Errors are inevitable in life. The test of character is how you respond. After its terrible unemployment forecasts last year, the Bank of England is being challenged as never before. To date its reactions are not very edifying.
Last August it predicted unemployment was likely to remain above 7 per cent until mid-2016. The latest data suggest that threshold was probably reached at the end of 2013, almost three years earlier. The fall in joblessness has been well outside the BoE margin for error. In August it thought such a rapid decline was essentially impossible.
Instead of accepting its error and thinking again, the BoE has wriggled on the hook. Its first instinct was to deny the labour market was improving as fast as it was. Its second was to blame the Office for National Statistics for producing dodgy data. On Wednesday the minutes of the January meeting of the Monetary Policy Committee suggested there were good reasons to ignore the unemployment rate.
This will come as quite a surprise to those who thought they had been listening to Mark Carney since he became BoE governor in July. Did he not insist that unemployment told us all we needed to know about slack in the economy and hence inflationary pressures? Keen students of the BoE will be even more perplexed: the document introducing forward guidance in August was unequivocal in asserting that other measures were murky reflections of the state of the economy, and the unemployment rate was crystalline.
The document also made a clear commitment. “To ensure that [consumer price] inflation remains on track to return to the 2 per cent target, the Committee will need to withdraw some of the monetary stimulus before the unemployment rate falls back to its medium-term equilibrium.” That link between unemployment and interest rates has now gone, but without acknowledgment.
I calculate that 37 per cent of the slack it identified in unemployment in the second quarter of 2013 has already gone. I cannot be positive about my calculations because, despite preaching the mantra of transparency, the BoE prefers to keep its methodology opaque. But getting a different answer would require some outlandish assumptions.
The big question is whether declining unemployment has been a false omen of economic recovery. Was it a moment of madness in August when the BoE identified unemployment as its economic bellwether, even though it knew it did not understand recent movements in the data?
I thought the answer to that question would be “yes”. But I was wrong. For last August the BoE also published a list of variables to cross-check against unemployment, to help identify spurious movements in the data. These alternative measures also show big declines in labour market slack.
Whether it is hours worked, the ratio of vacancies to unemployment, the proportion of temporary workers who want permanent jobs or the participation rate, the gap between the latest measures and pre-crisis norms have closed significantly. On some of these measures, slack seems to have disappeared entirely. Rapid falls in joblessness seem to be telling us what is really going on after all.
The BoE’s problem is that it does not seem to accept the conclusions of its own analysis. The minutes of the January MPC meeting make clear that the committee “saw no immediate need to raise Bank Rate even if the 7 per cent unemployment threshold were to be reached in the near future”.
That would be understandable if the MPC conceded that it had erred not only in its forecasting but in its analytical assessment. It is perfectly reasonable that members should change their minds when an economy is so hard to understand.
The minutes show it now thinks the long-term unemployed have a greater attachment to the labour market than previously supposed, which should keep wages from rising. It points out that 1.4m people work part-time but would like to work more. This, it now says, is a telling indicator of slack.
These are the BoE’s new arguments for keeping interest rates low. Perhaps they are good reasons. However, after the old ones were discarded with so little ceremony, I do not feel reassured.
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