What I thought John Cochrane would have said about legislating a Taylor Rule for the Fed

John Cochrane recently responded on his blog to the news that Congress were going to debate that the Fed be required by legislation to choose a monetary policy rule, and stick to it, justifying when and why it departs from it.

His post surprised me somewhat.    It seemed relatively favourable to the idea.  Not entirely convinced.  But raising practical questions like:  what would go in the rule, what would be left out?  What about macroprudential policy?  Putting on the table the distinction between instrument rules [schemes that stipulate directly what should be done with the interest rate] and targeting rules [jargon to describe schemes for evaluating the outcomes of policy, where the policymaker is left to decide how best to do its job].

Cochrane has written quite a lot that bears on how much weight we should put on the literature that extols the benefits of Taylor-like rules in the sticky-price macro model.

One theme, in his  Journal of Political Economy paper, is:  the benefits claimed for rules like the Taylor Rule are much less reliable than you might think, because they are based on arbitrary and very unconvincing procedures for picking out one particular equilibrium in the sticky price model from the many possible.

Another theme, that he has developed in his blog,  focuses on policy recommendations for escaping the zero bound that emerge from the sticky price model.  The basic idea is:  at the zero bound, the sticky price model throws up some mighty strange results.  Rather than forcefully recommending the prescriptions that rely on them, these strange results should cause us to wonder whether the model isn’t itself wrong.

Key prescriptions are that the central bank should engage in forward guidance, lowering the future rate when it can’t push today’s interest rate any lower.  And implementing a fiscal stimulus on the basis that the multiplier is so large in these models when monetary policy is stuck at the ZLB.

The results that Cochrane [rightly in my view] says are weird, are what protagonists have dubbed the ‘paradoxes’.  Like the paradox that if you reduce potential output, by destroying capital, or force workers to work part-time,  you can increase inflationary pressure, so much so that the economy escapes the zero bound and output  increases.  [There are other exotic results too, like the fact that if you fix interest rates for protracted periods, these models can go from generating huge inflations to huge deflations as you extend the period of fixed rates out just one more quarter].

So, to recap, I was expecting John Cochrane to say that it was way too early to start legislating on the basis of a literature that used dodgy logic to select equilibria, and threw up so many paradoxes at the zero bound.  [And I would have agreed with him].

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Bailey and Carney punch the Bank for International Settlements below the belt

Mark Carney (Governor of the BoE) and Andrew Bailey (Head of the Prudential Regulatory Authority within the BoE) were sharply critical of recent warnings by the BIS that central banks were fueling another crisis by keeping rates too low.   Carney said:  “It’s a report that’s made in a vacuum though, the vacuum of Basel, a world where a central bank doesn’t have a mandate… a world where a central bank is not accountable to Parliament and through Parliament to the people, to achieve specific targets.”  Bailey:   “It’s an interesting commentary from an institution that doesn’t have policy obligations.”

As I wrote in earlier posts, I agree with the substance of these Bank of England remarks, that tightening policy now would be ill-advised.  But, two concerns.

First, these remarks come close to reading like this:  ‘the BIS see clearly what would be in society’s best interests in the long run, but unfortunately we have these local political masters who have set us inflation targets that we need to hit, and doing that means we can’t do what’s right.  What a pity we can’t do the right thing.’

Second, there is an element of this:  ‘you shouldn’t take seriously their views, because their minds are not concentrated by the reality of having a real job to do.’

I doubt anyone at the BoE holds the first view, but it’s a dangerous one to allow to be read into your utterances.

The second I think was intentional and misjudged.  It could be read as an attempt to devalue all independent commentary.  Not a policymaker?  No right to comment, since you are other-wordly.  Presumably academics, journalists, employees of the IMF would fall into the same bracket.   In fact, who would be qualified, outside the BoE itself?   An organisation like the BoE, with so many important powers, and with such imperfect systems holding to account, is in a delicate situation.  It must be seen to welcome scrutiny and challenge, however daft.  The more defensive and undermining it is of its critics, the more likely it runs the risk of corroding the political consensus around its independence.

