certain. Decisions will need to be taken about whether this
greater financial texture should be directly incorporated in the central model currently in
use—Compass in the case of the Bank of England. That decision will involve familiar
modeling tradeoffs between simplicity and completeness. On the one hand, a key advantage
offered by Compass relative to its predecessor is a simplicity of structure that allows staff to
easily manipulate it and that allows policy makers to understand it. And the use of “suites”
of models outside Compass hold out the promise of enhancing the analysis of financial
factors without complicating Compass itself. Still, models can act as “framing devices” and if
key financial linkages are excluded from the central model, those linkages may tend to get
less consideration in the forecasting process.
Option 2: Support even greater engagement with the academic community on forecast
125.   Rationale: A small group at the Bank are engaged in the development and use of more
cutting-edge statistical forecasting techniques. Those individuals are well aware of the work
being done by academic econometricians and statisticians on the theory and applications of
forecasting techniques. But Bank staff efforts could be leveraged up by supporting and
encouraging greater engagement of the academic community on forecasting issues of
interest to the Bank. I interviewed a number of academics who felt there were likely mutual
advantages from greater interaction than already takes place. Model combination, forecast
evaluation, the direct forecasting of probability distributions, and the development of joint
probability distributions were some of the areas mentioned. Staff at the Bank concur that
mutual benefits would accrue to this effort.
126.   Issues to consider: Some small amount of resources might be required to organize and
sustain increased interactions between Bank staff and the relevant academicians.
Option 3: Hold four “special issues” meetings each year that would be used to explore topics
relevant, directly or indirectly, to the forecast but that need greater attention than can be devoted
under the meeting constraints of the forecast round. To create time for MPC members to attend,
these meetings could replace four pre-MPC meetings.
127.   Rationale: As noted in the review, the forecast process now carries the heavy burden of
being the principal vehicle of presenting macroeconomic analysis to the MPC. In part this is
because other demands on MPC members’ time mean their attendance at presentations of
longer-term analysis outside the forecast round cannot be relied upon. To be effective, the
special issues meetings put forward in this option would need to carry the same general
obligation of attendance that is currently associated with the forecast meetings—hence the
suggestion that this additional claim on MPC members’ time could be offset by a little less
time spent being briefed on short-term developments. This option would allow for detailed
staff analysis and research bearing on forecast issues to be surfaced with the MPC outside
the pressure of the forecast round, which may allow freer engagement between Committee
members. The staff participating in these efforts would extend beyond the Forecast Team to
specialists with expertise on policy-relevant topics; this approach would offer an additional
avenue to the specialists to more directly participate in the support of the MPC. Divorcing
the presentation of these special analyses from the forecast/policy process might also
encourage freer engagement of MPC members with the staff on issues when that discussion
is not viewed as being part of the lead up to a policy decision.
128.   Issues to consider: The members of the MPC and the staff are already very busy, and the net
addition of meetings to the calendar may be difficult. Although there are likely many ways
that the time for these meetings could be “funded”, as noted above, one possibility would be
to eliminate four pre-MPC meetings each year. The loss of four pre-MPC meetings risks
adding some distance between the MPC members and the incoming data. But other less
costly vehicles are, or could be, made available to MPC members for keeping abreast of the
recent economic and financial news. Alternatively, there may be other activities that could
be reduced or eliminated so as not create additional net demands on the time of the MPC
members or the staff.
Option 4: Produce a staff forecast and present that forecast to the MPC prior to each Inflation
129.   Rationale: The principal benefit provided by the development and presentation of a staff
forecast would be that it could provide the MPC with an independent assessment of the
economic outlook. As noted above, one objective for the MPC should be to develop a range
of “entry points” for alternative thinking and to create “speed bumps” that are capable of
breaking the momentum of the house view. Developing a staff that is capable of and
encouraged to provide independent assessments would be one way to serve that objective.
