UK’s MPC vote. Does going from 7-2 to 6-3 mean a hike is coming sooner than we thought?


First, recall that the inveterate hawk McCafferty is about to depart the Committee, to be replaced by Jonathan Haskell.  It’s not possible to parse his views at this stage, but McCafferty’s were at the very hawkish end of the scale, and it’s surely likely that a random new draw for the vacancy would be less inclined to vote for a rate increase than he was.

Second, Chief Economist Andy Haldane’s switch into the camp voting for a rate increase may be less of a bell-weather than you might think from reading press coverage of it.

His views about monetary policy seem to me to be somewhat more changeable than those of others.  [This is not meant as a criticism].

His speech outputs – so one presumes also his time input – seem less engaged with the run of the mill monetary policy work at the Bank, ranging across subjects that extend far beyond the Bank’s core jobs.

And he often seems to relish taking contrarian positions and floating radical thoughts [eg reform of monetary institutions to allow for negative interest rates].

So a fair argument could be made that AGH might very well change his mind again.   Or, even if he doesn’t, be unlikely to take anyone else on the Committee with him that would not already be thinking of doing so in the future.  Or, equivalently, even if persuasion is not part of this process, his own change of heart may be less revealing of currents of thought that are soon to sweep up others in the ‘dove’ camp.

For these reasons, I don’t read much [concerning the likely trajectory of rates] into the change in the balance of votes by itself.

[Is this what happens?  At some point one starts writing stuff with hawks and doves, with no qualification at all necessary?]

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Social care funding, inheritance tax and hypothecation

Social care funding is as pressing now as when the issue blew up Theresa May’s 2017 attempt to decimate the Labour Party and assert control over the Brexit process.  A consensus of sorts seemed to emerge from that discussion that it was right to expect those who would otherwise pass on large estates to pay for their social care either partly or wholly through taxes on those estates, levied after death or not.

I blogged at the time that I didn’t think this was ‘fair’.  My reasoning was that you can view unexpected longevity combined with ill-health – which requires a lot of money spending on social care – as getting a bad draw in the lottery of life.  It wasn’t fair that one’s financial resources, and what one could pass on to the next generation, should be dependent on what draw one gets in the longevity and ill health lottery.  As a result, social care funding should be offered out of general taxation.

The debates about the appropriate level of inheritance tax and social care funding are separate, conceptually, although because social care funding – or its shortfall – constitutes such a large line item in public finances there is bound to be a practical link between the two:  finding so much more money is likely to mean looking across the whole range of taxes.  But the issues are no more linked than are the debates about the level and progressivity of income tax and the level of funding for state education.

The appropriate level and schedule of inheritance tax depends on weighing political desires to eradicate/perpetuate inequality on inheritance, economic evidence about the ability to collect and enforce without taxes being avoided or evaded, and economic evidence on the harmful effects of that inequality, or the harmful effects on incentives of taxing accumulated wealth away.  The economic evidence is uncertain on all accounts [as always], and different people will have different ethical positions on equality.

To illustrate the conceptual separateness of social care and inheritance, two thought experiments.

First, imagine an economy in which there was an overriding social norm that old people commit suicide at the first sign of irreversible dependency, so that there was no social care expenditure, private or public.  [For clarity, I’m not advocating this:  it’s a thought experiment to make a point].  In such an economy, there would still be a legitimate and important debate to be had about the appropriate level and schedule of inheritance tax.  The euthanasia of otherwise-about-to-be-dependent old people would leave open the question of what to do about those bequests, which could create harm through next generation inequality, or, if taxed away, reduce incentives in the future too.  In this extreme case, social care funding levels and inheritance taxes are seen to be entirely separate because there is no social care funding, and yet inheritance is a live possibility, there to do its harm [or not, depending on your perspective].

