There has been lots of comment in the media on the criticisms that former chair of the US Federal Reserve and economics Nobel prize winner, Ben Bernanke, has made of the Bank of England’s forecasting techniques. He undertook a review of these methods at the invitation of the Bank because so much concern has been raised about how poor their forecasting has been, particularly since the Covid crisis.

In general, observers have suggested that Bernanke must have been thorough because he has made twelve recommendations for what people think to be significant reforms within the Bank. Bank of England boss, Andrew Bailey, has already said that he will act upon them. That, however, to me is the surest sign that Bernanke has missed his target. If he had suggested anything that would have created real change Bailey might have resisted his recommendations a lot more obviously.

A long time ago a wise person taught me that I should, when reading reports of this nature, not consider what is said within them, but what is left unsaid, meaning that an issue has been ignored. It is in this light that I have read the report.

Before noting those exceptions let me make it clear that I am unsurprised that he has said that (and I am summarising his twelve, heavily overlapping, recommendations when noting these issues):

1. The Bank’s methodologies are out of date.
2. The Bank’s technology is outmoded.
3. The Bank is over-reliant on data analysis.
4. The Bank has structures that do not encourage the promotion of expertise.
5. There has been resistance to change within the Bank.
6. Critical thinking that challenges the Bank’s forecasting has been discouraged, even in the Monetary Policy Committee.
7. The Bank’s systems are orientated to processing normality, and not exceptions to the norm.
8. There is a bias against narrative explanation of the Bank’s opinions and forecasts.
9. Its reporting methods might be familiar due to their habitual use but they are not necessarily useful.

I stress, this is not how Bernanke puts things; I offer these as reasonable interpretations of what he says. To me they say that the Bank:

1. Is outmoded in its thinking.
2. Has failed to invest despite the enormous resources available to it.
3. Requires compliant obsequiousness from its staff.
4. Does not encourage critical thinking.
5. Hides behind opacity.
6. Lacks creativity.
7. Most of all, is seeking to reinforce what it thinks it knows rather than what might actually be happening.

Again, I stress he did not say that: it is what I think he means.

That said, there are, in my opinion, major failings in what Bernanke has done. For example, has not questioned the basis of the economic approach adopted by the bank, which is based on what is described as dynamic stochastic general equilibrium modelling (DGSE). This is unsurprising. Bernanke is deeply invested in this economic method methodology, as all central bankers are. However, the model is profoundly unsound. There are a number of reasons.

Firstly, the model is based upon microeconomic foundations. It assumes that the model of decision-making that is appropriate for individuals, households and companies is also appropriate for the state. To put this another way, the household analogy is built into it from the outset. The result is an inherent logic that the government is just another player within the economy when it is nothing of the sort. It role is not only normally the inverse of all other actors within the economy, it also sets the rule for everyone else.

There is another problem arising from the use of microeconomic foundations. Many of the crass assumptions within microeconomics, including that markets can produce optimal outcomes and that they can clear supply and demand, are implicit in DGSE modelling, quite inappropriately. You cannot build sound economic forecast on the basis of nonsense. Bernanke does not say this.

Secondly, although it is claimed that these mathematical models can handle uncertainty, I do not think that is true. They can only handle risk, which is probabilistic. I am not convinced that they can handle uncertainty, to which probability cannot be attached, although it happens, nonetheless. This is why they were quite unable to handle the global financial crisis of 2008 and the Covid crisis. Those events simply did not exist within the range of forecast probabilities. Bernanke does not point this out.

Third, these models assume that there is such a thing as equilibrium, i.e. an optimal economic outcome to which we can aspire. There is no evidence that such a state as ever been achieved. In that case, why it is appropriate to assume that this is the basis for forecasting is very hard to explain. Bernanke offers no such explanation.

Fourth, as Steve Keen has explained, relentlessly, models of this sort are based upon the assumption of a barter economy where there is no role for money. Any adaptations within the model to include the role of money are necessarily a fudge. Why the Bank is using such a model to control monetary policy is hard to explain.

