Super models shame about the figures

July 31, 1998

They have the power to bring misery or joy to millions. After six interest rate rises in 15 months, it's been mainly the former. So have the academics on the Bank of England's Monetary Policy Committee got their economic models in a twist? Phil Baty finds out

It was hailed as a masterstroke when chancellor Gordon Brown announced last year that he was handing over the government's power to set interest rates to the Bank of England. And a masterstroke not just in the fine art of spin doctoring.

It was thought that a strong presence for academic "outsiders" on the new inflation-busting power - the Monetary Policy Committee - would ensure that intellectual rigour was applied to decisions on how much borrowing should cost. When three out of the committee's nine members were named as practising academics a stunned City agreed that the MPC, governed by the Bank of England, would shield interest rates from political whim.

Charged with getting core inflation down to 2.5 per cent or less, and keeping it there, the committee was expected to herald a new sane and stable era for British economic policy. There would also be a new transparency, as the group's deliberations would be published and its individual votes made public.

But six interest rate rises later, legions of businessmen, not to mention six million homeowners on variable-rate mortgages, are feeling the pinch. Minuted revelations of internal U-turns and major policy splits have sparked a City backlash against the committee, where Bank of England governor Eddie George has been forced to use his casting vote to settle intellectual disagreements. This week a report from academics at the London School of Economics warned that if interest rates rise again after the MPC's meeting next week, the economy could be swept into recession.

The intellectuals in charge are now vilified as out-of-touch fuddy-duddies. It is claimed that they have no idea how their deliberations are affecting ordinary people with mortgages to pay or businesses trying to service their loans. So who are these other-worldly people with our wellbeing in their hands?

The MPC is governed by the Bank of England and chaired by its governor, Eddie George. It comprises nine experts, including George. Only one, former chief economist for British Airways and Shell, DeAnne Julius, is considered a real business brain. There are two deputy governors of the bank, David Clementi and Mervyn King, one bank veteran, Ian Plenderleith, who has notched up over 30 years service, and one former Tory Treasury adviser, Sir Alan Budd. There are also three academics who are essentially bank outsiders - Oxford University professor of political economy, John Vickers; London School of Economics professor of banking and finance, Charles Goodhart; and Cambridge University professor of international macroeconomics, Willem Buiter. Although Mervyn King is a professor of economics and co-founded the Financial Markets Group at LSE, he is seen as a bank insider.

They all have sound credentials. But after last month's interest rate rise - the sixth in 15 months - the Sunday Times was quick to point out that most of the members of the committee determining the cost of borrowing did not have mortgages (see boxes below).

The Confederation of British Industry, with the Institute of Directors and the Forum of Private Businesses, has led the demand that "real" business people should be given a voice on the committee. Ian Campbell, director general of the Institute of Exports, went as far as to say that the committee was living in "wonderland" and refused "to allow reality to intrude on its economic models". Indeed, the presence of the four academics on the MPC has seen the revival of the tired old joke - put a bunch of economists together, and you get more theories than there are academics.

At the heart of all the mathematical modelling is one simple question - is the economy growing or slowing? But that is not easy to predict. "The problem with setting the interest rates is that it is a totally inexact science," says Romesh Vaitilingam, media consultant at the Royal Economics Society. "The models of the economy used to be fairly rigid. These days the models are very flexible and take into account a whole range of different factors. The MPC has to juggle data on not just the supply of money, but on the levels of employment, manufacturing output, skilled labour levels, private sector wage increases, export markets and the strength of the pound." The choice of data, and the weight applied to each factor, is all down to personal interpretation. On top of that, the economists have to try to guess how the public will react to each rate rise. This psychological calculation is a variable in the models that is very difficult to get right.

Former chancellor Kenneth Clarke said the MPC was using a computer model that had proved unreliable for years. Martin Weale, head of the National Institute of Economic and Social Research, says: "It would be nice to know more about the models they use."

The decision in July to freeze interest rates at 7.5 per cent seems to show the MPC was swayed by manufacturers' warnings of weak factory output and the strength of the pound. But just a month earlier the decision to increase the rate for the sixth time was put down to worries over wage rises, when signs of weak factory output were almost as strong. In future meetings, committee members will have to evaluate the potential inflationary impact of Gordon Brown's Pounds 56 billion spending spree after last week's comprehensive spending review.

These men have the power to inflict misery or joy on millions, based on the "psychology" behind an inexact science. The LSE's Goodhart, renowned for his work on the relationship between economic developments and the popularity of politicians, will surely find it apt that Gordon Brown's masterstroke has freed the chancellor from taking the flak over unpopular decisions.