Besides, the BoE is part owner of the BIS.  Collectively, central banks [ultimately through their governments] have agreed to tolerate a role for the BIS as an independent commentator on central bank policies.  There are good reasons to do it.  One might hope that if there were market failures in monetary or financial economic research, the BIS could act as a focal point for thinking and funding.  The BIS’s independent commentary could potentially be a force for good in orchestrating better global coordination for monetary policy, and averting self-defeating competition between countries over financial regulation.  This independent commentary, even if sometimes unsound or unwelcome, may, in the long term, bolster the independence of member institutions.  Local political regimes may be just a tiny bit less tempted to interfere if there appears to be an expert functioning community, of which the BIS is a part, evaluating what their central banks are doing.

If Carney and Bailey don’t want independent commentary, they should work behind the scenes to get an agreed change to the BIS’ mandate with other owners.  If that’s not an option, they should simply combat arguments they don’t like with economics, and not resort to near-smear-tactics.




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Why Civil Service Department Heads should have one eye on future governments

A document listing the desired attributes of a future leader of a Ministerial Department has caused a storm in the UK.  One of its recommendations is that a candidate be able to “balance ministers’ or high-level stakeholders’ immediate needs or priorities with the long-term aims of their department, being shrewd about what needs to be sacrificed, at what costs and what the implications might be”.

Some Tory politicians, sensitive to their current lack of legislative progress in this department, and looking for scapegoats, have complained that the civil service is acting unconstitutionally in choosing its leaders for their capacity to face down their incumbent ministers.

Well, here is an amateur argument for why that characteristic IS constitutional.  The constitutional feature we all learn about at high school in the UK is that no single Parliament should be able to bind future Parliaments.  This principle is obviously routinely flouted.  Since every penny of spending committed today deprives a future Parliament of the same discretion.  Every piece of land built on cannot be restored to its prior state…. And so on.  But here lies the salvation of that controversial document.  Department heads – known in the UK as ‘permanent secretaries’ [a misnomer, since they are not permanent, though usually longer-lasting than their political bosses] – faced with demands for splurges in spending, or drastic changes in current capacity that might constrain future capacity, might reasonably object on the grounds that future Parliaments cannot be unduly bound.

The tradition that future Parliaments be not unduly bound is question-begging, of course.  Why should that be a good feature of a democracy?  The soundest reason I can see is that as yet unborn or not independent generations want to have the same say in their own affairs as we had in ours.

If you haven’t already clicked through to the offending document, it’s worth doing so just to absorb the tone of the final section headed ‘The X-Factor’, which, I forecast, will provide much enjoyment and study for those immersed in the sociology of the cult of ‘leadership’ in the modern age.

Postscript:  it occurs to me that there is a contrast between HMTs view of the function of a perm sec and that of Francis Maude.  HMT asked Nick Macpherson to step outside his role as immediate facilitator of Coalition policies and offer independent advice.  Maude objects to criteria for selecting perm secs on the basis that they can formulate benevolent but independent views about what should be done.  Our hypothetical Maude might comment that NM only intervenes when instructed to do so, so NM’s contribution isn’t an act of constitutional subordination or independence.  However, if that were the case, then the SNPs charge that NMs views can’t really be taken seriously, since they would not have been aired if they had not agreed with the Government’s, would be valid.

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Market monetarist views are a mish-mash of the good and the silly that don’t belong together anyway

Market monetarism seems to be trending in the twittersphere and the blogosphere.  Before I ventured into these noisy arenas, I’d never heard of it.  After reading some of the outputs, I find myself struggling to understand it.  What the hell is it?  Why is it so popular?  Why does it have a name?  Most of us don’t go round declaring ourselves to be part of a school of thought, or coining terms to name ourselves.

