November Inflation Report Treasury Committee post mortem

This morning the Treasury Committee, the cross-party Parliamentary body charged with scrutinising the activities of the Bank, held a hearing on the Bank of England’s November Inflation Report.  It seemed like an anti-climax.  Lots to talk and grill the BoE about, but not much progress made.

There was a lot of jokey chaps humour between Carney and Tyrie [TC chair] and others.  At a time when the economy is not yet out of the woods, with the conventional monetary policy instrument trapped against its natural floor, and with all the other scrutiny the Bank faces on issues of malpractice in the industry, even inside the Bank itself, it doesn’t seem like the time for funny stuff.  This is really the fault of Tyrie and the other TC members for failing to set the right tone, and being unable to resist the temptation to crack clever jokes on TV with the celebrity policymaker.  Pompous though it seems to say it, as I read this back, isn’t this the sort of stuff that turns people off politics?  I suppose that it’s a fairly low risk forum, as only a few hundred BoE watchers will be tuning in.

Committee members bombarded Carney and the others with questions on migration.  These were an abuse of the process.  Members were trying to get the Bank’s officials, who have to study the labour market closely to figure out the appropriate stance of monetary policy, to make comments that could be used in the political debate about whether we should seek to try to renegotiate the EU Treaty to prevent freedom of movement of labour.  But time scrutinising the Bank is scarce, and when there are lots of important things to question them on, and the Bank’s accountability process is stretched – the BoE having so many more important responsibilities these days – it is a great shame to waste Committee time on issues that are not inside the BoEs remit.  Moreover, if the tactic of luring the Bank into political debate had been successful, it would have helped to corrode the Bank’s independence and impede its ability to do its job.  Just the opposite of what the Committee is for.

Kirsten Forbes improvised a cop-out of the migration question to the effect of ‘the academic literature on migration is a complete muddle’ [sic].  I don’t blame her for finding a way to get out of answering.  But I don’t think that is a particularly accurate summary.  I read the literature as arriving at some emerging points of agreement.  For example, the economics 101 prediction that inward migration would significantly lower wages into the markets were migrants compete, seems to have been refuted, highly germain to the false  sense of grievance that is being cultivated around immigration.

I missed Carney’s exact remarks, but read later that he reportedly played down the risk of deflation.   Well, if you buy some of the larger estimates of the biases in CPIs due to new goods bias and the difficulties of adjusting for quality change, as I remarked before, it’s conceivable that we are experiencing deflation now.

Measurement issues aside, I was looking for a good explanation of why a larger forecast undershoot of the target in the November Inflation Report – despite some yield curve softening – warranted no further action to try to loosen.  But if it was there I missed it.  If the economy were starting from steady state, with inflation on target, and interest rates well away from the zero bound, I could understand the MPC being relaxed about a widening 3 year undershoot of the target.  But right now, with rates pressed against what the MPC have decided is its floor of 0.5 per cent, I would expect hyper-sensitivity to any negative news on forecast inflation, and for them to go to excruciating lengths to explain why it is not possible or desirable to do anything about it.

TC members seemed to have been briefed extensively on Danny Blanchflower’s comments on the labour market aspects of the forecast.  One line of questioning was whether the MPCs forecast for real and nominal wage growth wasn’t just a prediction of mean reversion.  Carney managed to close off the questioning by remarking that this was a ‘fair comment’.  But the real point never got made or addressed, indicative of the general air of lethargy on the Committee side of the table.  The substantive point is tricky.  Danny has a point that forecasts of real wage recovery have so far been disappointed.  But then the eyeball econometricians on the Bank side of the table can readily claim that it’s fair to predict that old, average relationships reassert themselves, in this case meaning a return to productivity and real wage growth.

For more on the hearing, read Emily Cadman’s FT story, which cites Rob Wood [another ex BoE economist now at Berrenberg] and myself.

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How to run a research department, I mean hub, thingummy, whatever

This post pulls together and recaps last night’s tweets.

I was really struck by reading this document from the St Louis Fed, reflecting back solemnly on the culture of research first launched by Homer Jones in the 1960s.  It articulates what I think myself, only much better.  The essence is to give people time to do ‘undirected research’.  Trusting those at the frontier to define the right questions, answer them, and thereby keep themselves at it, perhaps even pushing the frontier back.

