I have long argued that central banks should utilise prediction markets for macroeconomic forecasting and for the implementation of monetary policy.

In today’s edition of the UK business daily City AM I have an oped on this topic and about how the Bank of England should have a closer look at prediction markets. See here:

IN HIS first major speech since becoming governor of the Bank of England, Mark Carney is today likely to defend a policy that has come to be described as the “Carney rule”. Also known as forward guidance, the rule effectively promises that interest rates will stay at present levels until unemployment drops below 7 per cent, so long as the Bank’s inflation forecast does not top 2.5 per cent.

 

This kind of forward guidance is welcome news for the financial markets. We will now at least have some sort of map to navigate monetary policy, instead of relying on insinuations from the lips of the wise men on the Monetary Policy Committee (MPC).

 

But this still leaves markets at the mercy of the Bank of England’s internal forecasters, whose credibility can certainly be questioned. The Bank doesn’t need to be biased to consistently predict that it will hit its inflation target, for example (though what institution would forecast that it will fail?). Even with the best incentives, it cannot possibly bring together all the private knowledge spread across investors, firms and households.

 

It is this inability of elite central planners to gather such a wide source of information that led even committed Marxist GA Cohen to agree that markets may be necessary for a rational economic system. No individual, however intelligent, can know enough about the economy to make a really reliable prediction about it.

 

And it’s not just the dragging-together of information from thousands of different sources that makes market predictions more accurate than those made by small elite groups. Investors betting in markets have skin in the game; they have an extremely strong incentive to get their bets right, since they will lose money for bad (inaccurate) bets and win money for good (accurate) ones.

The launch coincides with Mark Carney’s first major speech as governor of the Bank of England and follows his announcement earlier this month that the Bank will consider both inflation and unemployment when deciding monetary policy.