Market monetarism [MM here on] has embraced some of the following claims or views.  This list might be incomplete, and it’s possible that contrarian positions by MMs have been stated on some points below.  So this critique risks doing some an injustice.  But in order to start somewhere:

1.  Monetary policy is never ineffective at stabilising inflation or the real economy, even at the zero bound.

2.  Fiscal policy is ineffective [at, see above...] always.

3.  Fiscal policy is effective [at...], but not desirable.

4.  Those New Keynesian models omit to model money, and so don’t capture why monetary policy is effective.

5.  If you look at New Keynesian models carefully, they show that monetary policy is effective, even at the ZLB, which demonstrates why it, and not fiscal policy, should be used for stabilisation purposes always.

6.  Unlike in NK models, monetary policy isn’t just about OMOs, or even buying long dated government securities.  Expansions of the money supply can be used to buy all sorts of assets.

7.  Societies should adopt nominal GDP targeting.

8.  [And/or] It follows from some combination of 1-6 that societies should adopt some form of nominal GDP targeting.

9.  The crisis was caused by inflation targeting.  Following a MM perspective, including a nominal GDP target, would have averted it.

10.  Fiscal policy is ineffective away from the ZLB because it prompts an offsetting monetary policy response.

One way of responding to these statements is to look at them solely through the lens of either a) theoretical models of money and the macroeconomy or b) the empirical literature on the efficacy of monetary and fiscal policy, via the identification of monetary and fiscal policy shocks.

To summarise what the mainstream canon has come up with so far.  In so far as we can tell what sensible stabilisation objectives for monetary and fiscal policy are, and assuming that we accept that prices are sticky, the use of both instruments in pursuit of them is, away from the zero bound, always effective and desirable.  If the economy is at the zero bound, but expected to be there temporarily only, then, with a qualification, the use of both instruments is again both effective and desirable.  The qualification here being that monetary policy means the manipulation of future interest rates.  If you don’t buy that prices are sticky, then monetary policy is not an effective instrument, nor is it desirable to induce fluctuations in inflation for their own sake.  If the economy is at the zero bound and not expected to escape, monetary policy [in the form of expansions of the money supply] are not effective, though they are probably harmless.  Fiscal policy is probably effective and desirable.

That summarises, probably, the pre-crisis theoretical literature.  The empirical literature studying economies away from the zero lower bound, which has grown from the recommendations of Sims and others about how to identify policy shocks, conforms to this, which is unsurprising, as the theory was engineered to match the empirics.  We know less, for obvious reasons, about the effects of policy shocks at the zero lower bound.

The post-crisis literature has begun to confront the intriguing facts emerging from the unconventional policy actions of central banks forced down to the zero lower bound.  These are that purchases of long-dated government securities or other, private sector assets, through the creation of reserves, lower yields on those securities.  Modifications of the pre-crisis theory change the story told above a little.  Monetary, fiscal and unconventional monetary policy are always effective and desirable away from the ZLB.  Unconventional monetary policy is always effective and desirable at the ZLB.  And so on.  Assuming there are no costs of conducting it.

We are now in a position to go back and look at some of the MM statements and respond to them.

1.  Monetary policy is never ineffective at stabilising inflation or the real economy, even at the zero bound.

Well, yes it is.  If the economy is expected to stay at the ZLB forever.  Or if a corresponding money injection is not expected to be permanent, and therefore is associated with interest rate not being expected to be any lower than normally, once the economy has escaped from the zero lower bound.

2.  Fiscal policy is ineffective [at, see above...] always.

This is false, both contrary to the theory and empirics, as stated above.  Versions of the theory which display Ricardian Equivalence  – the ineffectiveness of fiscal policy – are rejected by the data.  And common sense. [I can't borrow against my future earnings in unlimited quantities, so I am not indifferent to the timing of taxes and spending].

3.  Fiscal policy is effective [at...], but not desirable.

If this is an appeal to practical or institutional problems wielding fiscal instruments, then we are on to interesting territory.  But, I’d say that at the ZLB, they are dominated by the necessity of a stimulus, and the uncertainties surrounding the alternatives.

4.  Those New Keynesian models omit to model money, and so don’t capture why monetary policy is effective.

True.  But modifications of them to include roles for QE or credit easing which match the data don’t change the basic story – certainly that fiscal policy is always still effective.  Moreover, an expansion of money to purchase private assets is the sum of a conventional open market operation, which is ineffective in these models still, and a debt-financed purchase of private sector assets, which one might label fiscal policy anyway.