This option would better increase the likelihood of disrupting the inertia that is built into the
present process; in the present process, the staff largely update the MPC’s previous forecast
for incoming data and changes in conditioning assumptions as the starting point for the next
round. To be sure, the staff can also make adjustments for new analysis—but those are
typically “adjustments” not “challenges”. A secondary benefit of moving in this direction is
that staff would have increased incentives to be more fully engaged in the forecast process if
they viewed themselves “owning” part of the output.
130.   Issues to consider: The development of a staff forecast would be a big step. First additional
resources would be required; attempting this enterprise at current staffing levels would be
inadvisable and likely counterproductive. And that expenditure of additional resources
would be wasteful if the MPC were not going to be open and willing to consider an
independent assessment of the outlook. Likewise, some staff might be reluctant to embrace
this activity for fear of having to challenge the MPC or its individual members. Or they may
feel discomfort with being held accountable for their forecast. Moreover, the staff forecast,
while being different than that of the MPC’s, could exhibit the same tendency toward inertia.
Even in that case, however, persistent differences should raise persistent questions that
could force an examination of the evidence in an effort to reconcile those differences. The
Bank may wish to consider publishing the staff forecast, albeit with a lag of sufficient length
so as not to distract from the forecast of most direct relevance to the policy decision—that of
the members of the MPC. In addition to enhancing transparency, knowing that the staff
forecast would eventually be published could very well sharpen the focus of both the staff
and the members of the MPC on this activity. All told, some cultural adaptations would be
required by the Bank, the MPC, and the staff to maximize the benefits of this option and
minimize its costs—though the value of change and adaptation should not be dismissed
Option 5: At some point in the forecast process, canvass individual MPC members for their
forecasts of real GDP growth and inflation.
131.   Rationale: At present, after productive debate and discussion about the positioning of the
fan charts, at two points in the process, the Chair asks each individual Committee member
whether they are comfortable with the fans and offers them an opportunity to provide
further suggestions. When at least a majority of the Committee assents to the fans, the
process is complete. But without more explicit input from the members of the MPC, there is
the possibility that centre of gravity might not always align with the fan chart. By collecting
this information, the MPC can better ensure that the process has led to an accurate
representation of the centre of gravity. In addition to possibly improving the process, if
individual members made explicit their quantitative assessments of the outlook, there would
be greater internal accountability as well. The extent of the potential problem here should
not be overstated; under an able Chair and with active MPC members—the configuration
that I encountered in the meetings that I attended—the agreed upon fans are likely to
accurately represent the centre of gravity. But that configuration may not always exist.
132.   Issues to consider: There is some risk that asking for individual forecasts would undermine or
degrade the effort to forge group consensus that underlies the present effective process of
best collective judgment. That cost should be considered carefully because, as I noted
above, the deliberative process stimulated by best collective judgment is a sound one that
should be preserved to the greatest extent possible. This risk could be diminished by
collecting the views of MPC members at the end of the deliberative process, so that the
forecast conversation does not commence with hardened views promoting particular
quantitative assessments. Adjustments could then be made to the fans if the individual
views suggested the fans did not adequately capture best collective judgment.
133.   There may be some concern that MPC members do not have the capacity to produce
individual quantitative assessments. If that is, in fact, the case for some members, they
should feel free to submit the exact same figures that underlie the agreed upon fans, when
they view themselves as in the consensus. For those with views farther from the consensus,
they should have some obligation to indicate how far they are from the centre of gravity.
The individual members need not convey their views in decimal places—fractions or even
integers might be sufficient in some cases.
Option 6: Develop richer and more systematic internal processes for evaluating outturns against
134.   Rationale: The MPC could probably benefit from a more comprehensive and systematic
analysis of its forecasting errors. As background to the preparation of the box in each August
Inflation Report, staff prepare a thorough note that examines recent forecasting errors and
provides some analysis of the sources of that error. Moreover, on an ad hoc basis, analysis is
presented on forecast evolution and forecast errors in key components of the forecast over
longer periods to shed light on current puzzles in the outlook. But there could be benefits
from stepping back to assess the sources of surprise in episodes of more persistent errors,
such as the over-prediction of output growth and the under-prediction of inflation that has
occurred in recent years. Greater investigation of those errors might provide clues about the
likely trajectory of events going forward. Observations about these past errors could also
help to set a work and research program to attack key areas of uncertainty. As noted in
Option 14, this type of analysis might also be valuable to communicate to the public.