It’s the culture that the current St Louis Fed President James Bullard was nurtured in himself, and one that eventually launched him onto the FOMC.

I’d add a silent rider to that document.  Which is that the ‘direction’ comes at the point of hiring.  Choosing people gripped with the same compulsive fascination with monetary macroeconomics (for example) you have yourself, guessing that their undirected nose-following will lead them just where the central bank should be going.

You might wonder whether the Bank of England is embarked on its own enlightened relaunch of research under the banner of Andrew Haldane’s ‘cultural revolution’.  It may.  But there are a few reasons why this would constitute an amazing departure from the past.

First, recapping on my previous post, despite the intention for the new research to be free of the need to toe the existing policy line, and for authors to be free [perhaps even compelled!] to ‘challenge the orthodoxy’, I noted that Andy himself was one of the most vigorous and risk averse content policemen in the Bank.  So this is a case of poacher turned gamekeeper.

Second, the new ‘research hub’.  This could not have existed prior to the departure of Mervyn King, Charlie Bean, Spencer Dale and others, because there was almost visceral objection to the idea of ring-fencing researchers inside their own managerial unit.  To be fair, there were discouraging examples that could be cited.  But even referring obliquely to the possibility in a conversation about management strategy was enough to mark one out as a contributor to be ignored.  So much the better then, that the hub now exists with Carney’s new regime.  But, note that Andy himself was as energetic in his objections to this idea as the others.  So the new ‘research hub’ is overseen by its prime opponent.  Should be interesting!

Third, the observant will note that the BoE are in the middle of a research hiring frenzy looking for PhDs.  Well, there’s an irony in that too.  As I remarked on Twitter, the very senior management view of PhD’s, subscribed to and espoused by Andy, might be summed up as follows:  1) the only PhDs we [BoE] can attract do research we don’t really want anyway, bar the occasional fluke and 2) the purpose of early years research is to find a way to co-opt the very small minority of PhDs we do want into policy work.  To turn them, in other words, from an activity that is useless, to something we can use.  I wonder, has there been another 180 degree turn on this view too?  (That would be something to celebrate).

Fourth, in stark contrast to the St Louis Fed model, Andy himself saw the pursuit of research to journal publication as pointless, and something the Bank should not sponsor, as those who attended his internal talks on ‘research in the Bank’ in the past will testify.  [I didn’t, but I had to spend several hours of my own time reassuring unnerved researchers that the Haldane view would not ruin their career plans].  I wonder, is this part of the new philosophy of the research hub too, or communicated as they are hiring new PhDs?  Or has there been another 180 degree turn?  If the latter, great.

Fifth, Andy had a veritable distaste for RBC/DSGE, financial frictions or no.  This is not at all inconsistent with the way the new research activity is being launched.  Which is going to be about ‘challenging orthodoxy’.  And I imagine that many would celebrate this.  However, rights and wrongs of this debate aside, I wonder how many of the recent or soon to be hires who have made this skill set their raison d’être know that what they are do is or at least was viewed as a blind alley?

Who knows if these aspects of the old Bank of England will cast a shadow over its exciting-sounding future.  I hope not.

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Dutching the fudge: enlarging the OBR’s role to scrutinise manifestos

Simon Wren-Lewis calls for an extension of the remit of the Office for Budget Responsibility, (OBR), the fiscal watchdog set up by Coalition Chancellor George Osborne, echoing Giles Wilkes.  The idea is to include in their services the option to scrutinise contending political parties’ fiscal plans, and in particular, to check that strategies for the overall deficit are consistent with individual policy proposals.  In this way the OBR would resemble the Dutch Bureau for Economic Policy Analysis.

I heartily agree with this proposal.  The idea, as Simon explains, is that, given the option, parties will feel compelled to take it up, for fear of not looking serious.  And this will help us see more clearly what parties intentions are.

I suspect the benefit will go deeper.  Knowing that they won’t be called on exactly what their fiscal ambitions are, and how they connect with their policies, parties probably don’t feel the need to think them through so deeply.  With limited resources, effort is diverted towards communication, story-telling, coherence, prioritising, adapting the policy message to the unfolding narrative of the campaign.  There is no money or patience left for nerds with large Excel spreadsheets.  So impending transparency will probably also deepen the parties’ understanding of the costs of social policy and macroeconomics.  Who knows, that benefit might even filter out to the rest of us.

