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How The Bank Came To Get Things So Wrong About The Crash

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http://www.telegraph.co.uk/finance/comment...-the-crash.html

According to a recent Gallup poll, Ben Bernanke, chairman of the US Federal Reserve, is held in lower regard among Americans than the Internal Revenue Service. I doubt the Bank of England is blamed by the UK public for our economic woes to the same degree. The British are natural cynics, and never had the same blind belief in the presumed divine powers of the central bank to produce happy outcomes. There has therefore, been less room for disappointment.

Even so, the Bank's credibility and authority have been greatly undermined by the events of the past two years. Whatever the Bank of England has to say about the future at tomorrow's Inflation Report press conference will be treated with appropriate scepticism.

I know this is unkind, but just to demonstrate how disastrously wrong the Bank's forecasting record has been, and therefore how badly its policy actions have been instructed, I've gone back to the same event two years ago. This seems a reasonable exercise, as the Bank has a two-year forecasting horizon; it sets interest rates to influence inflation two years out.

The August press conference of two years ago also marked almost precisely the beginning of the credit crunch, when the closure of three hedge funds by BNP Paribas sparked a global freezing up of debt markets.

As I say, this revisiting of past forecasts is a trifle unfair, as at the time most of us broadly went along with the consensus view represented by the Bank of continued, relatively benign economic conditions.

There had been plenty of voices warning of the dangers of the build up in credit, not least the Bank's own Financial Stability Report, which for some years had been highlighting the risks of undue reliance by banks on wholesale funding and the massive growth in the market for collateralised debt obligations. But nobody foresaw the carnage to come. Believe those who claim to have predicted it all with pinpoint precision if you like. Few if any of these claims bear scrutiny.

None the less, it's fair to say that some got it more right than others. The Bank of England was not among this former category. Its forecasts of two years ago were risibly wide of the mark. The quarterly Inflation Report famously uses a fan chart to illustrate a range of ten possible outcomes for the economy divided into equal deciles.

You might have expected at least one of them to point to economic contraction. Yet the chart for August 2007 foresaw no possibility whatsoever of a recession in 2009. The lowest possible level of growth was predicted to be 1pc, but this was viewed as no more likely than that growth would be 4.5pc.

The Inflation Report's opening remarks, like those of the Governor Mervyn King at the press conference, gave no hint of what was to come, though Mr King did refer in passing to the tremors already apparent in credit markets.

To his no doubt eternal regret, he then went on to repeat the received wisdom of the time that securitisation had made the banking system safer and more resilient as it meant that much financial risk was no longer on the banks' balance sheets. Oops! The most expensive words in the English language, according to the investment guru, John Templeton, are it's different this time.

To be fair, the Bank's forecasts were never intended as predictions. It was hard to keep count of the number of times a chastened Mr King said at his last press conference in May that he simply did not know how the economy would pan out. But there is a little bit of a con trick going on here, for the Bank's fan charts are indeed meant to convey the impression of calm, self-fulfilling stability and authority.

If the forecasts pointed to calamity, you'd want to know what was wrong with monetary policy that could allow such an outcome. By definition, the charts have to forecast that growth and inflation will broadly comply with trend at the end of the two-year horizon.

Regrettably, it is this reassuring, consensus driven approach to forecasting that is part of what went wrong. The flaw was brilliantly identified many years ago by the post-Keynsian economist Hyman Minsky, who observed that benign real economy circumstances invite increasingly aggressive financial market wagers.

The longer, these "Goldilocks" conditions persist – not too hot, not too cold – the more innovative the financial markets become in attempting to leverage them for gain. Extended periods of economic calm thus result in increasing financial system fragility.

Not many forecasters built these pearls of wisdom into their economic modelling. Worse, they failed to plan for the unpredictable, or what Nassim Taleb has termed the "black swan" event. Mr Taleb's treatise on black swans is in fact just an eloquent way of expressing the common sense notion that sometimes the unexpected happens. Failure to think through the consequences and plan accordingly will land you deep in the mire.

So the BoE was setting interest rate policy on predictions which created even more instability. Interest rates are set for what will happen 2 years hence and they thought 1% growth in 2009 was just as likely as 4.5% growth now.

Knowing when a bubble will pop is impossible to predict, the only certainty is that if you leave the bubble long enough then this is what will happen. Luckily this is exactly what the idiots at the BoE did because it wasn't in their remit.

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http://www.telegraph.co.uk/finance/comment...-the-crash.html

So the BoE was setting interest rate policy on predictions which created even more instability. Interest rates are set for what will happen 2 years hence and they thought 1% growth in 2009 was just as likely as 4.5% growth now.

Knowing when a bubble will pop is impossible to predict, the only certainty is that if you leave the bubble long enough then this is what will happen. Luckily this is exactly what the idiots at the BoE did because it wasn't in their remit.

its also very hard to see reality if you live outside of it.

these guys all have extreme salaries, they live with their rich friends, life is good.

you see this on the telly all the time with the presenters talking about £500 on a dress being good value ( on daytine TV), or witness the shock as house prices fell.

to Merv, a £180K mortgage sounds very affordable indeed. half a years salary.

he wont know ANYONE for whom a 180K mortgage is very affordable.

three, four years ago he sees, 180K mortgages going out the door like there was no tommorrow.

He asks the CML, what are the multiples?...."oh about 3 times salary Merv".

He asks the FSA, are any banks in distress?.."none at all, indeed, Northern Rock and RBS are World class leaders Merv".

He asks the treasury, how are tax takes?..."UP Merv UP and rising.

He asks other Feds, how are YOU doing?.." its all fine, even places like Iceland and Ireland are earning a fortune Merv.

Every where he looks, the World is right.

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Blanchflower has certainly come out of the whole crisis smelling of roses, but I think this article is slightly unfair. At the end of the day, although the BoE did have their eyes pointing in the wrong direction (still concerned about inflation), when they realised how bad it was they reacted pretty damn rapidly, with record rate cuts and £175bio of QE.

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Blanchflower has certainly come out of the whole crisis smelling of roses, but I think this article is slightly unfair. At the end of the day, although the BoE did have their eyes pointing in the wrong direction (still concerned about inflation), when they realised how bad it was they reacted pretty damn rapidly, with record rate cuts and £175bio of QE.

yeah...crisis starts ...In Amerwica..August 2007. first Bailouts what...April 2008...total bailout September/October 2008 with QE.

course, they STILL have their remit of 2% CPI....a target that needs to be met whichever side the actual goes.

This is in the hands of Darling. not Merv.

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Aptitude apparently has no bearing on how seriously your views will be taken in the future, as far as the media are concerned. They only care if you are telling them what they want to hear.

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