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How predictable is the economy?

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On the first Thursday of every month the Bank of England’s Monetary Policy Commission (MPC) has a little get together to decide what to do about interest rates for that month, and a couple of weeks later the notes from that meeting are released to the press. Until recently these notes didn’t generate a lot of interest, but now that everything’s going to hell in a handcart, the media likes to pore over them in the hope of gaining some insight into what the MPC’s plans for the future might be.

The nine members of the MPC rarely agree on whether to cut, raise or hold rates, and even when most of the members agree on a particular course of action, there’s usually at least one voice of dissent. This month for example, eight of them voted to hold, one voted for a cut – often the voting is a little more evenly balanced.

Most people like to believe that the business of running the economy is a straighforward (if not exactly simple) mathematical balancing act. But if it really were that straight forward, the nine members of the MPC would simply have to consult some mathematical formula which would provide them with the right answer, in fact the MPC wouldn’t be needed at all, the job could be easily done by a software model. But it’s just not as simple as that – the truth is that most of the economists who work at the Bank of England and in the rest of the financial services sector are at best making educated guesses about what will happen in the future based on any given course of action, and at worst are simply taking wild stabs in the dark and dressing their decisions up in impressive sounding, but ultimately meaningless, financial jargon (like “we see significant downside potential“).

The economy is, quite simply, unpredictable. If the stuffed suits of Threadneedle Street were really any good at predicting exactly how things are going to pan out in future, then we wouldn’t ever have to deal with credit crunches and economic downturns. The economy largely does what it wants, the MPC can try to steer it in the right direction by making small adjustments to interest rates, but this is like attempting to steer the Titanic to safety by hoisting a small sail on the deck.

You should treat the predictions of economists and financial industry analysts with caution, especially the ones who are employed by the banks and other vested interests. For example, when the Council of Mortgage Lenders says that it expects house prices to fall by 7% this year, you have to ask how exactly it reached that figure and since it has a vested interest in the housing market, isn’t it just possible that the Council might be tempted to paint the situation as being a little rosier than it really is.

 

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