135.   Issues to consider: Conducting this analysis will require staff and MPC resources. Perhaps a
“special issues” meeting of the type discussed in Option 3 could be devoted to this topic
from time to time so that the demand on staff and MPC time could be more easily
Option 7: To promote a more assertive and experienced staff, increase the participation and
influence of specialists within the Monetary Analysis Directorate of the Bank in the forecast
136.   Rationale: Economists from around Monetary Analysis (MA) are already drawn into the
forecast process. They provide inputs directly into the forecast; develop, monitor, and
report on models that filter high-frequency data; and contribute analysis on key issues. But a
number of economists outside the Forecast Team expressed the view that it was sometimes
difficult for their work to have the influence and visibility it deserved when the Forecast
Team were, in essence, the gatekeepers to the process. Meanwhile, the Forecast Team work
very hard under tight time constraints—one factor behind the high turnover and relatively
short tenures on the team. Some shifting of responsibilities for preparation of forecast
materials to those outside the Forecast Team could be mutually beneficial to all groups. As I
noted earlier, senior management within MA are well aware of this issue and have been
actively working to effect improvements. And by most reports, the staff have already sensed
137.   Issues to consider: To be effective, the specialists outside the Forecast Team will need to
better understand the issues most central to the forecast and be capable of providing the
Forecast Team with products that are timely, well focused, and capable of integration into
the forecast product with a reasonable degree of ease. (See Option 8 for one way to
increase the awareness of economists outside the Forecast Team to the policy-relevant
issues.) Likewise, the Forecast Team will need to be flexible enough to relinquish some
control of the process and products, while still ensuring that the trains run on time.
Implementing this option without clear mutual expectations about the rules of engagement
could ultimately put even greater pressure on people and a process that are already
operating close to their limits.
Option 8: To the extent possible, consider increasing the number of staff allowed to witness
forecast presentations and meetings.
138.   Rationale: The most common complaint lodged by the staff about the forecast process was
the constraints placed on their ability to witness some of the key forecast meetings—either
in person or by remote video. With justification, the staff argue that in order to organize
their work efforts and research programs to address the issues of highest value to the MPC,
they need to be better informed about Committee discussion. The Chief Economist provides
a de-brief for staff after the forecast round is over; this is viewed as helpful, but is not viewed
as a perfect substitute. This problem is considered most acute by those outside of the
Forecast Team—further adding to some of the discontent noted in Option 7.
139.   Issues to consider: I seem to have received an equally common and adamant response from
Bank executives to this staff concern: Limitations on staff attendance at these meetings is
intended to preserve the free-flowing discourse that is promoted by a meeting with small
attendance. And, that free-flowing discourse contributes to the overall quality of decision
making—the ultimate objective of the process. In my observation, the small room and
limited attendance of many of the forecast related meetings did contribute positively to an
active and interactive dialogue among members of the MPC. Current and former MPC
members indicated that the move to a small room with limited staff in attendance had
improved the quality of discussions. I do not think that should be sacrificed, at least not
lightly. But whether the limits on the number of staff that can witness the meetings by
remote video are set at exactly the right level seems open to question. Some modest
experimentation with those limits is warranted. Just as a free-flowing conversation
contributes to good decision making, so does a well-informed and motivated staff.
Option 9: Contemplate encouraging longer tenure in positions and less rotation.
140.   Rationale: Staff experience in MA is relatively lean at present. Longer tenure in forecast
positions, for example, would over time cultivate a staff with greater standing and ability to
participate in the forecast process and to challenge, when appropriate, views expressed by
members of the MPC. This would improve the quality of the intellectual content of the
forecast and the process by which it is developed. This could become especially valuable if,
at some point in the future, there were less expertise in forecasting on the MPC than is the
case at present. An experienced staff can contribute to institutional continuity and provide
valuable institutional memory. This is reportedly an issue at the Bank beyond MA, though
that was beyond my remit.