Now consider the opposite case.  An economy with no bequests.  Imagine that there was an overriding social or religious norm such that on death there was a ceremonial bonfire of all the recently deceased assets.  Who knows why:   perhaps there is a belief that they will be transmitted to the old person in the afterlife, or a belief in self-sufficiency of the next generation.  [Again, for clarity, I’m not advocating such a norm:  this is a thought experiment to continue making a point].  In such an economy, despite the fact that there were no bequests, there would still be a legitimate question as to how to fund social care, and an argument for using taxation [note here there is no inheritance to tax] to avoid that life satisfaction through extended end of life dependency does not depend on the lottery of life [ie how much end of life ill-health has to be endured].  The absence of a potential inheritance tax base would not negate the case for public funding when there are other – eg income, spending and profit – taxes to dip into.

The conflation of social care and inheritance is part of an increasingly popular idea that taxes should be hypothecated to fund particular items of public spending.

Hypothecation might have a basis in terms of offering a way to sustain public support for spending taxes on public services.   But it is conceptually flawed.  The examples described here are extreme case illustrations of why.  If hypothecation between inheritance tax and social care spending were the rule, in one of our economies we would have no inheritance tax [because there was no social care funding] even though it could do good;  and in another there would be no social care spending [because there were no inheritances to tax] even though it could do good.

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Interest rate forecasts, again

I hope someone can correct me here, but I dimly remember a Stanley Fischer chapter in the old Handbook of Monetary Economics, on central bank independence, that carried an entertaining footnote.  In it, Fischer reports that he showed a draft of the chapter to Milton Friedman, who retorted something like ‘central bankers only have 2 objectives, maximising discretion and avoiding public scrutiny’.

Recent discussions about whether the Bank of England should publish interest rate forecasts are going to seem to many like evidence in favour of this Friedman comment [assuming I remembered it properly].

Supposing that the MPC do privately concoct such forecasts, so that monetary policy is coherent, concealing it does have some advantages.  Frequently, MPC members are going to make mistakes interpreting the data, or its significance for policy.  If you don’t disclose your full interest rate forecast, then of course you can quietly change it when you realise your mistake.  Concealing mistakes that even competent analysts would make will seem like a route to enhancing your reputation.

Further, not disclosing a forecast amounts to not laying out all your conclusions for policy open to scrutiny.   This makes it less likely that any conclusions that are contestable or wrong can be shown to be such from the reasoning behind an interest rate vote set out in the public record.   If you don’t tell me that today’s vote for an interest rate rise is part of a crazy plan to get rates up to 7% by 2020, then I can’t detect the full extent of your craziness now.

Developing this thought further takes us back to the premise at the start that there are indeed interest rate forecasts constructed that are not being disclosed.  Perhaps internal discussions are loose enough that MPC members are not forced to arrive at coherent interest rate plans.  There is nothing in the public domain that would contradict surmising that there is simply staff analysis of the data, a collective inflation forecast based on expectations of rates derived from the yield curve, and a free-for-all to pluck interest rate votes and plans out of thin air.  An advantage of not publishing an interest rate forecast, and emphasizing in worried tones the deleterious consequences for communication if you did, is one way to avoid revealing that there are currently no satisfactory procedures for arriving at such forecasts that would look good if exposed to public scrutiny.


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MPC’s discussions on publishing forward interest rates

I gleaned from the Guardian’s liveblog of the Treasury Committee hearing this morning that Carney disclosed that the Bank of England’s Monetary Policy Committee had discussions on whether to publish interest rate forecasts.

A majority were not in favour, so they are sticking to the status quo.  I think it’s hugely positive that such discussions were had, and that it has been disclosed that they took place.  Whether or not to publish such a forecast seems to me to be a matter that has to be left to the MPC itself, as compelling it to do so against its will would open the door to unacceptable infringements on operational independence, and anyway be impractical.  So putting the decision to some kind of informal vote seems like the best way to manage disagreement.

Such a vote puts all members in an interesting predicament.  We might reasonably presume that MPC have to have one communications policy.  The minority who prefer publishing forecasts would further reveal the forecasts of those who did not if they went ahead anyway and disclosed forecasts of their own vote.  [For example, MPC member Jan Vlieghe’s comments about the need for perhaps 6 interest rate rises over 3 years in his own world view can be used to narrow down our distribution on the concealed views of the other members’].  Yet on the presumption that every interest rate vote only makes sense as an implementation of an entire interest rate plan, the majority who vote against publishing deprive the minority of a key piece of evidence that they can use to defend their own vote and be individually accountable for it.