5.  If you look at New Keynesian models carefully, they show that monetary policy is effective, even at the ZLB, which demonstrates why it, and not fiscal policy, should be used for stabilisation purposes always.

This seems to be what David Beckworth was saying by tweeting links to Woodford and Auerbach and Obstfeld to me in our exchange.   Well, no.  NK models show what I already explained.  Monetary policy can work if the economy is temporarily stuck at the ZLB, sure.  But so can fiscal policy.  And both are desirable.  And anyway, it’s a bit odd to throw 4 and 5 at us.  We thought you didn’t like the model?!

6.  Unlike in NK models, monetary policy isn’t just about OMOs, or even buying long dated government securities.  Expansions of the money supply can be used to buy all sorts of assets.

True.  But we dealt with this.  And it didn’t amount to concluding that fiscal policy wasn’t desirable.  And repeating my smug semantics, we saw that we could even call this fiscal policy if we were so minded.

7.  Societies should adopt nominal GDP targeting;  8.  [And/or] this follows from some of 1-6.

Well, in some model set ups, nominal GDP targeting is the right thing to do, but in many, in fact one might say usually, it is not.  Even in the general case where it is not, Woodford has advocated it as a means to managing expectations of short rates, so that people get the idea that the inflation undershoot has to be followed by an inflation overshoot, for which a reasonable approximation is that people get the idea that a nominal GDP growth undershoot is followed by a nominal GDP growth overshoot [as is the case with a nominal GDP levels target].  So there is something to NGDP targeting.  But it is really only a special case that emerges occasionally.  That’s not to say that what central banks actually do matches what is more generally supported in theory either.  Who knows what they do precisely, for that matter.   However, there is no result screaming out there to justify a major change in frameworks.  [The Bank of Canada used this argument in favour of rejecting Price Level Targeting].  And the most mysterious thing about the interest in nominal GDP is the strange, magical, mythological jump from money to nominal GDP.  Formally, the interest in nominal GDP targeting is, so far, a non-sequitur as regards the MMs worries about NK treatments of money.  The fact that views 7 is grouped with the others undermines them as a ‘movement’.  Where, in the literature, we do find support for nominal GDP targeting, it’s not because of any of 1-6.

9.  The crisis was caused by inflation targeting.  Following a MM perspective, including a nominal GDP target, would have averted it.

There are BIS-like claims that inflation targeting caused the crisis, through its alleged neglect of financial stability concerns, and asset prices.  These are debatable.  [Answer:  it would have been too costly to avert the crisis with tight interest rates].  But the MM claim I am aware of relates to a different point, to do with the fact that the Fed was insufficiently stimulative, and would have been more so had it appreciated the efficacy of monetary policy even at the ZLB even more than it did, and sought more energetically to generate a boom to make up for the slump.  I think this argument has more to it than the others.  But mainstream New Keynesian macro would say it differently.  Policy might have been better had we already had in place a prescription for a future, post recession inflation overshoot, which would have managed expectations in such a way as to make the initial undershoot less severe.  And, anyway, although some would not agree with me on this, the fact that inflation stayed pretty close to target indicates to me that demand-side policy was doing not far short of what it should do.

10.  Fiscal policy is ineffective away from the ZLB because it prompts an offsetting monetary policy response.

It’s true that away from the ZLB a fiscal expansion would prompt a partially-offsetting monetary contraction, but, this wouldn’t make it ineffective [referring to NK theory and VAR studies of historical policy] or undesirable [referring to theory here].  You can find fiscal instruments [eg the sales tax] that under some settings can be wielded in such a way as to be identical to monetary policy.  But in general, it isn’t, and from this flows the statement that begins this paragraph.

As a retort to each and every one of these points, MMs, or anyone else for that matter, could say ‘I don’t like your models, I’m talking about the real world’.  [This has been the flavour of some of the MM critiques].  Well, I’m not claiming that these models are right.  But they are relevant.

First, MM claims often make use of them, not always correctly, misunderstanding what is in them and their implications for the desirability of fiscal policy.