141.   Issues to consider: Less frequent rotation of the staff among various positions might slow
the process of developing a well-rounded staff with a broad understanding of the work of the
Bank. That, in turn, might inhibit the training of the future leadership of the Bank.
Moreover, Bank executives would need to provide and communicate clear incentives for
staff to remain longer in positions, especially those working on the forecast, where long
hours and pressing time constraints are the norm. In that regard, some greater sharing of
the forecast burden throughout MA could be helpful.
Option 10: Analysis of monetary policy options and strategies could be included routinely in the
142.   Rationale: The MPC currently devotes little or no time during its forecast round to discussing
monetary policy strategies and tactics. But policy is best thought of as a sequence of actions
that need to be taken to promote achievement of the policy objectives, and hence material
on alternative possible sequences of actions and their implications for the economic outlook,
and discussion of that material, should be useful to the members of the MPC in arriving at
their decisions. Moreover, that information may help Committee members better
understand and better communicate both the outlooks for policy and for the economy.
Indeed, Committee engagement on these issues might be further enhanced if expected
policy trajectories were to be published as part of the forecast process (see related Option
15). The material might include information on so-called “optimal” policies and on a variety
of alternative rules. This analysis might be especially valuable when policy settings are far
from their likely steady states by providing some perspective on when and how policy rates
and the Bank’s balance sheet will need to be re-normalized. The size and nature of the risks
surrounding the economic outlook might also bear on risk management strategies employed
by the MPC. In general, the materials could be structured by the MPC and the staff to
encourage and support systematic and routine strategic thinking about monetary policy and
its relation to the economic forecast.
143.   Issues to consider: Developing these materials and implementing a process for their routine
preparation and presentation would be costly of staff time, and adequate resources would
need to be devoted to the effort. However, there are staff in several units of MA already
thinking about and working on issues related to monetary strategy. Some coordination of
that work might be necessary, but I sense that staff would be eager to provide the MPC with
greater support on monetary policy design—for some staff, that interest is the chief reason
for working at the Bank of England.
Option 11: Consider creating a forecast with an extended horizon beyond the current three-year
144.   Rationale: A three-year forecast interval is too short in many circumstances. In some
situations, inflation or economic activity may be so far from desired levels that a reasonable
return to target or equilibrium will likely occur beyond the three-year horizon. Policy makers
should have an understanding of what policy adjustments may be required beyond that
horizon to achieve their objectives. Moreover, a longer forecast interval allows for the
identification of emerging imbalances (fiscal, financial, current account), and it forces policy
makers to think through the consequences of the various ways in which those imbalances
can unwind and their implications for the economy. When those imbalances can be affected
by monetary policy actions, a forecast with an extended horizon can provoke consideration
of the costs and benefits of alternative policy approaches—the consequences of large versus
small actions or the virtues of acting now versus the benefits of waiting to act.
145.   As in other settings, the forecast serves as an important framing device. So unless the
horizon of the forecast is long enough to capture the unwinding of significant economic
imbalances, questions surrounding those imbalances and their policy consequences are less
likely to get serious consideration. In addition to its value for internal deliberations, some
consideration should be given to communicating with the public about key economic issues
that might be raised by a look further out into the future.
146.   Issues to consider: Again, additional staff work would be required to implement an extended
forecast. But as noted earlier, an extended forecast is less a statistical prediction of the
future and more a calibrated construction. For that reason it is most likely to be generated
by a model-based process where costly data-intensive judgment is less useful. Moreover,
because incoming news about the economy is likely to have only small effects on the longer-
run forecast, its care and feeding should be less costly than that associated with the near-
term forecast. Another approach would be to produce an extended forecast twice a year
rather than quarterly. All that said, there would still be costs in terms of staff time and effort
Option 12: Consider publishing some alternative scenarios.