The reason given for not publishing by the majority, we are told, is that there was a fear that such forecasts would be interpreted as ‘promises’.  The idea is that the forecast would explain what would happen to interest rates if the economy develops as MPC anticipate;  so that if things do not turn out as expected, rates also will not move in line with the forecast.  And the concern is that the initial conditionality of the rates path on the forecast will not be appreciated, and the change of path interpreted as breaking of a promise.  That might be bad because it might signal that the promise-breaking related to the pursuit of the inflation target itself.

These concerns are not unfounded.  But to make a point about the process governing this discussion, stated simply like this they are not yet evidence-based.  Such an important decision for the MPC surely ought to flow from some kind of thorough report and analysis, with each side explaining and substantiating its position fully.  One would expect the MPC to take evidence from other central banks who have chosen to publish those forecasts, and from outside observers who consume and interpret the Bank of England output.   If this discussion took place in the context of such an exercise, the Bank should publish the proceedings, supporting papers and evidence, and minutes of the relevant meeting.  If not, we might reasonably wonder why not.  Given that the MPC membership turns over slowly, we might also be given forward guidance as to when the decision would be reviewed.

On the substance of the ‘promise-breaking’ argument, there are counter-arguments, made many times in this blog and by others.

Because monetary policy, and the shocks it is seeking to offset, take time to have their full effects, monetary policy making must entail making forecasts, including those of the interest rate and asset purchase instruments.  If the policy making process does not involve such a process, it must be deficient, and sooner or later will be revealed to be.  If it does, then at some point, when enough people realise this, they will see the communications process as being about attempting to obscure or conceal the instrument forecasts.  If MPC are worried about being seen as promise breakers, then it is worth thinking through the possibility that outside observers may twig that a good way to get away with breaking promises is to hide or at least obscure the promise being made.

To some extent the communications process now adopted, which involves frequent coded references to the concealed interest rate forecast, already runs the risk that the MPC majority fear – of making promises that are not kept.  That is why, fairly or unfairly, Carney is frequently referred to as the ‘unreliable boyfriend‘.  Think of the status quo communication policy as revealing the forecast, but injecting a little bit of noise amounting to a few policy changes here and there.  On occasion, you are going to be accused of breaking the ‘promise’ even when you haven’t, precisely because of that noise.  [Or rather, on occasion, events will turn out such that the hidden interest rate forecast has not changed much, but because you did not signal that forecast accurately enough, observers will incorrectly update their estimate of your forecast and wrongly conclude it has changed when it hasn’t.]  Dave Ramsden is reported to have remarked that published forecasts would be ‘lost in translation’:  arguably the same loss is being experienced currently.

Previous to today’s remarks, Ben Broadbent was reported to have commented on the matter to the effect that the Bank should not have to ‘spoon feed’ markets, and that the general public at large was not so concerned about the short run outlook for interest rates.

These remarks are not persuasive.

The Bank does not disclose enough about its interest rate reaction function [how it responds to events], nor its interpretation of the ambiguous monetary policy mandate, nor its interpretation of the state of the economy for that matter [we don’t have working versions of the forecast plus judgement to scrutinise], for outside observers to be able to forecast what the MPC itself will do if its own forecast comes to pass.  So an interest rate forecast is not properly described as ‘spoon feeding’.

It is also not appropriate to appeal to service to the wider public as a justification for concealing its interest rate forecast.  Much of the wider public has mortgages, and their forecasts of their own disposable income will depend on the outlook for interest rates.  By contrast, I doubt that all that many people are interested in this quarter’s vintage of the answer to the question ‘how this time are we forecasting inflation to converge back to 2 per cent?’, a caricature of the Inflation Report that is sometimes not far from the truth.

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Democracy’s vortex

I had a go at rewriting old blogs about the perceived-grievance-wrong-headed-sop-vortex that we might be headed into. ….