Second, many MM claims might persuade others that there is a competing theory, but there isn’t.  There is a competing body of thought in the academic literature that seeks to tell better stories about why people hold money, in the work of the ‘new monetarists’ like Wright and Williamson and Lagos.  But this literature is not a theoretical foundation for MMism.  We don’t know all that much yet about what such models would advocate for central bank or fiscal policy design.  To some extent, the modelling difficulties involve preclude building a model that is sufficiently realistic in other ways to address questions discussed in the NK literature.  Addressing these questions is also obscured by the mission of new monetarists to junk the assumption of sticky prices, since they view this assumption as superficial, and question-begging, and don’t like our habit of taking the empirical literature in favour of it at face value.  Many of those models for this and other reasons would see business cycles as efficient, not to be ironed out by any policy instrument.  These are positions that would seem, superficially, to conflict with the MM optimism about the usefulness of monetary policy to avoid booms and busts.

Third,if the MMs want to claim to be speaking about the real world, they need to rebut the overwhelming evidence in the empirical literature on monetary and fiscal policy.  And replace it with a competing empirics.  And interpret it through the lens of a coherent world view, ie, a theory.  MMs have neither a competing theory, nor a competing empirical canon.


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Should Congress legislate so that the Fed is forced to follow policy rules?


But, as John Taylor alerted us in his blog, a new bill has been introduced that would have this effect, if passed.  I presume that this is one of those bills that no-one expects to pass, but is put before it to stimulate debate.  Debate is always a good idea, but even a tiny chance that it might actually pass is a cause for concern.


Even before the financial crisis, I would have said that the ‘Science of monetary policy’, to borrow a phrase from the elegant survey of modern sticky-price-monetary policy macro by Clarida, Gali and Gertler, had not progressed to the point where anything could be gained by attempting to legislate for such a rule.

Why not?

Because even then there was too much disagreement encoded in the controversies about the transmission mechanism of policy to produce a consensus about what such a rule would look like.

Even if such a rule were chosen by the Fed, and reported to Congress, everyone would rightly expect that the necessity to deviate from it practically every period would dominate the benefit from generating further predictability in policy.  And hence little or no further predictability would result.   If, by some strange quirk, the Fed found itself forced or tempted to follow such a rule, macroeconomic policy would surely suffer, and uncertainty would soon return as everyone speculated about the point at which a consensus would build to cast of the shackles of this legislation.

John Taylor and John Williams wrote a great survey of the applied theoretical work on monetary policy rules for the revised Handbook of Monetary Economics.  And if you read that you’d find that following simple policy rules like those John Taylor himself hit on in his 1993 classic paper [the credit for which in discussion amongst some afficionados is allocated equally across JT, Dale Henderson, Warwick Mckibben, and others] does quite a good job, across a range of models, in recovering the performance of the best possible policy in each model.

But, this range is still pretty small.  It’s confined to sticky-price, rational expectations DSGE [dynamic stochastic general equilibrium] models.  Many disputes within the DSGE community question the apparent attractiveness of this result. First, no-one seriously believes rational expectations should be used to assess such an important feature of policy design.  (Correction:  I don’t.  To say ‘no-one’ is probably wishful thinking).  There are many alternatives, and no settled one.  But I would bet my house that the ‘Taylor Rule or similar does great’ result would fall down if one substituted in many of these alternatives.  The result probably doesn’t survive the inclusion of financial frictions.  Woodford suggested that the Taylor Rule could be amended with the addition of a spread.  But can you imagine a central bank committing to any particular spread, or to responding to it in a fixed way, given all the vagaries and misunderstandings in asset prices and associated yields?  I can’t.  And we still have not stepped outside (essentially) representative agent models.  Heterogeneous agent DSGE work has yet to study carefully the design of monetary policy rules.  And….  I could go on and on making similar points in the same vein [the state of the art in macro doesn't have a proper model of money yet, so legislating for the fine details of monetary policy seems ludicrous;  the state of the art in macro can't generate financial crises yet;  how would legislation encode responses at the zero bound?  experience of other instruments at the zero bound (QE's effect on yields) confounds most macro models......]

