The Bank of England”s decision on the next move in interest rates can be decided by tiny differences in economic statistics. But if such statistics are inaccurate, then interest rate decisions may be made on the basis of wrong information.
A new report by Anthony Garratt, Gary Koop and Shaun Vahey, published in the July 2008 issue of The Economic Journal, shows that the chances of ”substantial” revisions to GDP are less than one in twenty – roughly once every five years.
This is especially important as GDP figures are used by the Bank of England to forecast future GDP and future inflation, and therefore affect decisions on interest rates. Statistics matter. If the Bank of England cuts rates on the basis of inaccurate information, inflation could rise too high. Alternatively, if the Bank raises rates because the statistics wrongly suggest the economy is overheating, then unemployment could increase. And if the Bank ”corrects” rates as soon as the accurate figure is known, then this could increase volatility.
The quality of UK GDP statistics now is a marked improvement on their quality before 1990, when the then Chancellor of the Exchequer, Nigel Lawson, described them as ”little more than a work of fiction”. Part of the reason for the unprecedented macroeconomic stability of the last decade and a half was better informed decisionmaking by both the Treasury and the Bank of England.
But substantial revisions can and do still happen – as in 2003, when the estimate of second quarter GDP growth was revised upwards from 0.3% to 0.6%. The report looks at the chances of GDP being revised by more than the amount it was revised in 2003, a change that generated considerable media attention. It finds that the chances of a substantial revision for any one GDP statistic are less than one in twenty.
”Forecasting Substantial Model Revisions in the Presence of Model Uncertainty” by Anthony Garratt, Gary Koop and Shaun Vahey is published in the July 2008 edition of The Economic Journal.
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