According to Idealised Democracy 101, the way things are supposed to proceed is this: when something goes wrong in the economy, or the polity, as it inevitably will, the prospect of holding office encourages politicians to put together solutions, based on a sound diagnosis of the problem. Competition between aspiring rulers incentivizes finding good solutions and discarding bad ones.

These diagnoses and solutions percolate up from civil society, academia, think-tanks. Diagnoses are ranked according to which are most likely to explain the problem. Solutions are ranked according to which gives the best outcome.

The totality of this analysis gets transmitted to the electorate by a technically articulate media free of any commercial or political imperative that would tamper with the analysis.

Those with the winning solution get elected, put their plan into action, and things get better. Rewarded for good behaviour – that is, behaviour which makes things better – politicians repeat the cycle next time round. Of course, whatever happened might not have any solution at all, and the policy production process here is supposed to figure that out too.

Things don’t seem to be proceeding like this lately.

We seem to be in danger of entering a vortex of ever worsening outcomes, in which things deteriorate along the following lines: after something bad happens, perceived grievances arise, are conceded by media and the politicians, who offer wrong-headed sops. They are wrong-headed in that they make things worse, stoking a new round of resentments, or giving rise to new ones, and the cycle repeats itself with more force.

There might be debate about at which point the UK entered the vortex and how. But, for the sake of argument, date it at the outbreak of the financial crisis in late 2008.

The crisis, the recession and the sluggish recovery that followed it stoked up resentment and anti-government-establishment feeling. One perspective is that 2008 taught us that financial regulation needed to be tightened [it was] and that the post 2008 period we needed more activist fiscal policy in recessions.

However, populist politicians on the right offered a different diagnosis and solution. The problem instead was immigration and globalisation, and the solution was Brexit, less immigration, less globalisation and the contradiction of more money for the NHS [a contradiction that is, because in a poorer economy this is not possible without less money for other stuff].

It could be argued that the populist left are feeding off the same discontent, offering their own misdiagnosis, comprising Brexit’s deglobalisation with a retreat from, or a wholesale replacement of capitalism, depending on whether one takes Labour’s manifesto as a final compromise, or a step along the road to the leading faction’s long held positions.

We have not got there yet, but it seems highly likely that the overwhelming expert opinion that Brexit will make us poorer will be borne out. Brexit and lower immigration is going to mean less money for the NHS, not more, and lower income per head. This could well provoke a search for new scapegoats, or cause politicians and their voter clients to double down on the ones they already mistakenly found.

The dynamic that is supposed to prevent this vortex from deepening – the process by which rational, evidenced-based analysis is funnelled to politicians and voters – has not been working. The credibility of expert opinion – overwhelmingly judging Brexit to be to the detriment of the economy – was fatally undermined by the financial crisis, in which it was [fairly] judged complicit. That credibility was perhaps never as robust as we thought beforehand. Efforts to synthesise expert opinion were thwarted by the construction of a fringe balancing opinion [see below]; by framing experts as being part of a vested interest in the status quo; and by the tactic, not always untruthful, of dubbing the mainstream view as exaggerated [‘project fear’].

At least three pernicious forces at work are serving to thwart the media’s effectiveness in, well, mediating expert analysis.

First, a commercial imperative which makes it attractive in some markets to mirror, rather than inform. Second, in state media, the motive for self-preservation that makes it a necessity that the political balance at large – quarters of which are occupied by the snake-oil-peddling politicians – is reflected in broadcast treatment of a topic. [This is a kind of no taxation without representation rule]. And third, the fact that some subjects are dry and hard, and only occasionally pertinent, so that it does not pay [say, a TV station] to maintain a deep analytical capability.