I’m all in favour of exploiting what wisdom we have on policy rules.  Most central bank compute their inflation forecasts assuming that they themselves will follow a rule (which might sound paradoxical, given that they intend not to), and it would be helpful for them to disclose these assumptions, so that forward guidance and yield curve talking could be made more concrete.  But taking this far as legislation seems premature.

Moreover, we should remember some of the background to John’s encouragement of this legislative charade.  He sees the performance of the US post-crisis as resulting from the deleterious effects of uncertainty about policy that come with a departure from rules-based policy.  This view, which he has held to for some years, always struck me as peculiar.  JT himself pioneered the basic outline of the modern sticky price macro model, yet his views conflict with how I see the policy prescriptions that flow from it.  Those would be: [inexcusably crude summary follows]  follow a policy rule that responds to forecasts of inflation and real activity [Bernanke artfully explained this modification to Taylor's rule, given the long lags between policy and actions].  Deploy counter-cyclical fiscal policy in concert:  automatic stabilisers might be enough.   If the zero bound constraint binds, you will probably need extra stimulus from both monetary and fiscal policy, to be got from discretionary fiscal measures, and – not in the model then, but implied by it, and since incorporated – unconventional monetary policy.  Whether you have done enough or not can [I'm talking still from the model's perspective here] be read by looking at measures of spare capacity, and inflation itself.  In the US, it’s fair to say that one could argue there was an undershoot.  Still looking at the issue through the spectacles of this model, we’d probably argue there was a case for a significant OVERshoot [Woodford argued this for some time, using basically Taylor's model].

It seems likely – the Bloom, Baker, Davis work on policy uncertainty seems to confirm this – that there was significant uncertainty about policy, both monetary and fiscal.  But, returning to the model, this would be of the form:  we’re uncertain if Congress are going to agree to enough fiscal stimulus as prescribed by Taylor’s model;  we aren’t sure how the hell the Fed can stimulate the economy [as per Taylor's model] with its instrument pressed against the zero bound.  And in the face of this uncertainty, [this isn't in the model, but interesting work that modified it afterwards offers some support], the prescription is not, as JT is suggesting, a return to less stimulus, but MORE stimulus, until the uncertainty unwinds.  (Assuming the uncertainty weighs more heavily on demand than potential output, which, with a significant inflation undershoot and spare capacity, relative to the ideal moderate overshoot, seems a fair starting point).

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ECB minutes: Draghing the ECB into the 21st century?

President of the ECB Mario Draghi has announced that from January 2015 the ECB will publish an ‘account’ of the deliberations of Council meetings on monetary policy.  Whether and how this new step along the road to greater transparency is taken is a matter of great import, and, to me, it is puzzling why they are considering doing this now at this delicate juncture in the ECBs face-off with markets.

In years past, a fiction was spun around such meetings that monetary policy decisions were not taken by voting, but instead were made once a ‘consensus’ had been reached.  Unlike other systems in which dissenting views were irreconcilable, we were to believe that Governing Council members could instead reason their way to a common view of what was to be done with interest rates from month to month.  Few believed this description of what went on, and I suspect no-one who had worked inside a central bank believed it either.  But the fiction was useful, because it fended off inquiries about dissent, pretending that there was no dissent.  And since there was no dissent, there could be no case to answer that Council members who were also Governors of member state central banks might be acting along national lines, which would be against their mandate as participants in the monetary policy discussions.  Since short-term national interests ought always to conflict with their average, it would be impossible for a decision based on ‘consensus’ to be arrived at by members pressing parochial concerns.

The fiction that there was and is no dissent is long gone.  It was surely gone by the time the ECB were debating the Securities Market Program, and subsequently the Outright Monetary Transactions, which appeared to trigger the resignations of Axel Weber, former Governor of the Bundesbank, and Juergen Stark, former Chief Economist at the ECB.  Depending on how the ‘account’ of policy discussions is written, dissent will be out in the open.  For discussion will be whether votes are attributed or not.  But the insinuation in the announcement by Draghi is that votes do happen, and will happen, regardless.