Fifth, if, instead of an equilibrium state being modelled there is instead a model that presumes that the status quo prevails (which Bernanke implies to be the case), then the model has built within it an assumption of reversion to the norm. That would be great if that norm was what everyone desired, but very clearly the norm within the economy in which we all live at present is not working. That means that the model is inherently in conflict with society - and what is happening in the real world.

Sixth, the most massive macroeconomic externality, in the form of climate change, is effectively ignored within this model, because that is what its microeconomic foundation necessitates. This fact pretty much undermines just about everything the Bank does.

I could go on, but I think that my reservations are now clear. I am, of course, aware of that I am generalising, but I also know that in almost every model of this sort where adaptation is introduced to try to accommodate the criticisms made, the assumption is that the exception from the model’s requirements is contrary to economic well-being i.e. the model always tries to make prediction that resort to its implicit over-riding assumption that pure market economies must exist, fundamentally free of government interference. The reality that a central bank exists to implement government policy is in fact contrary to the implicit assumptions in the models that presume that no such thing should happen.

Bernanke mentions none of this. As a result what he says will fail us.

But that was also guaranteed for another reason. It would appear from the commentary that he has provided that he spoke to no one, at least of consequence, outside the Bank when undertaking his work. In other words, he has made recommendations for reform of the way in which the Bank works without ever once considering the opinion, or needs, of the Bank’s stakeholders, whether they be the government, other politicians, society at large, or business of all sizes. His comments do, therefore, represent the ultimate statement of central banker arrogance. In the opinion of central bankers, nothing but their view matters. Bernanke did not say this, but whether he recognises it or not, it is clear that he thinks it.

Bernanke was always the wrong person for this job. He was a central banker marking another central banker’s homework, without ever questioning the assumptions on which the central bank worked. This investigation was doomed from the outset as a consequence.

And these are the people that Rachael Reeves is placing her faith in to run the economy when a Labour government is in office.

This comment was posted on the blog overnight by long term occasional commentator Jonathan:

Interestingly, now the Guardian have discovered your Taxing Wealth Report it seems they have started reading this blog – and based tonight’s editorial on this post.

It will be interesting to see if this continues, and whether the Labour Party realise they need more credible advisors.

I did, as a result, search out the Guardian’s editorial today, which has this headline:

The editorial does, I admit, raise a great many questions I noted here yesterday, including about the suitability of both Edward Troup and Bill Dodwell to be appointed to Labour’s new tax advisor panel, and Margaret Hodge’s’ past comments upon them.

They also picked up on my concerns about the appointment of a panel of the supposedly great and good to advise on financial services related issues, which I reposted here yesterday.

In addition, they suggested that a much broader basis for the recruitment of expertise should have been adopted by Labour, as I have said many times before.

And the editorial appears to explicitly support the Taxing Wealth Report line on taxing income from high earnings and wealth more.

So, just for the record, I had no idea that this was being written, and although I did speak to Guardian journalists yesterday, including about my concerns on the membership of this panel, I had no involvement in this editorial in any way, even though its alignment with my views is high. But, that said, I am not complaining. If they stick to this line The Guardian can build a strong policy platform for holding Labour to account, which is essential.

The editorial is here.

The University of Notre Dame has announced the creation of the Jenkins Center for Virtue Ethics.

According to a press release, the center will

support preeminent scholars whose research advances human flourishing in both moral and spiritual contexts, facilitate the development of undergraduate courses exploring topics such as justice and the common good, and deepen the ethical formation of Notre Dame students and faculty. The center will also play a transformative role in public discussion, drawing citizens into meaningful dialogue informed by virtue ethics. 

The center is named for Rev. John I. Jenkins, the current president of the university, who will be stepping down at the end of the academic year.

According to the university,

the center will be an essential part of the Notre Dame Ethics Initiative, a University-wide effort to establish Notre Dame as a premier global destination for the study of ethics, offering superb training for future generations of ethicists and moral leaders, a platform for engagement of the Catholic moral tradition with other modes of inquiry, and an opportunity to forge insights into some of the most significant ethical issues of our time. Virtue ethics will be a key area of focus for the initiative, as well as technology ethics, business ethics and environmental ethics, among others.

