The Bank of England’s economic software has “serious deficiencies” and its rate-setting Monetary Policy Committee should include “alternative scenarios” in its forecasts, according to the Bernanke Review.  

The former US Federal Reserve chair was commissioned by the central bank last May, after it failed to predict inflation would hit a four-decade high of 11.1% and that it would remain high. This drew heavy criticism from politicians and independent economists.  

In his report, Bernanke sets out 12 recommendations, organised around three major themes for the Bank:  

• Improving its forecasting infrastructure, including data management, software, and economic models  
• Providing a forecast process that better supports the MPC’s decision-making. This includes equipping the MPC and the Bank’s staff so they can learn from past forecast errors, identify and quantify risks to the outlook, and deal with uncertainty and structural change in the economy  
• Helping the MPC communicate its view of the economy, the risks and uncertainties surrounding its outlook, and its policy rationale, to the public  

Bernanke says: “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.   

“Some key software is out of date and lacks important functionality.”  

He adds that the Bank’s baseline economic model, called Compass, “has significant shortcomings”.    

The report recommends that Compass be scrapped, “or at a minimum, thoroughly revamped”. It adds that the work the Bank has begun of updating its forecasting software “should be continued with high priority and as rapidly as feasible”.  

The Nobel Prize-winning economist points out that “effective communication is essential for effective monetary policy”.  

He says: “The publication of selected alternative scenarios in the Monetary Policy Report, along with the central forecast, would help the public better understand the reasons for the policy choice, including risk management considerations.   

“Selected alternative scenarios could also provide the public with information about the MPC’s policy reaction function and its views of the monetary transmission mechanism.   

“The MPC should determine which scenarios are published, choosing those that members deem to be most informative about the policy decision at a particular time.”  

The Bank welcomed the report, saying it is “committed to action” on all 12 of the report’s recommendations.   

It will provide an update on the changes it has made by the end of the year.  

Bank of England Governor Andrew Bailey says: “This is a once-in-a-generation opportunity to update our approach to forecasting, and ensure it is fit for our more uncertain world.”

Bernanke adds: “The forecasting and policy challenges faced by the Bank of England in recent years were hardly unique. Still, they have served as a stress test of forecasting at the Bank.   

“The Bank, like other central banks and policy institutions, will be working to draw the appropriate lessons from this experience.”