It’s time the Bank of England rethinks monetary policy - and its own methods

THE BANK of England’s handling of inflation has been met with increasing levels of criticism. Despite its suite of academically fashionable mathematical and econometric models, the Bank seems to be acting in a daze, unable to comprehend what is going on.

A paper just published in the American Economic Review advocates an alternative way of understanding monetary policy and its impacts on the economy. The article in question has more standing than most. It is the Presidential address to the American Economic Association at their annual conference held earlier in the year.

Christina Romer of the University of California at Berkeley gave the address as President, and the paper is written with her husband David.

The paper is unusual for a top economics journal because it mainly consists of words. There are a few charts and statistical relationships, but the essence of the paper is in the title: “Does Monetary Policy Matter? The

Paul Ormerod

Narrative Approach after 35 Years”.

The question is very pertinent because the Federal Reserve doesn’t appear to attach much importance to the quantity of money - like both the Bank of England and the European Central Bank.

The 35 years refers to a paper the two economists published in the late 1980s advocating an approach to macroeconomic analysis based on a thoughtful reading of text rather than using abstruse maths.

In the Presidential address, they offer a post-war monetary history of the United States to identify significant contractionary and expansionary changes in monetary policy.

The narrative approach is an empirical technique which gathers systematic evidence from contemporaneous qualitative sources such as newspapers, government reports, and policy meeting transcripts, and incorporates it into statistical analysis.

The Romers conclude that monetary policy is indeed important. Monetary shocks have large effects on unemployment, output, and inflation.

Intriguingly, they argue that an analysis of available policy records suggests a contractionary monetary shock likely occurred in the United States in 2022. Based on the empirical estimates of the effect of previous shocks, they expect substantial negative impacts on real GDP and inflation as we move through 2023 and into 2024.

This is exactly what prominent monetary economists such as Tim Congdon here have been arguing. A sharp monetary contraction has been experienced in the US, the UK and the EU, and a recession is therefore expected.

The narrative approach is one which should be investigated more thor- oughly. With UCL colleagues David Tuckett and Rickard Nyman, I published a paper in 2018 entitled “News and narratives in financial systems: exploiting big data for systemic risk assessment". The piece actually appeared as a Bank of England Working Paper, Nyman having spent some time at the Bank on secondment when Andy Haldane was Chief Economist. to prove their worth as these apps develop over time as free or very minimal costing resources. Using AI in education could be a once in a generation opportunity for the UK to develop a world-class education system fit for the future, but we must move quickly. As with education, regulation has the potential to differentiate the UK while ensuring that AI is used and developed safely and ethically. Although the UK has been relatively uncompetitive and unable to keep pace with the rate of technological change over the last 30 years, one of the few upsides of Brexit is that we have the opportunity to move faster than our competitors if we want. With Rishi Sunak currently in the United States to promote the UK as a leader in global AI governance, we have an opportunity to make a name for ourselves globally. We could carve out our place on the world stage as an attractive place for the next stage of technological innovation, but whether we can create the environment needed to succeed remains to be seen, as the EU and the US are already discussing methods of regulating AI.

Haldane appreciated that a wide range of approaches should be explored to get a better understanding of how the economy as a whole behaves. In addition to narratives, he encouraged work on, for example, networks and agent based models.

None of these will prove to be a panacea. Indeed, the Romers stress that this applies to their own narrative methodology. But the Bank has hardly been so successful that it can afford to ignore alternatives to their own conventional models which have proved to be so inadequate.

There are certainly risks around AI which shouldn’t be ignored. But in the same way that medical research could unwittingly release a super virus, development cannot be held back on account of the risks. Far from it, AI is simply the next stage in our evolution as humans. It will bring challenges as well as opportunities but if used correctly it will allow us to focus on the one thing that is most important and that technology will never be able to do: be human.

£ Guy Hands is chairman and founder of private equity company Terra Firma

A Win For Sue

The Sue Gray and Labour saga is finally over. Keir Starmer has won his battle. He’ll be able to appoint the former civil servantwho wrote the report on the Downing Street parties - as his chief of staff from this autumn. Gray will only have to take a six months gardening leave

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Paul Ormerod is an author and economist at Volterra Partners LLP