Prospect piece: Janan Ganesh, law, morality and fairness

Here is a piece out on the Prospect website today, responding to Janan Ganesh’s FT column last week.

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HMT, the ‘shock’ of Brexit, and the mix of policy at the zero bound

What we understand to have been so far left out of the HMT Brexit report is the impact of the potential ‘shock’ that a Brexit report would consider.

I sketched suich a shock in an earlier post when I responded to George Osborne’s [mostly] mistaken warning that mortgage rates might rise.

The shock would be something like:  a sharp fall in confidence and demand, prompting rates to rise later than otherwise, or perhaps even fall 0.25 percentage points, and perhaps even a resumption of asset purchases, with the Bank of England’s MPC looking through the short-term boost to inflation that an associated fall in Sterling would imply.  The need to loosen policy would be much greater if the shock were to trigger worries about the ability of our major banks and other intermediaries to fund themselves in the face of a possible capital outflow.

If HMT are worried about such a shock, they might also wonder whether it was wise to set a deficit trajectory so tight that it was appropriate for monetary policy to be so close to the natural floor for interest rates, leaving little room for further cuts to respond.

Either HMT are not that worried about a Brexit shock – hence current fiscal policy is ok – or they are and current fiscal policy is hazardous.  The way to reconcile this is to believe in the power of unconventional monetary policy to substitute entirely, and without other collateral damage [excuse finance pun], to provide extra stimulus.  But I think that the MPC’s revealed response to the disappointments of inflation failing to return to target as quickly as they thought, and indeed some of their explicit statements, show that not even they think of QE and similar policies as effective as that.

 

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Osborne’s Brexit cost ‘forecast’ and regular budget forecast uncertainty

‘Leavers’ were out in force trying to denounce the Treasury’s report on the costs of Brexit, arguing that if Osborne could not forecast the deficit accurately a few years ahead, why should anyone take seriously his forecast of the cost of leaving the EU 13 years ahead?  Prime offenders were Tim Montgomerie, John Redwood, Iain Martin [from CapEx] and Dominic Cummings, from VoteLeave.

[Previous version of post fingered Andrew Lilico as offending here, but this was an error, for which apologies].

Giles Wilkes of the FT trumped several tweets I contrived about conditional forecasting with the observation that he might not be able to forecast his own weight in 2030, but he can nevertheless accept the analysis that if he eats butter, that will make him heavier, other things equal.

To make the point much less neatly, the Treasury document is comparing the difference between two forecasts, all else being held equal except the EU membership status.  While we might nonetheless be uncertain about the effects of EU membership [we surely are, despite the overwhelming preponderance of analysis that the central tendency is that it is beneficial] all the other uncertainties are cancelled out by us comparing the difference between these two forecasts.

Who knows if there will be another regional war.  Of if oil prices will recover before 2030.  Or if climate change might accelerate to the point where radical measures are taken.  Or if global central banks will escape the zero bound.  All these things cloud our ability to predict our incomes in 2030.  But they do not cloud our ability to predict the difference between our incomes in and out of the EU.  [At least, under the assumption that membership doesn’t affect climate change, or the chances of an oil price rise, or a regional war].

I don’t know what this tactic says about the Leave campaign: whether it means that they don’t understand this analytical point, or they do but are trying to blur it for political advantage.

 

 

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I doubt that Osborne’s worry that mortgage rates will rise after Brexit is right

It’s being reported that George Osborne warns that Brexit will prompt a rise in mortgage rates.  I doubt this.

There are two plausible things to worry about.  First, the drop in confidence and demand that would follow from news that we were to leave, as uncertainty about what ‘out’ means and the central expectation that it means lower prosperity, weigh on the plans of firms and consumers.  Second, the drop in Sterling that would probably occur.

The Chancellor’s logic seems to be that the fall in Sterling would cause inflation to rise, and that this would push the BoE to raise its policy rate.

