What we must still learn about the great inflation disaster

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The Bank of England has failed. It has an inflation target of 2 per cent a year that it has not met. Over the three years to March 2024, the UK consumer price index jumped by 21.6 per cent, equivalent to an annualised rate of 6.7 per cent. In three years, prices have risen by as much as they should have in 10. So, even if one assumes that inflation will now return to target, as the bank surely intends, the overshoot in the price level will be permanent. That could also shake trust in the long-run credibility of these targets.

What is to be learnt from this record? A part of the answer came from the recently published review commissioned from Ben Bernanke, a former chair of the US Federal Reserve and Nobel laureate, on “Forecasting for monetary policy making and communication at the Bank of England”. Its helpful conclusion, at least for the bank, is that the forecasting failures were run-of-the-mill ones. Failure loves company: the bank has been in splendid company.

As the Bernanke review states, “the surge in inflation that began in mid-2021 was largely, though not entirely, unanticipated by all the central banks . . . the Bank of England’s inflation forecasts were neither the worst nor the best of the central banks shown.” It did better than the ECB and Swedish Riksbank, but worse than the Bank of Canada, the Norges Bank and the Reserve Bank of New Zealand. (It proved harder to make comparisons with the Fed.)

In a recent speech, “Outlier or Laggard: divergence and convergence in the UK’s recent inflation performance”, deputy governor David Ramsden similarly defends the bank against the charge that it has been an outlier in performance. He argues it has been a laggard, instead. The conclusion is that the bank’s record on control of inflation is just not much to moan about. The IMF’s decomposition of recent inflation outcomes in the US, eurozone and the UK in the latest World Economic Outlook gives further support to this view. UK inflation overshoots look similar to those of the eurozone, with huge “pass-through effects” from big adverse jumps in relative prices.

Is the right conclusion that there is nothing to see here? The failure was not truly a failure, since nobody could have foreseen what happened. No. This conclusion is at least questionable. More important, it is the issue Bernanke ought to have been asked to address, not whether it is a good idea to replace fan charts with scenarios: in fact, it is sensible to use both. More important, forecasting is in any case impossible when it most matters, which is when the world changes. As suggested in my column last week, efforts to provide “forward guidance” are thus bound to mislead because they assume a knowledge of the future that central banks will possess least precisely when it is most needed.

Yet that does not mean we cannot learn from what has gone wrong. For this aim, however, the terms of reference for Bernanke were too narrow, deliberately so, I suspect. He should have been asked to consider what went wrong. He would then have had to assess whether these inflation overshoots were not, in part, because nominal demand was encouraged to explode from deeply depressed to above long-term trend levels everywhere. In the UK, for example, aggregate nominal demand jumped by 41 per cent between the (Covid-struck) second quarter of 2020 and the second quarter of 2022. In the US and eurozone, these jumps were 30 and 28 per cent, respectively. In all these cases, demand also ended up above long-term trend levels. Of course, there were also unforecastable supply shocks. But is it plausible that the fiscal and monetary policies that drove demand levels so strongly had nothing to do with the inflation?

It is of course possible that the inflation overshoots, though large, will indeed be temporary and the real economies will also be permanently stronger than would otherwise have been the case. But these questions, too, should be asked and, yet again, not just for the UK.

In sum, this huge surge in inflation has, whether a disaster or not, been a dramatic event in the history of our economies. We should be in the habit of learning from such events systematically and rigorously. That should not be embarrassing, but normal. It is what our marvellously successful air transport safety systems do as a matter of course. It should be just as usual to try to learn from macroeconomic policy disasters.

Maybe, the great inflation of the last few years was inevitable. I, for one, doubt it. In any case, this is the question outside experts ought to address. So, ask Bernanke back to analyse what has gone wrong, why it has gone wrong and whether it matters.

martin.wolf@ft.com

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