147.   Rationale: In some cases, the forecast may be greatly affected by a key judgment about
which there is considerable uncertainty. In these situations, there could be value in
publishing an alternative scenario that illustrates the sensitivity of the forecast to this key
judgment. While in principle the fan charts should capture this uncertainty, alternative
scenarios could provide valuable information to the public about some specific sources of
uncertainty and the implications of those uncertainties for the outlook. Because these
scenarios would likely mirror the discussions being had by the MPC on key issues, they would
provide greater transparency to the MPC’s thinking about the risks to the outlook.
148.   In recent years, such scenarios might have included alternative assumptions about the
evolution of productivity, the response of consumer spending to deleveraging, and the
implications of exchange rate depreciation for inflation and output. Some individuals that I
interviewed went so far as to advocate dispensing entirely with a central forecast and
substituting instead several different forecasts. For a variety of reasons, I would not be
prepared to endorse that suggestion at this point, but the possible inclusion of some
alternative scenarios in the Inflation Report is motivated by a similar concern.
149.   A second function that might be served by alternative scenarios would be to illustrate a chief
source of disagreement among policy makers on a forecast judgment. In the early 2000s, the
Inflation Report included, on a few occasions, a table (Table 6B) that highlighted the
consequences for the forecast of an alternative judgment about a key forecast parameter.
Those tables were included at the request of MPC members whose judgment differed from
the consensus of the Committee. While that particular vehicle may not be the preferred way
to go, there could be value in using alternative scenarios to bring greater transparency to
views of MPC members outside the consensus.
150.   Issues to consider: The cost of constructing these scenarios is likely to fall disproportionately
on the staff, so some additional resources would likely be required to implement this option.
Moreover, for scenarios that were designed to reflect the collective uncertainty of the MPC,
the deliberative cost of approving the scenarios would be impractical if the MPC members
insisted on having the same level of input on the construction of the alternatives as they do
on the construction of the central forecast. Some control for the design of the scenarios
would need to be relinquished to staff in order for the process to remain manageable.
Finally, there is some risk that the inclusion of alternative scenarios could detract from the
message of the central projection, making the MPC’s message more complicated.
151.   The Bank may also want to consider this option in parallel with Options 13 and 15, below, to
provide greater detail about the forecast and to provide information about the path for
policy given that forecast. Providing more detail about both the MPC’s central forecast and
about alternative scenarios would likely increase the informational content, and, therefore,
the usefulness, of both. Likewise, allowing interest rates to respond to the economic
circumstances depicted in the alternative scenarios would make those scenarios more
plausible and informative.
Option 13: Provide greater detail about the consensus forecast.
152.   Rationale: One frequent request that I heard from outside forecasters and market
participants was for the MPC to provide greater detail about the central forecast, beyond
that offered by the fan charts and the text included in the Inflation Report. There were a
range of requests. Some wished to see the type of expenditure and price detail produced by
most large forecasting organizations and which they assumed that Bank staff were already
producing in support of the MPC’s forecasting operation. Others would be content with
more quantitative information about key variables that are central to the MPC’s forecast—
for example, the output gap or unemployment rate, the household saving rate, productivity,
and profit margins. As noted earlier, this information would allow outside observers of the
MPC’s forecast to better understand its rationale and to audit its outcome. Furthermore,
outside interrogation of the MPC’s forecast might provide valuable feedback to the Bank and
members of the MPC about the outlook. In my words, it would provide another “entry
point” for alternative views that could be helpful in ventilating the forecast process.
153.   Issues to consider: As with the alternative scenarios, providing additional detail on the
central forecast might be difficult if the MPC felt it needed to approve all of that detail. One
practical solution would be for the MPC to outsource the production of the forecast detail to
the staff. The staff could present a product, perhaps outside the Inflation Report, that would
represent a reasonable construction of detail that is consistent with the MPC’s fan chart
forecasts. My sense is that such an output would go a long way toward satisfying the desires
of outside observers without bogging down the policy process. The demands on staff time
would be minimal because, as I understand it, this output is already produced by staff as part
of the forecast process. A drawback to providing greater forecast detail is that it might
constitute another distraction from the simple message conveyed by the fan charts. That
would especially be the case if MPC members routinely distanced themselves from the
published detail. But even in this situation, there could be some benefits; MPC members
who disavowed the details might be forced or might feel some obligation to explain the
details underlying their alternative view of the outlook. More generally, the risk of
distraction from the main messages of the Inflation Report might be mitigated by the
inclusion of the detail in an appendix to the Report, or in another document altogether.
