Monetary policy mistakes, and central banks’ reluctance to discuss them

Watching the Bank of England Inflation Report Press Conference webcast this week, the subject of whether a monetary policy mistake was made in the aftermath of the Brexit vote in June loomed, with questions from Ben Chu and others.  This potential mistake is the corollary of the August 2016 forecast that, ex post, has turned out too gloomy.

Aside from the substance of this particular issue around Brexit, it struck me again how reluctant central banks are to discuss their current plans in terms of responses to things they have already done that ex post look like mistakes, and even ex ante might have been mistakes.

Mervyn King, former BoE Governor, used to bat away questions with this kind of implication with words like ‘it’s for you to judge us‘.

There is certainly a trap that can be fallen into if one marks ones own performance in public.  (Of being too kind to oneself).  But, there could be big advantages in terms of clarifying current policy strategy, and enabling scrutiny and accountability.  My experience was that the reluctance wasn’t about problems in facing the public with this:  there was no appetite internally either to couch the analysis of policy in terms of past policy mistakes.

Analytically, extracting the monetary policy mistake and responding to it is important.  In the BoE and other central banks’ models, a monetary policy mistake demands its own particular response from monetary policy today [and in the future].  And one potentially different from a re-examination of some other disturbance, say to the supply side.

One place where mistake-silence causes a problem is in the communication by and perhaps even decisions by the dissenters.  It used to baffle me how dissenters would position themselves a consistent x basis points away from the consensus.  Each time their vote was overruled, they ought to be noting a monetary policy mistake demanding its own response.  This was not spoken about.  And if it was accounted for, something else in the analysis came along to perfectly offset the amplification of the dissent that you would expect to get as a vote was overruled again and again.

The invitation by the Treasury Committee for written submissions evaluating the BoE’s policy is a welcome counter to this state of affairs.  I hope it does not prove to be a one off.

For one thing, my own submission will make the point that it was a mistake for the BoE to refuse to characterise its own evolving strategy in terms of (perhaps perfectly forgiveable) past mistakes.


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Perceived grievance/wrong-headed sop vortex, updated

Last year, I wrote this post.  Worrying about a vortex of ever lower prosperity and policy rationality.  It was in the aftermath of the EU referendum in the UK, which can be taken to be a vote against immigration and globalisation.  That is the perceived grievance.  The wrong-headed sop is the withdrawal from the deep, free trade structure of the Single Market, leading to immigration controls, non-tariff barriers restricting our trade in services, reducing prosperity and the feasible size of public services.  Next round the grievances are felt even more acutely, and the policy sops worsen.

You can change some of the nouns and the story is the story of the US, or wherever.

Looking back, and taking in the Trump victory, and the way he and his associates have handled the transition, the story seems to miss something.  The vortex described above is fallen into almost by accident, as a misinformed but pivotal part of the electorate demands something that will make itself worse off.

But the vortex we – that is the West – risk falling into is one that was partly designed.  The perceived grievances did not arise by accident, but have been stoked and crafted ruthlessly.  And in an environment where the media and expert checks on pernicious policy can be circumvented or deflected, the policy measures, [the wall, import taxes, trade agreement dismantlement], although they make things worse, can be sold as a success, whose ill effects are blamed on simply not punishing the imaginary villains enough.  And the next round follows.

The vortex is stoked and our descent into it  is piloted in the name of the ‘will of the people’.  But in fact the journey is in the service of the populist-controllers who have managed to sell the people the bad policies.  What do they get out of it?  Publicity, gratification, media careers, control over policies that affect the net worth of companies they and their associates are connected with.

In the UK, the vortex piloters [this is not a spoof blog post, honest] seem more subtle than Trump & co.   But the deliberation is still there.  Repetition of ‘Brexit means Brexit’ and ‘we are going to make a success of it’ makes it easy for us to read that as ‘whatever we get, we are going to sell it as a success even if it isn’t’.  And our desire to find something to substitute for the single market with the US makes us a supplicant to the US vortex, warping not just our trade, but our approach to defence, security and human rights.

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Political economy of pre and post crisis Eurozone inflation

Before the financial crisis, a standard assumption [I subscribed to] was that the Southern peripheral countries were on a path converging their income per capita to Northern levels, and as such, through Balassa-Samuelson effects, experiencing faster inflation.  The Balassa-Samuelson effect describes how increases in traded-goods-sector productivity in the South bids up the price of non-traded goods their, relative to abroad.