My guess is that the confidence effect would outweigh this effect of Sterling.  And anyway that the BoE would probably look through what was i) something that would affect inflation only temporarily, as import prices adjusted to a new, higher level and ii) partly a consequence of the world expecting UK interest rates to stay lower for longer.

If events played out very badly indeed, it’s possible that worries might mount that the banks doing mortgage lending would have difficulty funding themselves, and this may lead to banks charging higher mortgage spreads, and contracting mortgage lending.  Thus, despite the policy rate being lower than if Brexit had not been triggered, mortgage rates might not be lower, and may even rise.

But to me that eventuality looks relatively unlikely.

That mortgage rates are unlikely to rise following Brexit is not to say that Brexit is not to be worried about, of course.  On the contrary.  We should all be hoping that the recovery proceeds so that the monetary policy rate and the mortgage rate can rise to more normal levels.  The fact that Brexit would postpone this is not to be welcomed, but feared greatly.  And a major reason why it is daft to contemplate leaving at all.

 

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Would the UK Treasury have headed off the financial crisis if the BoE had not been independent?

Probably not, it seems.

Nick Macpherson was interviewed by the FT, and, amongst other things, pointed out that the financial stability team there was ‘quite small’ before the financial crisis hit, using the number 20.  Alex White from the Economist Intelligence Unit tweeted that quite small really meant 1.

Whether 1 or 20, this is relevant for the debate, begun by Simon Wren Lewis, about whether the Bank of England should remain independent given that it failed to avoid the financial crisis.

This small team reflects the fact that there was, as Nick put it, a ‘collective intellectual failure’, crossing both sides of ‘town’, ie the Treasury and the Bank.  Had the Treasury the insights it had now, it would have something like the resources devoted to financial stability that it has now.  [100?]  And, as I pointed out in the previous blog on this topic, the banks would be confronted with the same regulatory edifice [FPC, a reformed Basel accord, resolution procedures, etc etc] that we have now, whether administered by the Treasury or the Bank.

Without Bank of England independence, the financial crisis would have played out as it did, unforeseen by the ‘small team’ at HMT, who, one would guess, were pray to the same intellectual failures that afflicted people like me at the Bank of England.

 

 

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Everyone has their own ‘monetarism’

This follows reading Paul Krugman’s recent post.  I wasn’t there.  Too young, and never in America.  But, nevertheless, I’ll sketch my own version of what ‘monetarism’ means to me.

  1.  The belief that monetary policy mistakes were behind the business cycle – illustrated by Friedman and Schwartz’ chartism concluding that the Great Depression was caused by too-tight monetary policy.  They were probably right about this, and this is one bit of ‘monetarism’ that has proved enduring and useful.
  2. A focus on the bookkeeping identity of monetary policy PT=MV.  This was helpful during the years when policymakers thought that inflation was a ‘cost’ phenomenon to be tackled with prices and incomes policy.  This idea also endures.
  3.  The unfortunate idea that it follows from PT=MV that central banks could use money targets to deliver desired changes in P.  These targets were ditched as it was realised, through difficult experience, that money demand [‘v’] was too unstable for growth rates in M to lead to desirable changes in P.
  4.  Arguably, ‘monetarism’ includes, or begat a related failure to apprehend that at the zero bound money can increase without bound without affecting P.
  5. Alongside 3 is the view of Friedman that activist monetary policy to stabilise the business cycle was not likely to succeed because policy was hampered by long and variable lags.  Not only could money growth rates deliver growth rates in prices, but this is all policy should aspire to do.  This scepticism about the omniscience of policy was probably overdone, but it was a useful idea, valuable at the time when policymakers thought that armed with huge macroeconometric models they were omniscient.

That’s it.

As I read it, the wars over microfoundations had not much to do with ‘monetarism’.  Except that those – especially in central banks – who insisted on bolting on sticky prices and wages to microfounded models cherished this old idea that Friedman and Schwartz shared.

 

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Prospect Panel on international tax reform

ICYMI a paragraph by me on international tax reform in an expert panel published by Prospect Magazine, also including other people who actually know about this stuff.

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