Option 14: Expand the forecast evaluation exercise currently published in the Inflation Report to
include a fuller discussion of how outturns have differed from expectations.
154.   Rationale: If Option 6 (internal evaluation of forecast errors) and Option 13 (publication of
forecast details) were implemented by the Bank, then including a more detailed examination
of forecast errors in the Inflation Report would not require much additional work for the
MPC or Bank staff. As in Option 6, the idea would be to step back from a year-by-year
assessment of errors and look at episodes as a whole. Making the assessment public would
contribute to a better understanding of the Bank’s interpretation of the important economic
developments of the past six years. And, it would allow others to scrutinize that
interpretation and offer alternatives for the MPC to consider. Providing this analysis to the
public would contribute to the MPC’s transparency.
155.   Issues to consider: If the MPC declined to offer greater forecast detail, more thorough multi-
year evaluation of forecast expectations and outturns would still be possible to include in the
Inflation Report, though the value of the exercise would be reduced because it would
necessarily be more qualitative.
Option 15: Consider publishing a summary of the individual forecasts of the MPC members as a
156.   Rationale: There might be some benefits for external transparency in providing a summary
of the assessments of individual MPC members. When there is considerable consensus
among the MPC members about the outlook, these benefits are likely to be small. But when
there are more widely diverging assessments of the outcome, the fan charts can provide an
incomplete picture of Committee views. As a consequence, some consideration should be
given to publishing a quantitative summary of individual Committee assessments—perhaps
the range and the median of the individual forecasts, with additional information about
assessments of variance and skew if that were deemed helpful. Again, this information
provides another formal “entry point” for divergent points of view to be expressed,
explained, and examined by the MPC and the public.
157.   Issues to consider: One potential cost to making the range of individual views available is
that the central consensus message of the MPC’s forecast would be overshadowed by
attention given to the differences among the policy makers. That cost would need to be
weighed against the value of greater external transparency.
158.   As for potential value added to external transparency, many current and former MPC
members reported that MPC members already have adequate opportunities to publicly
express their alternative views. Some MPC members have certainly taken advantage of
those opportunities. So the magnitude of the benefits offered by this option in promoting
greater external transparency is open to question. Nevertheless, there would appear to be
potential vulnerabilities to a process that relies solely on the initiative of MPC members to
publicly express alternative views and to choose the appropriate forums for presenting those
Option 16: Consider increasing communication about the outlook for policy as part of the forecast
159.   Rationale: As noted above, in recent years, some central banks have moved in the direction
of providing more explicit information on the outlook for their policy instruments in the
context of their economic forecasts. Two major purposes are served by the provision of this
information. First, to the extent that central bank projections of policy rates help shape
expectations, those projections can increase the effectiveness of monetary policy. This
communications tool may be especially valuable when the policy rate is stuck at the effective
lower bound; in these circumstances, forward guidance about the policy rate can influence
long-term interest rates and broader financial conditions even when the short rate is fixed in
the near term, and thus it has the potential to deliver additional monetary stimulus. Second,
greater transparency about the policy outlook provides another element of institutional
accountability. To avoid undue focus on near-term policy decisions, indicators of policy rate
expectations could be provided for periods one-year ahead, two-years ahead, and three-
160.   Issues to consider: This would be a very consequential move, and one that would be difficult,
though not impossible, to back away from once implemented. One often cited concern
about greater specificity by a central bank about the expected path of policy is that it will
come to be seen as a commitment by the public and market participants. This, in turn, might
make the central bank more reluctant to alter policy than in the absence of public
projections of the policy rate. The publication of policy expectations in the Inflation Report
would also add an additional dimension of complication in arriving at the overall best
collective judgment. The potential size of the benefits and costs would need to be weighed
carefully before moving forward. As for the benefits, the evidence on the value of policy
guidance is not clear cut (and, even without forward guidance, the yield curve in the United
Kingdom is currently quite flat). As for the costs, I suspect that, with experience, market
participants and the public would come to learn the difference between a conditional
forecast and a commitment—though I would not rule out that the learning process could be
painful both for the public and for the Bank. Moreover, the difficulties of reaching consensus
on that policy path might be reduced if the Inflation Report were to supplement the
consensus forecast with some summary of the degree of divergence in views—that vehicle
might provide the MPC members with enough wiggle room to more easily reach consensus.