If the OBR were tasked with this, it would raise some issues.

First, there is the issue of parties’ funding.  If I am right that fiscal detail is not just hidden, but actually does not exist, then other things equal, parties will have to find more money to undertake the work.  (Or:  perhaps it would be a beneficial side-effect that they would be forced to spend less on spinning and advertising).  Major parties struggle financially, and regularly expose themselves to embarrassment by courting funding from dubious donors.  It’s hard to see where that money would come from.   So OBR costing of election manifestos brings to the fore the question of whether parties should receive state funding.

Second, and relatedly, there is the problem of whether the incumbent Government is at an advantage going into an election.  Although it is currently required to work up its manifesto using its own resources, and not those of the civil service, it does so after a few years working closely with armies of state paid analysts and their marvellous spreadsheets drilling into the detail of public spending and taxation.  It surely has a much better idea what works and what doesn’t, and how much things cost, than a rusty opposition party.

Third, such costings will pitch the OBR into much more heated and more regular political controversy.   That will shine a light on the institution:  the appointments processes for its head [currently Robert Chote] and its advisory board, and its hiring and resourcing.  These have to be as insulated from government interference as possible.  Otherwise a suspicion would lurk that the OBRs costings are skewed to make sure that life is more pleasant for it after the election.  What would that mean?  I speculate, of course, but if there were a clear leader in the polls going into an election, the OBR would have to feel confident that bashing the leading party’s fiscal plans would not prompt a sacking or resource squeeze once that party took over.  Chote and his staff have done an excellent job bedding down the new OBR and establishing a reputation for independence of mind, but do they have an institution that is strong enough to weather the stormier environment of heated election campagins?  The acrimony that developed over the Treasury mandarin Nick Macpherson’s intervention on Scottish Independence – in particular the reflex of the SNP to dismiss the analysis as propaganda – is a case in point.

Some existing working practices might prove hard to sustain if the OBR took on this enlarged and more politically charged roll.  For example, currently, the OBR uses a macroeconomic forecasting model that is jointly run and maintained by itself and the Treasury.  In the OBR’s Memorandum of Understanding governing its working relationship it’s clear that the OBR also draws on other working level analytical support in the course of writing its reports.  I’d suggest that it would be better able to discharge this enlarged roll if it ran its own model, and was as independent of other analytical support as possible.

 

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Haldane on cutting the umbillical research cord

A quick reaction to Andrew Haldane’s latest speech, released this morning.  After a great survey of the literature on behavioural econ and finance, and economic psychology, he says:

“The Bank is about to embark on what will be, in the area of research, a cultural revolution. To caricature slightly, Bank research in the past was typically used to nourish and support the  Bank’s policy thinking and framework. Relatively rarely was it used to challenge that prevailing policy orthodoxy, at least in public.
That is about to change. As part of its strategic plan, the Bank has decided to cut the umbilical cord. In future, it will carry out, and publish externally, research covering the whole waterfront of policy issues it faces, monetary, financial and regulatory. Through new publications, we will put into the public domain research and analysis which as often challenges as supports the prevailing policy orthodoxy on certain key issues.”

If Andy Haldane’s speech announces a relaxation of what was, in essence, a regime of censorship, then it is to be very much welcomed.  In my day there was a clear understanding by those doing research that results or prescriptions that contradicted policy or policy frameworks would not make it to publication stage. Most, but not all, of the time, actual censorship was avoided, so such policy-challenging research rarely got undertaken in the first place, self-censorship being the rational response of anyone who wanted to build up a cv of publications to give themselves an outside option. Relaxing this practice will bring the BoE more into line with the ECB, Fed and other central bank research paper series, which regularly publish results that challenge their policymakers’ views.

That said, this is going to be a great case of the poacher announcing he was turning gamekeeper.   Despite the confidence he had in expressing his own dissents from Bank of England lines in his speeches,  in my view Andy himself was one of the more stringent and risk-averse enforcers of the research content regime when heading up Financial Stability.

We must also look forward to finding out how the cultural revolution is going to happen. Researchers already felt, rightly or wrongly, beleaguered, isolated, and discriminated against in the promotion stakes. Only the most indifferent or saintly could ignore the incentives to curry favour with policymakers or senior managers by being supportive. Andy’s call to arms will help a lot. But Andy may not be there forever himself, or at least not in that job as Chief Economist, so the cultural revolution will need more than his words to make it self-sustaining.