Got a mortgage?

He has an apartment in Notting Hill, London, said to be worth Pounds 250,000. It is mortgaged, but Professor King has not confirmed whether the rate is fixed or variable.

How is he qualified to determine interest rates?

Deputy governor of the Bank of England - and tipped to be the next governor - King is the key academic insider, nicknamed "the professor". He was a professor at the London School of Economics, where he co-founded the Financial Markets Group with Charles Goodhart. He joined the bank as chief economist in 1991. King is a visiting professor at the LSE and at Harvard University. He is also senior Olin fellow at the National Bureau of Economic Research, and a fellow at the Centre of Economic Policy Research.

He got a first in economics from King's College Cambridge in 1969.

Hawk or dove on interest rates?

A Hawk. Understood to have approved the shock June increase, although minutes of the meetings are not yet available, convinced by tight labour markets and above-trend growth.


Got a mortgage?

Reported to have a fixed-rate mortgage on a cottage in Great Gransden in Cambridgeshire.

How is he qualified to determine interest rates?

Former consultant to the World Bank, now professor of international macroeconomics at Cambridge University. He was formerly of Bristol, Yale and the London School of Economics, where he was Cassel professor of economics with special reference to money and banking. He is a former adviser to the office of the Chief Economist of the European Bank for Reconstruction and Development and a member of the Council of the Royal Economic Society. He is also a former special adviser to the House of Commons Select Committee on the Treasury.

He began his studies at the Universiteit van Amsterdam in the Netherlands and got a first-class degree in economics from Cambridge in 1971. From Yale, he got an MA, MPhil and PhD - with distinction.

Hawk or dove on interest rates?

Macroeconomist par excellence. The toughest "hawk", a fan of European Monetary Union, concerned to get the United Kingdom economy more in line with European partners, to curb pay rises and nip inflation in the bud. Vociferous in favour of higher interest rates, he lost respect when he was controversially reported to have described the sixth interest rate rise as "chicken feed".


Got a mortgage?

Vickers lists his address as All Souls College, Oxford (no mortgage), but refuses to say whether he has a mortgage elsewhere.

How is he qualified to determine interest rates?

He is Drummond professor of political economy and fellow of All Soul's College, Oxford University. He was appointed executive director, Bank of England, in June. He was formerly a fellow in the economics of business and public policy at Nuffield College, Oxford, and is on the editorial boards of four economic journals. He is also a governor of the National Institute of Economic and Social Research.

He graduated from Oriel College, Oxford, in politics, philosophy and economics in 1979, and became a financial analyst for Shell Oil before getting his MPhil in economics in 1983. He quickly specialised in privatisation issues.

Hawk or dove on interest rates?

With very little experience of macroeconomics and essentially new to statistics, he is seen as the man to challenge the hardened ideas of the macromodellers. "The idea that because he has little experience in the field makes him inappropriate is wrong," says one economist. "He has gone down very well at the Bank of England. With his brain power he is proving useful. He is asking questions, which is a good thing. We wouldn't want them all to be dyed-in-the-wool macromodellers.".


Got a mortgage?

Goodhart is understood to have a farm in Devon (he is a keen sheep farmer), worth a six-figure sum and a Georgian townhouse in Kensington. At 60 years old, he is understood to have paid off his mortgage and to have inherited a substantial sum from his father, former master of University College, Oxford.

How is he qualified to determine interest rates?

He is a former chief adviser of the Bank of England and he joined the London School of Economics in 1985 as the Norman Sosnow chair of banking and finance. Earlier he taught at Cambridge and the LSE. He is the co-founder, with Mervyn King, of the LSE's Financial Markets Group.

He began in academe as a monetary historian, but soon moved to contemporary issues. His recent interests have focused on European Monetary Union, and Central Bank Independence.

Hawk or dove on interest rates?

Has already made two U-turns over interest rates, moving from a rate-rise hawk to a softer dove, and back again.


Macroeconomics is concerned with the study of economics on a large scale, looking at how big groups of agents - governments/industries - act together nationally or globally. Microeconomics focuses on the smaller scale, looking at the individual agent.

A macroeconomist looking at the oil industry would examine how the oil industry affects us nationally or globally, perhaps how oil prices might affect exchange rates. A microeconomist would work in terms of individual firms, their incentives, pricing or employment practices. Macro-economics began to lose credibility in the Thatcher years. Before then, the macro field was seen as the way to manage the economy; macroeconomics influenced political decisions about public spending, taxes, fiscal and monetary policy. In the Thatcher years, more attention was given to the stimulus and incentives faced by individual agents, such as trade unions.

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