161.   One approach the MPC might take to this issue is to first commission and then implement
the type of routine monetary analysis for incorporation in the internal forecast process that
was suggested in Option 10. As greater comfort and experience was gained internally with
considering a forecast conditioned on a policy path that produces “desired” outcomes for
inflation and output, the MPC could consider how best to communicate that information.
Because the use of interest rate forecasts as part of public communication is at an early stage
in most central banks, the success of those efforts is not yet assured. The MPC could use
experiences at other central banks in formulating its own policy communications strategy, if
it determined such a strategy would be beneficial.
Option 17: Consider publishing a vote by MPC members on the forecast in addition to a vote on
162.   Rationale: At present, members of the MPC vote only on the policy decision. A dissent on
the policy decision could reflect either a difference of view about the forecast or difference
of view about how best to respond with policy to the situation presented by the forecast.
Separate votes on the best collective judgment forecast and on the policy decision, with
supporting explanations for dissents, would provide valuable information to the public about
alternative views held by MPC members concerning the economic outlook and the direction
of policy. This transparency would again serve the broad objective of adding entry points for
non-consensus views, the discussion and exploration of which might encourage greater
contemplation of vulnerabilities to the consensus view. That information would also further
enhance the accountability of individual MPC members. If the MPC were to publish more
information on the range of the views of individual MPC members as suggested in Option 15,
there may be less communications value in recording votes on best collective judgment,
though there would still be some accountability benefits.
163.   Issues to consider: The transparency and accountability benefits are not likely to be large.
That would be especially true if the policy preferences of the MPC members are very
homogenous so that dissents almost always reflect different economic outlooks rather than
how best to respond to the economic outlook. Moreover, by shedding greater light on the
diversity of views, this option could, like some others, distract from the main message the
majority of the MPC wishes to convey.
Option 18: Outsource to a reputable and impartial research organization the responsibility to
organize once- or twice-a-year meetings of the MPC with leading researchers and scholars,
focused on difficult or controversial issues. This outside group would set an agenda based on
what they think the MPC should hear, including views that would challenge prevailing
conventional wisdom at the Bank.
164.   Rationale: The Bank already organizes and reports on the meetings of its semi-annual
Monetary Policy Roundtable. Many individuals inside and outside the Bank report that those
meetings are helpful, though the size and format of the meetings makes detailed discussion
of major issues difficult. The type of meeting that I have in mind would be a much smaller
gathering, for which the organizers might commission 3 or 4 short papers on one important
or controversial topic that the organizers judged would help inform the MPC on policy-
relevant research. Each paper might have a couple of discussants. MPC members would be
“at the table” to engage in the ensuing discussion. Attendance would be limited to
participants and some staff so as to ensure unfettered give and take. In order to maximize
open discussion and, therefore, the effectiveness of such meetings, they could operate under
Chatham House rules, but with the papers made available to the public, and perhaps a short
summary of the meeting subsequently published. Again, the objective is to maximize the
probability that difficult and controversial topics and viewpoints get surfaced with the policy
makers. Given recent experiences, the meetings might include issues such as understanding
productivity, the latest work on exchange rate pass-through, optimal monetary policy design
and communication, forecasting inflation, and other similar relevant topics.
165.   Issues to consider: Choosing an appropriate organization to undertake this task will be
important. In the United States, the National Bureau of Economic Research would be the
type of organization that I have in mind. The Centre for Economic Policy Research or a
similar type organization could be asked. Alternatively, a council of respected scholars with
enough practical familiarity with policy making and policy making institutions could be
established to organize these meetings. For some topics, the meetings could rely on
researchers outside the UK.