ECB watchers used to worry about the pressure to vote along national lines when all that was at stake was tweaking the interest rate up and down a little to smooth the already moderate Eurozone business cycle.  But these pressures have been greatly magnified by developments in the phase of the crisis when private financial risks became socialised, threatening the solvency of EZ members, and the future integrity of the currency area that they form.

They have been magnified in two ways.

First, the consequences of making a policy mistake, either for the EZ as a whole, or, if one is determined to vote along national lines, for one’s own country, are much greater.  In the periphery, it seems conceivable that bad monetary policy might not just result in an exit from EMU, but that the orderly functioning of democracy and capitalism itself might be endangered.

A second kind of magnification of the pressures on Council members is that at the core of the debate is what the ECB is for;  what it can do given its mandate.  SMP and OMT are judged by some [usually Northerners] to amount to fiscal policy, and anyway undesirable.  They are judged by others [usually Southerners] to be desirable regardless.  It might be easy for member state Governors to disappoint their Finance Ministry bosses when they are asked ‘throw us a soft interest rate will you?’ than when they are asked ‘get us unlimited purchases of our otherwise unsellable short-term bonds, will you?’

Should the ECB publish these minutes or not?

Publishing minutes will reveal to Governments – if they did not already know from grilling them privately – whether their Council members did what they were told or not.  Does this matter?  Governors are appointed by their home governments, and can’t be sacked before their 5 year term is up.  But those terms can be renewed, so home Governments can threaten not to renew to tilt their Governor’s votes.  This threat would be more credible if the Government knew what its Governor had been saying and doing at Governing Council meetings.  Even if a Governor were not interested in renewing, or they had reached the end of their second term, there are still other goodies that could be denied them.  One might think that such a Governor might hope to rotate into another important non-Government job, or a political post, or even that the Government might facilitate or not stand in the way of a move into an influential private sector job.

Another argument against is that publication might complicate the operational effectiveness of the current policies.   The legitimacy of the promised OMTs is, for some, open to question.  Publishing dissent could involve publishing influential text repeating this view that OMTs are outside the ECB’s mandate.  This might or might not be material in any of the legal proceedings involved, but it would certainly increase political pressure to withdraw the necessary fiscal backing and make OMTs less likely to happen should a sovereign member be the focus of a market run.  Regardless of whether the issue of legitimacy was on the table, dissent about whether OMTs were simply desirable would also, and more immediately, affect whether markets thought they were likely to happen or not.  As I have argued before, in my view OMTs are an almighty bluff, requiring potentially unlimited backing that there can’t conceivably be political support for.   A bluff is more likely to work if everyone bluffs together.  If you read later that some were hesitant ['should we try this or not?  would we really follow through?  I'm feeling queasy about this'] you might speculate that the majority for undertaking OMTs would not be there when needed.

The ECB seem to have thought this through carefully thus far, and were scrupulous to explain the policy in terms that made OMTs most likely to succeed.  There was a careful [if, in my view, theoretically dubious] attempt to claim that one could separate solvency from liquidity problems with a sovereign.  And, based on this, that one could therefore define OMTs as a monetary and not a fiscal action, the latter supposedly taken care of by the European Stability Mechanism.

So why publish now, if it might make things harder for the ECB?

The ECB is given the vaguest of goals, to preserve price stability, and is left to interpret what that means itself.  So one can see that – as with many European institutions – there is a very good case for tightening accountability mechanisms.  As I argued in the debate about whether the UK MPC meeting transcripts should be published, such steps towards increased transparency make it easier to monitor whether technocrats delegated jobs by democracies are doing what they are told, and doing it competently.  But this pressure has always been there.  Why now, when it is most inconvenient in operational terms?  The large risks of taking this step seem to lie clearly on the downside.

