The Bank of England (BoE) needs to increase its intellectual diversity in order to combat groupthink, a House of Lords committee heard.
Martin Wolf, chief economics commentator at the Financial Times, said members of the bank’s Monetary Policy Committee (MPC) appeared to have voted “all in lockstep for a very long time.”
But the risk of groupthink is not unique in the UK’s central bank, peers on the Economic Affairs Committee were told. Academics, as well as the U.S. central bankers, have also been susceptible, according to Wolf and Donald Kohn, former vice chair of the U.S. Federal Reserve and former Financial Policy Committee member at the BoE.
Groupthink is a term used to describe a phenomenon that occurs when a group of individuals reaches a consensus without critical reasoning or evaluation of the consequences or alternatives.
Asked what went wrong in recent years that resulted in double-digit inflation in the UK, Wolf said he believes the BoE failed to anticipate that the global supply chain “would be in such a mess” in the aftermath of the COVID-19 pandemic.
Noting that the BoE’s view during the pandemic that the inflation pressure was “transitory” was shared by other central banks and major official forecasters, Wolf said the banks’ decisions during the pandemic contributed to “a global inflationary environment.”
Wolf said the MPC members may have missed the alarm bells of runaway inflation because of a lack of experience in dealing with high inflation.
The committee had been concerned with inflation being “persistently too low for a very long time” that it had “become the normal way of thinking about it,” he said, adding that he suspects no committee member in 2020 had experience “with relatively high inflation environment.”
He also told the committee that the MPC members appeared to have been “in lockstep too much.”
“I think that members of the MPC seem to have forgotten that they are being judged on their own individual vote. And I do think that it would be a good idea to have people with rather different views on the committee. And my sense—many of them are admirable economists—but my sense is, they are all a bit too similar for my liking,” he said.
Wolf also said he had been “very struck in the last two decades [by] how far academic respectable academic macroeconomics has converged on a certain view of how the economy works,” which he believes is wrong.
“And having everybody think the same way in that sense, particularly if it’s wrong, is very, very troublesome,” he said.
Wolf later confirmed he was referring to the use of New Keynesian models of Dynamic Stochastic General Equilibrium (DSGE) to analyse business cycles and make forecasts.
Commenting on how to address the risk of groupthink in the government and in BoE appointments, Wolf said he believes the bank shouldn’t give forward guidance, which he said is “bound to create groupthink.”
Forward guidance is the tool a central bank uses to influence individuals’ and businesses’ financial decisions by announcing the banks’ forecast of the economy and its policy intentions. For instance, if the BoE says it expects the interest rates to stay low, commercial banks may lend more freely with lower interest rates, businesses and individuals would in turn be more like to borrow. The expectation is that a booming economy would keep inflation under control.
But once forward guidance is given, “it becomes very, very difficult [to] subsequently just change it because you’re then breaking your word,” Wolf said.
“I think once you’ve agreed on forward guidance, you are going to be trapped. And I also don’t believe we will ever know enough to be that confident.”
He also said the personality of the BoE governor can influence how much groupthink there is in the bank and that the ministers should “go out of their way” to make sure there are diverse views in the MPC.
‘Precisely Wrong’ Modelling
Asked about the DSGE models, Wolf said they could be “another trap” for the MPC.It’s almost impossible to incorporate the financial sector sensibly, he said, adding that the “core problem” with intellectual analysis of unbearably complex decision-making under uncertainty is that “you would rather be precisely wrong than roughly right. And the only way you can be precisely wrong is to have an agreed intellectual framework, which is rigorous, estimated, and will deliver precise outcomes.”
The models are “pretty good” when things don’t change, but “when things change a lot, they’re likely to give you very, very bad advice,” Wolf said.
Therefore, trying to stick to the model “can be another trap for the committee,” he said. “I will be shocked if the bank doesn’t come up with some sort of analysis, at the end of this quite a detail, one of why they were wrong.”
He also said forecasting models of all the major institutions, notably the IMF and OECD, “are immensely powerfully mean reverting,” but “when it isn’t true, it really gets you into a terrible mess.”
“I think the point here is we are trying to do something in economic policy now, which is steer economies, which I think to some degree we have to do, but our understanding of economies is not sufficient to do that with any degree of reliability,” he said.
Kohn told the committee that economists at the Federal Reserve were each using different models, but still failed to capture the “2008 disruption,” suggesting the issue isn’t limited to DSGE models, but “any model is built on history” and therefore doesn’t work well on predicting the unexpected.
Kohn said human “judgement is absolutely essential,” and external experts brought into central banks “need to be sufficiently sophisticated to know what to ask without having bought into the whole thing.”
Kohn told the committee he believes the BoE’s basic set up is right and works better than its U.S. counterpart. The experts also said the BoE should concentrate on its primary responsibilities of maintaining price stability and financial stability, without being burdened with secondary remit such as climate considerations.
