The IMF’s growth downgrades will make tomorrow’s newspaper headlines but the more striking point is its decision to massively rewrite British economic history. As Citi’s Michael Saunders notes (PDF), the IMF now believes that UK economy was massively overheating in the boom. What we had thought was normal growth was, in fact, crazy exuberance. Britain’s economy was more overheated by any in the G7, the IMF now tells us. Things were worse in 2007 than in the ‘Lawson boom’. Had we known about this overheating, of course, it ought to have been remedied by an interest rate rise. The asset bubble might never have been blown and the cheap debt party (in which the bankers were bartenders, not organisers) might never have got so out of hand.
No metaphor involving horses and stable doors could do justice to this tragic failure of economics, or express its uselessness as a warning system. Most economists know this and joke about their ‘dismal science’ — but the danger comes when people forget that fact. The Bank of England set Britain on a cheap credit binge, thinking they had found a holy grail of stability because CPI inflation index was stable. But this was all based on an outdated economic orthodoxy, one that didn’t factor in freakish shocks like the deflation from globalisation. The result is what we now know to be a near-fictitious account of UK economic stability.
And today the Bank of England is conducting the biggest Quantitative Easing experiment the world has ever seen — telling us not to worry because the economic consensus says it’ll all be fine. Maybe so. But when the IMF rewrites history like this, it should be a warning: economics is, as a social science, fundamentally flawed. You can’t predict the future: there are too many variables. Policymakers are at their most dangerous when they forget that economic forecasts are just educated guesses – the truth can, and often does, lie elsewhere. Banks and governments placed such calamitous debt-fuelled bets in the boom years because they were assured that they were not, actually, boom years but some kind of great moderation. The end of boom and bust, etc. Too much faith in faulty econometric models was a major cause of crash. Or, I should say, a cause of the bubble – which was always going to burst.
The moral now is that we should take all forecasts and assurances with a massive pinch of salt. The Bank of England ought not to be so cocksure about their forecasts when they’re justifying the printing of all this funny money. Economics has not caught up with the globalised economy: the tools at our disposal are insufficient for working out what was happening in 2007 let alone what’s going on in 2012. That’s why the Bank should tread very carefully with this £500 billion QE programme. No one can say with any confidence how this massive gamble will end.