I don’t have a good answer to this.   From the point of view of those who incline against  OMTs or future credit or quantitative easing, publishing dissent gives them a less nuclear method of expressing it other than resignation.  But the disagreements of Weber and Stark seemed so fundamental, that one doubts that they could have been staved off by being able to write anonymised UK-style ‘some members…’ paragraphs into minutes.  Supposing that there are less resolute opponents on the Council still, and putting ourselves in the shoes of the majority in favour, we might speculate that publishing minutes would be attractive because the majority would calculate that since dissenters can then go public, the majority can press their case running a smaller risk of triggering more resignations.  Previous resignations seemed to fuel the sense of disorder and crisis in policymaking, and with published dissent the radical majority will be less likely to be held hostage by private resignation threats.

Actually, neither of these arguments seems that persuasive, and the timing of this development remains a mystery to me.  Perhaps I am being too cynical in assuming some calculation behind this, and Draghi is simply trying to make the ECB a better institution.



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The Bank for International Settlements crying interest rate ‘wolf!’

The Bank for International Settlements siren calls that central banks around the world should be raising nominal interest rates to choke off an orgy of risk taking grabbed more attention on the chatosphere than I expected, since this is what they always call for, and their reports make for more forecastable reading than the output of lobby groups for pensioners.

I was particularly struck by the pointed remark by the BIS that central banks themselves were not to be trusted to make the right judgement trading off risks to growth and financial stability, since they had failed to predict the 2008 financial crisis.  This is a rare personalisation of the issue.  Policy committees have turned over substantially since pre-crisis times.  Some committees [like the UK's financial policy committee] didn’t exist at the time they were meant to be foreseeing the crisis.  This is a rather lazy remark by the BIS.  If one wanted to engage in such public banter, one might draw attention to the fact that, like a stopped clock forecasting midnight, the BIS predicted a financial crisis every quarter for the best part of two decades and were eventually bound to be right.  Or, with the rhetorical equivalent of the sliding tackle, we might urge that people ignore the BIS’s interest advice because they have presided over a dilute and inadequate tightening of a capital adequacy regime that was proven and is still too complicated, all without complaint.

As Simon Wren-Lewis points out, the BIS discussion of the issue is extremely one-sided.  They fail to appreciate the gravity of the risks of greatly prolonging time spend at the zero bound and an associated period of deflation, or lowflation, especially considering the relative efficacy of instruments for tightening [taxes, interest rates, macro-pru] as against instruments for loosening [forward guidance, almost expended, and QE/credit easing, likewise].  The BIS seem to omit to mention that overly tight policy carries its own financial stability risks.  Canadian and Australian banks survived the crisis because their banks were lending into a private sector experiencing windfall booms.  A monetary-policy induced recession would increase firm deaths, increase unemployment, and weaken the balance sheets of banks lending to those dying firms and unemployed mortgage holders.

In my opinion they don’t give enough credence to the observation that monetary policy is, fundamentally, a weak tool for dealing with real phenomena, especially those that are slow-burning [highly apt description for financial stability problems] and have real causes [the BIS contest this in this case, with some merit].  A driving force for this argument is the BIS’ intriguing research on the ‘risk taking channel of monetary policy’.   This is manifest in a number of micro studies which show how the riskiness of loans correlates with nominal rates.  And the theory that credit market institutions mitigate towards what should be real decisions about the risk-return trade-off being affected by nominal, rather than real rates.

These views for me have the status of dissident challenges awaiting further work, rather than new wisdom around which monetary frameworks should be arranged.  One way of ensuring that interest rates are high forever would be to announce a permanent increase in the inflation target of 5%, or 10%.  Presumably the BIS wouldn’t be in favour of that, and would not argue that ‘risk taking’ would be forever cured by higher steady-state inflation.  And if not, what exactly is the argument?  Over what horizon, if not the long-run are tightenings effective at curtailing ‘risk-taking’?  Interest rates have been at their floor for 20 years in Japan.  Do we think that the Japanese economy is suffering from irrationally-exuberant risk-taking?

The correlations in these studies are just that, and not conclusive proof of a risk-taking channel.  And if one wants to get serious about pervasive, long run money-illusion, we should be even-handed about it.  If we apply the same logic in labour markets, then a tightening that forced down prices, in the presence of unyielding nominal wages, would price workers out of jobs.


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