This feel-good factor is adding momentum to the UK housing market. Businesses, too, have rediscovered their mojo. Surveys of output intentions are close to record highs. Quarterly employment growth is running at its fastest rate since the series began. Surveys of skills shortages point to the possibility of upwards, if localised, wage pressures. Output growth in 2014 Q1 is nearly 1% higher, and unemployment rate close to 1 percentage point lower, than the Bank expected last August. If history is any guide, these errors tend to be positively correlated, upside as well as down. Yet at the same time, the inflationary risks posed by such a scenario should not be overstated. As output and unemployment have surprised on the upside by 1%, average wages and inflation have surprised by the same amount on the downside. Real wage growth has been positive in only six months in the past six years. And inflation expectations remain well anchored to the inflation target. Inflationary ghosts are hard to find. A third uncertainty concerns the financial side of the economy. Global appetite for risk is, at present, voracious. Measures of financial market uncertainty are at or below pre-crisis levels across a range of asset classes. Many asset prices have rocketed and spreads plummeted. Two years ago, yields on Italian and Spanish debt were around five percentage points above US Treasuries. Today, they are 30–40 basis points below. Yields on corporate bonds, both high and low grade, are close to all-time lows.
Even for the natural sciences, dealing with physical constants and fixed laws of motion, the voyage of discovery can sometimes be a lengthy one. It took a century before estimates of the speed of light had converged to its true value. For much of this period, not only were best-estimates biased but the estimated confidence intervals around them often did not encompass the true value.6 Modelling complex, adaptive, socio-economic systems would make these estimation problems pale by significance. It is for these reasons that the Bank is also investing in its research capacity. For example, in our quarterly Inflation Report the Bank now shows alternative scenarios for inflation and output under different assumptions about how the world works. Alongside this, the Bank is putting greater effort into developing a pluralist set of approaches to model-building, drawing on other disciplines. Operating in the corridor In time, these investments in data and research will narrow the corridor of uncertainty. But for now, the key public policy question is what to do when operating in it? Rocket-scientists, of the real rather than metaphorical kind, have a clear answer to this question: avoid really bad outcomes.7 This is sometimes called a “minimax” strategy – the aim being to minimise the chances of the maximum possible loss. It is the policymakers’ equivalent of the Hippocratic oath – “do no harm”. So what, then, are these avoidable-at-all-cost scenarios? Let me consider three from a potentially long list.