The Bank of England risked our economy by believing a Peter Pan myth on inflation - CityAM

"Today is the 21st of June 2023 and it is currently 5 o'clock in the morning."

Paul Ormerod is an individual who specializes in economics and works for Volterra Partners LLP as well as being an author.

According to Paul Ormerod, the Bank of England is not successfully forecasting or managing the inflation rate as people lack trust in its aptitude to accurately predict the direction of the economy.

The Bank of England has come to terms with the fact that it must respond to the increasing disapproval of its inability to forecast or manage the consistently high inflation rate.

Answer: After the Treasury Committee of the House of Commons made requests, the Bank has chosen to start a comprehensive external investigation into its "forecasting and related procedures in times of notable ambiguity".

The most prominent way of macroeconomic modeling is called New Keynesian, and without agreeing to its principles, it's been difficult to join the MPC in recent years. However, this standard approach in economics has failed in the past during inflationary crises, and the current situation is not an exception.

For instance, back in August 2008, Olivier Blanchard, who was the top economist at the IMF, produced a document for Massachusetts Institute of Technology (MIT) named "The state of macro". This report stated that "a mostly common perception of variances as well as techniques has arisen... the condition of macro seems positive." In a short period of three weeks after the release of this report, Lehman Brothers went bankrupt.

The New Keynesian method comes in many forms that are very mathematically advanced. They all share two important economic aspects. Firstly, the amount of money in circulation is not important when it comes to inflation.

In June of last year, the head economist at the Bank, Huw Pil, didn't think much of the worries of monetarists. He put down in writing, "A few people who believe in monetarism were worried that the increase of central bank balance sheets because of QE during the financial crisis would make inflation worse. But, this fear turned out to be false."

To give Pil due credit, his paper shows a lot of consideration overall. However, regarding the issue of inflation, the chief economist of the Bank declared in June 2022 that there was nothing to be concerned about when it came to the quick growth of the money supply leading to inflation.

New Keynesian models have another interesting feature. They propose a concept similar to Peter Pan's theory of inflation. If we all have faith in fairies, Tinkerbell will survive, and if we all have confidence in the Bank's New Keynesian model, inflation will never become an issue.

Based on these models, the rate of inflation during a certain time period is influenced by the present output level and the predicted inflation rate in the future. When there's an anticipation of inflation increasing, it will, in fact, increase during the present period. However, there's a clever strategy used to keep it in check.

The central bank's choices on interest rates impact how much we think prices will rise in the future. If the bank sees either higher-than-normal economic activity or a higher-than-desired rise in prices, it will increase interest rates.

If the rate of inflation is predicted to surpass the target, it is likely that the Bank will increase its interest rate in the upcoming period. This, in turn, will lead to a decrease in output, ultimately leading to a reduction in inflation. Additionally, if inflation is anticipated to drop in the future, the current inflation rate will also decline.

The Bank of England has given significant importance to "anchoring" expectations of inflation in recent years. This approach may appear abstract, but its practical significance has been immense.

However, there is a significant issue with this approach. In order for it to be successful, all of us must have faith in the Bank's economic model as being completely accurate. Although people may have faith in mythical entities like Tinkerbell, it's become apparent that only a small number of individuals have confidence in the Governor of the Bank of England's model.