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On Neo Fisherianism and adaptive learning.

There is continuing debate on the blogosphere about whether, contrary to common monetary economics parlance, interest rates are not low because inflation is low, but low interest rates are actually causing low inflation, with more contributions from John Cochrane, Noah Smith and David Andolfatto.

A few thoughts.

1 I wonder if the debate isn’t gettting too hung up on models using rational expectations.  RE is just a convenient tool, probably a not very realistic one.  If we drop RE and use a version of the New Keynesian model with adaptive learning instead, we would arrive at answers that sound pretty much like what central banks already say.  And nothing like neo-Fisherianism.   Note ‘rational expectations’ refers to when agents in the model have forecasting rules for inflation that are the same as the rules you would have if you knew exactly how the model worked.  ‘Adaptive learning’ means here:  behaving like an econometrician, basing forecasts of the future on how inflation (and other things) have depended on past values of things you can see, and updating your forecasting rules as new data comes in, either validating or flouting the rule you used last time.

2 Relative to historically followed policy rules, a policy that cut rates to the zero bound and held them there, in the absence of any other shocks hitting the economy, would cause explosive upward movements in inflation.  The explosions would come from the initial upward movements in inflation causing private agents’ extrapolative forecasting rules to change, which would amplify the past movement, causing more forecast rule revisions, and so on.

3 The coincidence/comovment of falling interest rates and inflation could only come from policy responding to an inflation-depressing shock, and incompletely stabilising it.

4 If the Fed had shifted its preferences privately to deliver very low inflation, that would eventually deliver low interest rates and low inflation.  But, initially, it would have required an interest rate increase.  This seems a pretty implausible account of what happened recently.  For starters, interest rates did not increase since the onset of the crisis.  Second, FOMC members did not lower their inflation targets, or, at least if they did, they did it privately [and it didn’t even make the transcripts released] and contradicting what they had told us about their long term view of inflation.

5 In this model, although the Fisher equation will prevail in the long run, one can’t deliver a particular level of inflation with an interest rate peg worked out from this equation, unless one starts from steady state and there are no shocks.  In an economy buffeted with shocks, a fixed interest rate will cause explosive movements in inflation one way or the other, depending on the luck of the draw.

Bringing this together.  If you believe in a more realistic version of the popular New Keynesian model modified so that we have inflation expectations formed by adaptive learning, rather than rational expectations, then you can’t believe that low infaltion was caused by lowering nominal interest rates.  You’d believe things that sound pretty much like the received wisdom, the words coming out of the mouths of central bankers.

[Added later]

Making this small step on the road to realism helps simplify the problem too.  With RE we have to figure out the subleties involved with what happens when agents project out for the future fixed interest rates [if they are fixed for long enough, it can mean there are infinitely many paths for inflation] and for future fiscal policy.  With this model of learning, none of that is relevant.  Agents don’t form views about monetary or fiscal policy.  They aren’t aware that there are rules guiding policy instruments.  They simply run regressions of the things they need to care about on the things they see.

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Why no loosening, if conditions mean a greater, below-target deviation?

A quick Bank of England Inflation Report Press Conference Post Mortem.

The headline seems to be that MPC is forecasting a larger, protracted deviation of CPI inflation below the 2 per cent target.  That is despite some softening in the yield curve, which we could think of the MPC as validating, between August and November’s report.

Yet the MPC last week decided to leave current Bank Rate rates at 0.5% and QE assets at £375billion, and do nothing else.

Why?

A weakening in the outlook that leads to a larger and more protracted deviation of goal variables from target should prompt some loosening, unless there is good reason not to.

One reason might be that other concerns – real activity, unemployment – have improved.  But they haven’t.  The MPC isn’t trading off a larger inflation deviation against something else.

It’s possible that the MPC views particularly small changes in the outlook as not worth responding to at all, perhaps because continual adjustments to its instrument-settings would look like incompetence, or spurious fine-tuning.  But if that was the case, the initial launch of forward guidance ought to have been ruled out, which at that time seemed designed to reverse a marginal increase in long rates.