In the United States, the vortex is working perhaps even more forcefully for the bad. There, the financial crisis has spawned the Trump regime. Here is not the place to document all the departures from Idealised Democracy 101 involved there. But side effects of the US vortex are already making our own UK worse and will continue to. The correspondingly more severe perversion of public discourse on how to analyse and mange an economy has surely contaminated our own [viz ‘FAKE NEWS!’]. The determination by the US to retreat itself from globalisation and tilt trade circumstances in its favour makes the alternative to the EU’s single market worse for the UK, which is going to aggravate the second round grievances of the UK vortex. There is arguably a higher likelihood of an incidental war drawing in the UK looking to bolster its special relationship credientials… I could go on…

If this vortex is actually operating, is there any escape from it? Who can say. One thing that might do it is a period of stability without a crisis. A long enough run of good luck that rehabilitates experts and the other planks of civil society as unfairly as they were initially maligned, increasing the weight of its scrutiny on politicians, and squeezing the market for opportunistic populism.


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Eurozone monetary and fiscal policy

Simon Wren Lewis writes despairingly about the state of Eurozone fiscal policy;  Northern core countries like Germany, France and the Netherlands pursuing zero deficits or surpluses, at a time when ECB interest rates are at the effective lower bound, and core inflation is stubbornly well below its 2 per cent target.  Endorsing his post in its entirety, I have just a few things to add.

Tight fiscal policy would not be a problem if unconventional monetary policy [buying sovereign and private sector assets, in the case of the ECB] was a perfect substitute for counter-cyclical fiscal policy.  But this is a minority position in the econ and policy-making community.  And Northerners find it distasteful because they see it as coming close to breaking a taboo about monetary and fiscal separation.

The Eurozone institutional structure encodes learning from the German hyperinflation in the 1920s.  Insulate monetary policy from fiscal policy as securely as possible, in case fiscal policy gets out of control and monetary financing begins to look tempting;  and make sure fiscal policy is biased towards the conservative side anyway, to guard against this happening at all.  What Germany – or the Allied powers that imposed the post World War 2 constitution – thought had been learned from that episode was forced on the rest of the Eurozone as a condition for its creation.

Those institutions hard wire a lesson that was worth learning.  We are better off with the much diminished possibility of hyperinflations.  But the trouble is, we have learned another lesson in the last 10 years, which is that the chance of hitting the zero bound is higher than we thought, and that means that the delegation and assignment scheme implied by the old institution is deficient.

Eurozone politicians from the Northern core are behaving as though the monetary policy objectives delegated to the ECB are only the ECB’s problem, ie objectives that are only pursued with monetary policy tools.  But this is not appropriate when conventional policy is trapped at the effective lower bound, and assistance is needed.  Given what we know now, delegation of macroeconomic stabilisation to the central bank unconditionally, and shooting for fiscal surpluses unconditionally, is misguided.

The financial crisis has revealed a deficiency in the currency union model that we did not think so important beforehand.

In a country with a government ultimately responsible for its own monetary and fiscal policy, it is in principle easy for that government to organise itself so that fiscal policy steps in when monetary policy runs out of room [Labour’s proposals code for this explicitly, and pretty well].

When there are  many fiscal agents, there is no mechanism to coordinate the new fiscal policy, in particular to encourage individual countries to care about the overall Eurozone monetary policy deficiency / inflation target undershoot.

The Stability and Growth Pact was a leaky [ie never perfectly enforced] attempt to coordinate against overly loose policy;  the worry being that badly behaved governments would over-borrow, counting in some way on the common central bank and other implicit aspects of the union to bail them out if necessary.  But there is no attempt to coordinate for the reverse problem, overly tight policy.  That is not so surprising, because before the crisis, under-stimulation was not recognised to be a very likely circumstance, given the history of most Eurozone countries’ macroeconomic policy.

The issue is compounded in the Eurozone by fixing in stone [that is, Article 127 of the Lisbon Treaty] the monetary policy mandate.  The ECB pursues ‘price stability’ [in line with the German constitution] and interprets for itself what that means.  It chose the lexicon ‘close to, but below 2 per cent’.   A response to the lessons of the financial crisis could comprise 1) more aggressive and institutionally coded for countercyclical fiscal policy at the effective lower bound or 2) a higher inflation target, or, ideally, some combination of the two.  In the UK, the government retained the right to define and redefine the target for the central bank.  In the Eurozone, this right rests with the ECB, and the ECB’s mandate effectively forbids a higher target.

