How ‘flamethrowers’ and creaking IT burnt the Bank of England

Bank of England Governor Andrew Bailey has committed to modernising the institution – Hollie Adams/Bloomberg

The cloistered world of central banking is usually characterised by a clubbable atmosphere, but Ben Bernanke did not go easy on his colleagues at the Bank of England.

In his landmark review of the British central bank, the former chairman of the US Federal Reserve blamed “out of date” IT systems, inexperienced staff and “stale” financial data for critical flaws in the Bank’s economic forecasts.

“A lack of investment” in key areas has left economists overwhelmed with basic tasks such as data entry and with no time to consider the longer-term outlook and the bigger trends shaping the economy, or to improve the forecasting tools the Bank uses.

The review was commissioned after the Bank – along with other forecasters – failed to predict the severity of the cost of living crisis, and in turn missed the sharp drop in inflation in recent months.

Here are the main problems set out by the Nobel Prize-winning economist.

Creaking IT

A key issue is the ageing IT systems still used by the Bank.

“The most serious problems we found in our review are the deficiencies of the Bank’s forecasting infrastructure – the tools the staff uses to produce the quarterly forecast and supporting analyses,” Bernanke said in his report. “Some key software is out of date and lacks important functionality.”

Officials and economists must handle vast quantities of ever-shifting data, processing new information as rapidly as possible to try to understand the economy and prepare new forecasts.

But with outdated systems, economists must spend a disproportionate amount of their time copying numbers from one system to another, rather than analysing the information for useful insights.

“The process of putting the various inputs to the forecast together has become increasingly complex and consumes a high fraction of staff energy and attention,” Bernanke said.

“Steps that ideally would be executed automatically are instead done manually.”

This is not a good use of time for the Bank’s highly educated staff.

Nor does it help policymakers to understand the state of the economy and so identify the best way for them to respond.

The Bank’s Governor said he is taking action: a £30m system upgrade has already begun, which will include moving to a cloud-based IT setup.

Inexperienced staff

The Bank also has a problem with inexperienced staff as a result of a broken career ladder.

If you want to get a big pay rise at the Bank of England, you have to move around within the organisation.

Bernanke said the current incentive structures encourage people to apply for jobs outside their current divisions if they want to climb the career ladder.

“Based on what I’ve heard from staff, the Bank is too weighted towards having people jump from area to area,” he said.

While this helps people develop a “well-rounded exposure to the issues… my sense is that there should be more emphasis on the experience side in any given area.”

This is crucial, especially when it comes to the Bank’s main job of setting interest rates. As the review highlighted: “Staff members with extensive experience in a particular domain generally have deeper knowledge of their subject area and can engage policymakers with more confidence.”

Bernanke put it more bluntly: “It’s important to have people in key areas [who] understand the details and can stand up to an MPC member and say: no, you’re wrong.”

The Bank said it was working on “developing incentives for expert staff” to shape the improvements as well as “providing opportunities to progress through building expertise”.

Stale data

Perhaps most concerningly of all were the issues Bernanke identified with the Bank’s fundamental economic models.

The core model, called Compass, has “various shortcomings”, Bernake said.

Some of them are stunning – the model did not include a detailed recreation of either the financial sector or the energy sector. Such oversights were costly during first an energy crisis and then an inflation crisis.

Compass also struggled to “capture fully” the way monetary policy works in practice and was too optimistic, with a “tendency to predict over-rapid returns of the economy to its steady-state equilibrium (including to 2pc inflation).”

Gaps are filled with other models and, increasingly, economists’ and policymakers’ judgments. This only serves to “paper over problems”, Bernanke said.

Some data entered into the models come from financial markets, including traders’ forecasts of future oil prices and interest rates. But the cut-off date for taking in such data is a week before the Monetary Policy Committee (MPC) meets.

This is simply too long a gap in a modern economy, meaning the data is “stale” by the time policymakers are considering it, the report said.

In its response, the Bank acknowledged its models perform well when the economy is stable, but struggle when times get tough.

It said: “A forecasting framework that performed well during periods in which inflationary shocks were relatively small may be less robust during periods of large and unusual shocks and the associated heightened uncertainty, or in an economy transformed by structural changes, for example the emergence of artificial intelligence, or a realignment of trading relations.”

Confusing charts 

For more than three decades, the Bank has used so-called fan charts to visualise the uncertainty surrounding its forecasts.

Economist Robert Chote famously described them as “flamethrowers of uncertainty” because of the bright orange and red colours used in the Office for Budget Responsibility’s own version of the many-hued charts.

The charts are meant to convey to the public the range of possibilities and the inherent difficulties the Bank faces in making policy choices.

It’s a noble aim. But, Bernanke pointed out, most people have no idea what they mean.

While the former Fed chief recognised their “distinguished history”, he said they had “weak conceptual foundations and do not seem to be particularly effective communication tools”.

In short, they should be ditched.

Policymakers should instead focus on one central scenario that rate-setters were prepared to endorse, while outlining the risks surrounding that forecast.

Bernanke said the current system had created confusion at times. For example, in November 2022, the Bank’s central forecast predicted the UK would slip into the longest recession on record as prices surged.

However, policymakers did not endorse the forecast as it was based on market expectations of surging interest rates. Bernanke said communication issues offered more confusion than clarity.

“The person in the street thought that the Bank of England was forecasting a recession when perhaps that was not really [policymakers’] main scenario. I think that is something that needs to be thought about,” he said.

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Fixing the problems

Bernanke has left the Bank with 12 major recommendations and plenty of thinking to do.

Bailey acknowledged there is a lot to do: “We will take some time to develop the plans carefully, but the work has already started and we will provide a further update by the end of the year.”

The Governor indicated that IT reforms are a “high priority”. However, executing this overhaul – and fixing the other problems – will not be easy.

“It is a little bit like fixing a car while it is running,” said Bernanke, ominously.

Overhauling the fundamentals of the economic model will be hard when staff are already stretched and must still keep providing regular forecasts to the MPC.

Then there is the question of changing the way careers work at a 300-year-old institution that has a deeply embedded culture among its heavily academic workforce.

However, Bailey was keen to convey that he has the appetite for radical reforms.

“We have a once in a generation opportunity to update our approach,” he said. “We need to adapt and develop and ensure that our forecast is the best it can be.”

It will be some time before the public will be able to rely more firmly on the Bank’s projections.

Bailey offered some reassurance in the meantime, arguing that the economic forecasts have performed well when the global economy is not riven by gigantic shocks.

“I hope I am not going to jinx this in any sense at this point – we are in calmer conditions at the moment,” he said.

“If you look at the Bank of England’s approach pre-Covid, the forecast errors were in line with everyone else’s forecast errors, and they were much smaller. So you can take comfort from that.”

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