Bank of England turns a blind eye to euro crisis

What is it about the Bank of England’s growth and inflation forecasts? For nearly two years now, the Bank of England’s quarterly inflation reports have pretty much consistently both underestimated inflation and overestimated growth. The inflation forecasts we can perhaps forgive; the Bank of England cannot target a rate of inflation constantly buffeted by unpredictable external pressures and sudden jumps in sales taxes. But it’s long been hard to see why it is so optimistic about growth.

This pattern has persisted into the latest Inflation Report, published on Wednesday. The immediate growth forecast for this year has been trimmed a little in the wake of recent, weak data, and it takes longer for growth to pick up speed and return to trend than it did in previous forecasts. Yet the Bank is still forecasting pretty robust growth of something like 3pc annualised by early 2014. What is more, the Bank’s famous fan charts point to hardly any probability of outright recession. And the Bank makes these forecasts despite the fact that one of its deputy governors, Charlie Bean, conceded on Wednesday that the Bank had cut its estimate of the economy’s potential output. There is probably less spare capacity in the economy than the Bank had previously thought, he conceded.

Does the Bank honestly think these growth forecasts the way to bet? Somehow I doubt it. One possible explanation is that the Bank, in drawing up its forecasts, has ignored the possibility of calamity in the eurozone, prospects for which appear to have risen significantly over the past week. According to Mervyn King, the Governor, these risks are “unimaginable and unmentionable”, and in any case cannot be quantified in any meaningful way. They have therefore been excluded from the fan charts. (see page 38 of the Inflation Report for a full explanation of this omission)

Yet as the Inflation Report points out, the greatest risks to global growth right now come from the eurozone. This is the greatest uncertainty, and it has just got a whole lot bigger. OK, so no-one knows how to model for meltdown in the eurozone, but if you were only to forecast for things that were certain, then it would be as pointless as forecasting that you will be taking the bus to work as usual tomorrow morning.

Given that this is the biggest threat to the world economy right now, it’s hard to understand why it should be completely ignored. At the very least, the uncertainty it’s causing will act as a further, significant drag on the economy.

While I was out in Japan recently, an economist pointed out that the West used to like lecturing Japan on how its two decades of post bubble lost growth were all the fault of policy error. “Now you see it isn’t so simple, eh?”, he said. It’s looking ever more possible that despite our supposed superiority in policy making, we are heading the same way. Still, if we do, I guess it will all be blamed on poor policy making in euroland. Hey ho.