This feature of the Eurozone was a feature, not a bug;  but now it has become both.

Monetary union would not have been possible if the German authorities thought it likely that the other governments could gang up on it and hike up the inflation target.  Encoding the target in the Eurozone Treaties, which conferred many other benefits and so was much less likely to be torn up as a whole, was a guarantee against this happening.  In the old world when the effective lower bound seemed like a curiosity [even if one suffered by Japan by the time EMU got going], there were no obvious costs to making it so hard to move the inflation target.   Now we know that there are.



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What did Monty Python metaphors ever do for us?

Tim Harford’s excellent adaptation of Monty Python in the face of generalized attacks on the economics discipline rather overshadows the other contributions, including mine, to the FT pieces published as a response to the Tom Clark / Chris Giles debate.

The piece by me was a crop of what I am reposting below, reproduced because the FT version does not contain the hyperlinks to other work, which were there to make a point about what is actually out there in econ that you can read.  And also because it chopped a paragraph on money, something Tom Clark seemed to suggest was ‘rarely discussed’.  [I don’t resent the edit:  I was given a word limit and singularly failed to hit it.]

“Tom Clark might be right [FT 24 April] to point out that the economics profession is ‘in a defensive mood’. If it were, it would not be that surprising, confronted repeatedly with critiques that misconstrue it and betray an isolation from what is actually happening in economics.

For example, in his lament in about economics Tom writes that “The strange status of money — a socially-created promise to pay, not an ordinary good — is rarely discussed.”

Apart from ‘is rarely discussed’ that phrase is apposite. Money is a socially created promise to pay, and not an ordinary good. (At least not usually, not now). But monetary economists spend their time discussing exactly that – just how that promise is created and sustained. There are hundreds of them, filling journals like the ‘Journal of Monetary Economics’ and ‘Journal of Money, Credit and Banking’. One feature of money being a socially constructed promise to pay, and not a normal asset, is that it pays no interest. And that means that central bank interest rates cannot fall much below zero. One can glimpse just how ‘rarely discussed’ this topic has been in the 20 years or more since Japan hit the zero bound by googling ‘money zero bound central banks’.

A theme in Tom’s piece is that what little ‘economic reasoning’ is deployed to good effect is ‘obvious’. He uses the example of adverse selection. I have to confess that my limited talents left me not finding it ‘obvious’ that hidden information about pre-existing health conditions can cause markets to disappear entirely, and to be the foundation on which state provision rests. Or how adverse selection conditions how central banks should devise reverse auctions to buy risky private securities to stimulate the economy. I did not find it ‘obvious’ what policymakers should do about model uncertainty: something Tom think economists don’t contemplate but leading economists in most central banks talk about routinely, explored laboriously by Nobel laureates Hansen and Sargent and others [even myself]. Neither was it initially obvious why the zero bound disrupts the normal rule that more money means higher prices. (Something the ‘permahawks’, as Paul Krugman refers to them, refused to grasp in their opposition to quantitative easing.) Nor was it self-evident at first that one could use a change of the unit of account to escape the zero bound. I didn’t find the implications of debt, demographics and inequality for the natural real interest rate ‘obvious’ either; nor the analysis explaining when persistent trade and finance ‘imbalances’ are healthy and when they are a threat. It wasn’t initially ‘obvious’ why it should be that immigration does not lower native wages; or why minimum wage legislation should not reduce employment. It still is not obvious what the relative contributions of low real interest rates and housing supply are to real house prices. It doesn’t seem ‘obvious’ to others how to find an economic and ethically consistent way to fund social care.   It wasn’t ‘obvious’ to me at first pass how and why the argument about the ‘costs’ of nationalisation were fallacious.

Rather than taking pre-emptive aim at economics, critics should read more.  However well intended, generalized attacks on a discipline that are not based on familiarity serve the same end as Michael Gove’s comments about having had enough of ‘experts’.  If we sound defensive in the face of these attacks, it’s because there is something worth defending: a lot of work society can draw on to improve the way it runs itself.”

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