Mervyn King: Uncertainty in macroeconomic policy making – art or science? Lecture by Mr Mervyn King, Governor of the Bank of England, at the Royal Society conference on “Handling Uncertainty in Science”, London, 22 March 2010. Accompanying slides to this speech can be found on the Bank of England’s website. David Aikman, Philip Barrett, Sujit Kapadia, Mervyn King, James Proudman, Tim Taylor, Iain de Weymarn and Tony Yates (Bank of England) contributed to this paper. * 1. *  *  Uncertainty and public policy  Most questions of public policy relate to uncertainties. Answers depend upon an ability to understand and evaluate those uncertainties. Yet many commentators and members of the public want to believe in certainties. They want to cut through the thickets of caveats and technical difficulties to the “bottom line”. We see this in economic policy, weather forecasting and the interpretation of secret intelligence. Five years ago, the Bank of England and the Met Office held an informal seminar to exchange ideas on how to communicate measures of uncertainty to the general public. Although we failed to persuade broadcasters to explore the issues of economic and weather forecasting in more depth, the bilateral relationship which developed between the Bank and Paul Hardaker, who moved from the Met Office to take over the Royal Meteorological Society, flourished. Today’s conference is a tribute to Paul’s persistence. It could hardly be more timely.
In particular, economic outcomes are sensitive to the way people behave under uncertainty, and to their beliefs about the past, present and future. Perceptions of uncertainty affect behaviour. If enough people are uncertain about their future job prospects and save more as a precaution, that may lead firms to cut employment, so increasing the chance that jobs are indeed lost. But uncertainty about whether it will rain today does not change the weather. Beliefs adapt over time in response to changes in the environment; and this in turn affect show economic systems behave. Because the surrounding environment can affect economic decision-making, there are probably few genuinely “deep” (and, therefore, stable) parameters  3  This particular example is fortuitous for earth science and biology, since it helps us date rocks and the fossils they contain and chart continental drift, based on the history of changes in the magnetic field of the earth. BIS Review 36/2010  3  or relationships in economics. In contrast, in many settings in the physical sciences there are stable “rules of the game” (e.g. the laws of gravity are as good an approximation one day as the next). The study of decision making under uncertainty has a distinguished ancestry in economics. Frank Knight (1921) wrote about the difference between risk (where frequencies could be used to calculate probabilities) and uncertainty (where there was no objective basis on which to derive probabilities).