Further details here.

The post New Virtue Ethics Center at Notre Dame first appeared on Daily Nous.

Rachel Reeves is making an announcement today on how she will plug the gap that she thinks exists in her financial plans as a consequence of Jeremy Hunt stealing her intention to close the domicile rule.

As the Guardian notes this morning, she has resorted to the age-old intention of politicians who do not know how to balance their supposed books by claiming that she will close the tax gap.

Firstly, let me make it absolutely clear that I welcome that intention. It is entirely appropriate. I discuss it at length in the Taxing Wealth Report 2024. I look at the issue in chapter 15 of that report, where in four subsections, I deal with the need to better estimate the tax gap, to undertake tax spillover assessments, to set up an Office for Tax Responsibility to monitor delivery on this issue, and to reform HM Revenue & Customs so that its presence in local communities might be recreated so that it might deliver on this promise.

It would also be well worth looking at chapter nine, and in particular subsection 9.1 on reforming the administration of corporation tax and subsection 9.3 on the reforming of Companies House, both of which are essential if we are to close the tax cap.

In that case, given my enthusiasm for this topic, it would be churlish in the extreme to not welcome Rachel Reeves' intention to tackle this issue.

That said, excepting her comments on domicile, which are appropriate because the Tories are very clearly trying to manipulate the replacement rules for this in favour of the wealthy, Reeves’ comments this morning do appear to have an inappropriate focus to them.

In particular, she is highlighting another age-old mantra, which is that we must pay great attention to offshore tax abuse use if the tax gap is to be closed. Whilst there will, inevitably, be some outstanding opportunities for tax investigations during the period when the domicile rule is closed as matters, previously unseen come to light, I overall doubt that this is where the focus of attention for HMRC should now be. After all of my years campaigning on offshore, I am not saying the issue has gone away. It has not, but it has reduced, considerably. All the effort expended on it has now paid a considerable return. As a consequence, the evidence is now very strong that the problems in tax recovery are not to be found offshore. Nor, by and large, are the problems created by tax avoiders. It seems that HMRC is catching up with them. Instead, the problem that we face is in collecting tax from those who owe it and choose not to declare it within the domestic economy.

As I note within the Taxing Wealth Report 2024, whilst the overall claim of HMRC is that the tax gap is falling (which I doubt) what is also unambiguously true is that the tax gap for the self-employed and small businesses is very high, and in the latter case, in particular, rising rapidly.

In the case of small companies, it is estimated that 30% of all corporation tax liabilities owing or not now paid. Although HMRC never seems to extrapolate a tax loss in one tax to imply that there must be a consequent loss of revenue in another tax, it necessarily follows that if this is the case, then those same companies that do not pay the corporation tax that they owe must also fail to pay the VAT and PAYE that they owe, meaning that it is my belief that both those estimates are seriously underestimated as a consequence. In addition, I do not take seriously HMRC’s claim that the tax gap amongst the self employed is now only 18.5%, representing a decline over the last few years from a peak of 32.5%. If small companies fail to pay 30% of the tax that they owe there is no reason to think that small businesses do anything significantly different.

If Rachel Reeves is serious about closing the tax gap, this is where she would start looking for money. And, as I note in the Taxing Wealth Report 2024, if she wants to collect the significant sums involved in this loss, then she would require that HMRC begin to reopen its local tax offices because only by having a presence in the communities that it serves, and which pay tax, can it understand who is not paying that money, and who is helping them to evade it.

Simultaneously, she should be transforming the information that UK banks are required to submit to HM Revenue and Customs each year so that all those companies trading in the UK can be properly identified, and she should be massively increasing the resources available to Companies House to increase the effectiveness of its operation in tracking down corporate data in the UK.

There is a real opportunity to reduce the tax gap in this country, but Rachael Reeves will not close the tax gap by looking overseas. Pretending that the problem is elsewhere is no longer realistic. It's in her own backyard.