Option 19: Consider changes to the fan charts. The Bank could reduce the fine gradations of the
fan chart and add a line for the mean and/or modal forecast. And, some consideration should be
given to moving away from a continuous quarterly projection and providing projections for half
years or years.
166.   Rationale: The current format of the fan charts, with fine gradations of the bands throughout
the three-year forecast period, might convey a sense of greater precision about uncertainty
assessments than is actually held by most MPC members. But even with the current degree
of precision, the fan charts still make it difficult to identify the mode or mean of the
forecasts. A simple chart with the mean or modal forecast and, for example, the 70 and 90
percent confidence intervals would be both transparent and easy to digest—delivering the
key information of greatest interest to most outside observers. Another simplification might
involve moving away from the continuous quarterly forecasts of the fans to forecasts of key
variables by year or half year.
167.   Issues to consider: The inclusion of the mean or mode and the elimination of the fine
gradations of uncertainty may erode the central message that the forecast is a continuous
probability distribution not a point estimate.
Option 20: Consider the creation and publication of cumulative density functions for inflation, the
168.   Rationale: Cumulative density functions would simply be transformations of information in
the existing fan charts. But they would provide readers of the Inflation Report the
information necessary, for example, to determine the MPC’s assessment of the probability
that inflation would be above or below various levels at some specific date in the future13.
Cumulative density functions could also be made available for growth of real GDP and the
169.    Issues to consider: Some readers might not be familiar with the concept of a cumulative
density function, raising some possibility of confusion or misinterpretation. If the gradations
of the fan charts were reduced to avoid too great a sense of precision about uncertainty,
then adding cumulative density functions might just reintroduce that sense of precision.
Option 21: Publish the supplementary data with the quarterly detail and the probability
distribution parameters underlying the fan charts at the time of the release of the Inflation Report
rather than a week later.
170.    Rationale: At present, considerable effort is undertaken by market participants and some
journalists to infer the modal forecast from the fan charts. Indeed, several outside observers
reported that they and others project magnified versions of the fan charts on screens and
then manually measure the location of the bands to determine the point forecast. This
seems a socially inefficient use of resources. Moreover, providing this information to
everyone at the same time may be preferable to conferring informational advantage on
those with the biggest projectors and finest rulers. There is another element of transparency
that might tip one in the direction of releasing this information immediately. The
information in the supplementary table actually represents the way that the forecast is
constructed. The forecast process develops a central forecast with the information on the
variance and skew added around the central forecast; this is a sensible process, and it is
neatly and accurately represented by the information in the supplementary table.
171.    Issues to consider: Providing explicit information on the point forecasts (modal and mean)
might dilute the message that the forecast is really a probabilistic enterprise.
The current ‘Ribbon chart’ in the Inflation Report is a variant of this, but it indicates only the probability of
inflation being above or below the target.
Annex: Terms of reference for the Review
Economic forecasts play a central role in helping the Monetary Policy Committee to assess the key
economic risks and uncertainties affecting the economic outlook and hence the appropriate setting
Since the onset of the global downturn in 2008–9, both output growth and inflation have been
significantly more volatile than in the preceding decade. And the Monetary Policy Committee has
found it more challenging to assess the outlook for growth and inflation.
The Court has asked David Stockton, former Director of Research and Statistics at the Board of
Governors of the Federal Reserve System, to review the forecasting capability of the Monetary
Policy Committee. This review will supplement the MPC’s regular annual review of its forecasting
The performance of the MPC’s projections for growth and inflation since 2008.
The analysis presented to the MPC in the production of those projections.
The processes followed by the MPC to produce projections.
The capability of the Bank to support the production of the MPC’s projections.
Overall, the review will examine whether the MPC’s forecasting procedures allow it to take full
account of the relevant risks and uncertainties, and thus support the MPC’s monetary policy
decisions in order to meet the inflation target. The review will be used to inform decisions about the
Bank’s forecasting procedures and methods.
Monetary Policy Committee theory
Conduct of Monetary Policy, Hearing Before the Committee on