By David Robinson

LONDON (MNI) – The Bank of England is set to replace its current
forecasting model with a new one, named Compass, although the changeover
will not take place until next year at the earliest.

The new model is intended to be simpler and a lot more flexible
than the current Bank of England Quarterly Model (BEQM). It will
initially be run in parallel with it, with no hard date set for the

Market News understands the work is being done in house. Richard
Harrison, a research advisor in the Monetary Analysis division, is a
leading light on the project.

The new Compass model will be, in the technical jargon, a dynamic
stochastic general equilibrium one. The BEQM model, which had a core
DSGE model, has been criticised by economists familiar with it as overly
complex and for running off track recently.

Harrison co-authored a BOE working paper in which he set out the
broad thinking behind the new model.

In it he described an “open economy dynamic stochastic general
equilibrium model, featuring many types of nominal and real frictions
that have become standard in the literature.”

The emphasis on frictions highlights the move in economics away
from the classical vision of perfect, frictionless market systems.

Nobel prize winning economist Paul Krugman once predicted that
“flaws-and-frictions economics will move from the periphery of economic
analysis to its center.”

The updating of the BOE model is not, however, in response to the
weakness of economic models highlighted by the credit crunch, which hit
its peak in the autumn of 2008.

The BOE decided to go ahead with building a new model in February
2008 and resources were actually diverted away from it when the credit
crunch was raging.

The total cost of creating the new model is put at stg2.4 million.

–London newsroom: 4420 7862 7491 e:mail

[TOPICS: M$B$$$,M$$BE$,MT$$$$]