In principle, it might be possible that the MPC perceives there to be a change in the likely fiscal stimulus that would compensate for the weaker outlook, requiring no more action from itself.  But that doesn’t seem to be the reason either, nor plausible.  There is only fog about what the fiscal stimulus will be beyond the election date.

We could infer that the MPC doesn’t view a tactic of trying to talk longer rates down further as effective or productive.  If so, why?  What’s changed about their view of future interest rate management since they last thought it necessary to guide longer rates down?

We could also infer that the MPC views QE as ineffective, or that further QE would be a net cost to the economy.  Yet that doesn’t chime with the policy of continuing to reinvest proceeds of maturing assets in the meantime, nor with other words about QE uttered along the way.

There’s also the possibility that MPC could cut rates below 0.5%.  Is it really the case that the UK is so different from the EZ or the US that we have to have a higher floor?  Are the factors that weighed against a lower floor still material?  Have all the new MPC members that have come on board since that floor was set studied the evidence on that floor and concluded that they are also signed up to it?  Why doesn’t the prospect of an increase in the below-target deviation of inflation warrant reviewing this evidence?

At the chosen floor for the conventional instrument, a worsening in the outlook should, other things equal bring about a disproportionate loosening in order to avert the risk of being trapped there for a long period, inducing damaging deflation.  The MPC seem to have chosen to be disproportionately passive, without an especially compelling reason.  When Carney arrived, he seemed determined to ‘secure the recovery’ as he put it, and particularly averse to signs that progress in doing so had stalled.  Now, there is no percetible response to this worsening in the outlook.  Although the positive growth seen since then is cause to be more relaxed about peturbations from the path back to the inflation target, the passing of more time trapped as the interest rate floor is cause to be less relaxed.

Of course, the forecast has one thing going for it:  one certainly cannot accuse the MPC of reverse-engineering the forecast to make it justify the policy decision, as I described them doing in years past.

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Helicopter drops: A dare from Turner

Adair Turner’s FT piece urges the central bank/government to finance future debt with helicopter money.  Leaving aside the merits of helicopter money, I found his argumentation unusual.  It’s a piece worth taking seriously, because one presumes there must be a high chance still that he gets a post on the MPC in some capacity in the not too distant future.

One of his reasons is that helicopter money, unlike QE, would not affect asset prices.  Three problems with this.

i) People should not take it as axiomatic that QE had a greatly material effect on asset prices.  The research is much less clear-cut.  For example, Vissing-Jorgensen and Krishnamurthy find that the Fed’s QE just pushed up spreads between government and private sector yields.

ii) Helicopter money-financed debt is fiscal policy but depriving the market of long dated securities, and giving instead reserves.  ie, it’s like the first leg of QE.  [Joining up the DMO debt issue and the declared temporary debt purchase by the BoE into one operation].  The BoE have said that QE will be reversed, so at some point the two policies will become different when the promise is kept.  But right now, they aren’t.  And maybe – HMT’s 2012 asset purchase facility profits grab is indicative – they won’t ever be.  In which case how is QE supposed to bloat asset prices but HM not?

iii)  Affecting asset prices is not all bad!  That could be the price to pay for encouraging spending, increasing demand and employment.

Turner also says that helicopter money would lead to rates being higher than otherwise more quickly.  I can see that one might argue that HM might stimulate more strongly, and so lead to the MPC later choosing, naturally, to raise rates back to normal.  But he doesn’t seem to mean that.  Other things equal [they aren’t, but never mind] dropping reserves out there means lower interest rates to clear the money market, initially.

As an aside, Turner says nothing about interest on reserves. Charlie Bean mentions this in a recent speech.  As I see it, [and 2 others I chatted this through who have to remain anonymous] HM requires us to drop paying interest on reserves, to avoid creating an ever-increasing reserves ‘liability’ [the corollary of the bonds and their interest that are retired].  Not paying IOR is ok by me.   But it means accepting lower interest rates for a while.  That is also ok.  But, to repeat, that means interest rates would not be higher [now at least] than under QE.

There are other reasons why Turner’s is a strange piece which I’ve mentioned before.  He doesn’t say why we should do HM now, when we can simply do a conventional fiscal loosening without taking risks with the framework.  And why we could not do more credit easing for that matter.  Perhaps eventually there might come a time to contemplate HM.  But not now.

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