For the conservative North that was uncomfortable with the 2 per cent inflation target [hence ‘below, but close to’ in the ‘clarified’ wording] this was fine, since it meant that hitting 2 per cent inflation in aggregate in the Eurozone would imply <2 per cent for them.

However, after the crisis, history in the South looks rather different.  The price of non-traded goods was bid up not by durable increases in productivity, but by excessive domestic demand, borrowing against future income that was not going to arrive, facilitated by spreads that were too low, ex post.  The South has been embarking on a protracted and painful internal devaluation.

The political economy of the aggregate 2 per cent target is now not so favourable to the North, since it means Northern inflation has to average >2 per cent to hit the target while this devaluation is going on.  Lo and behold, the aggregate inflation target is persistently undershot.

I think there are less conspiratorial reasons for the persistent large undershoot of the target:  the effect of the debt overhang on equilibrium real rates, and the zero bound.  But the political economy problem sketched here is intriguing.




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Open letter to Neel Kashkari

Dear Neel

I read that you are setting up a new research institute at the Minneapolis Fed to study inequality.

I think this is a good use of resources.

But I don’t think it’s appropriate for you to lead this or for your regional Fed to be seen to be majoring on this topic.

Fed independence is a valuable commodity, and this initiative puts it in peril.

To some it will look like you are using your discretion over regional Fed funds to push a political objective.

Your new President has Janet Yellen in his sights for simply keeping interest rates low in pursuit of the mandate.

The more conventionally conservative Congress have those amongst them that want to ‘Audit’ you, an initiative that stems partly from a concern [totally misplaced in my opinion] that you collectively lost your way by keeping interest rates low and undertaking unconventional policies like QE.

The risk that Fed appointees become politicised is aggravated by the politicians feeling that Fed employees use public money for political purposes.  Inequality is an unavoidably political topic.

Recent research and concerns about monetary policy have focused on how monetary policy works by redistributing;  and how inequality may have been a contributor to currently low real interest rates, which the Fed is accommodating.  But this would not warrant an institute for ‘Inequality’.  This would warrant a research agenda on the causes of low real interest rates;  or on whether there are alternative ways to implement monetary policy in pursuit of your mandate that have different consequences for inequality.

There is also an unfortunate personal angle to this.  Your prior pursuit of political office is bound to be used by some as evidence that this new initiative is part of an agenda to propel you once again into that career.  I don’t doubt your motives, but others might.

The best way to pursue this would be to leave the Fed and try to fund it conventionally, from NSF research grants, corporates, or wealthy philanthropists.  Inequality is rightly THE topic for those worrying about how to preserve the fruits of the enlightenment, and what we here in the UK call the mixed economy welfare state version of capitalism.  So I think you’d find there would be no shortage of willing participants.


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What did Tory Remainers get for giving into the hard Brexiters?

As I wrote here for Iain Martin’s site Reaction Life, the delay in being transparent about what the UK government wants was, I conjecture, mostly about conducting a negotiation between former Tory Remainers and the victorious Brexiteers.

The UK had to approach the EU with a schedule that explained how much it was prepared to pay in terms of obstructing trade for control over migration.  But the price differed between competing Tory factions.  The Remainers won’t pay anything, and perhaps even include those of us who view migration as a social benefit.  Hard Brexiteers see migration as costly, so will pay something.  And there are even those Brexiteers that have convinced themselves into thinking that separating from the single market will increase trade and prosperity overall, not reduce it.  So for those, migration is on the benefit side of the calculation, as is single market dismantling.

The hard Brexiteers have clearly won out.  But at what cost to them?  Did the Remainers and the liberal leavers extract a price?  Could they command one?  If they could, did the hard Brexiteers have anything to offer?

The hard-Brexit/rest divide tends to correlate with other views in the populace at large, so one could imagine in principle that Remainer/liberal leaver MPs could buy something with their capitulation.

But, thinking further about it, I can’t come up with anything concrete.

The post referendum mood seems to involve the Theresa May and the Tory Remainers tilting left.  Embracing less regressive taxes, industrial policy, regional policy.  That they would share with the hard Brexiteers, perhaps, who carry the UKIP manifesto in their pockets.  So that isn’t something the two factions could trade for Brexit capitulation.

Striking a deal seals the prospect of a long uninterrupted period in government, of course.  But both sides need each other for that.  So that also is not something that can compensate Remainers for giving up.

Any ideas?




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Submitting to demonetization, or not

The Indian government decided recently to withdraw 85% of paper currency.  Despite the hair-brained nature of this scheme, ostensibly aimed at reducing corruption and tax evasion, the Reserve Bank of India agreed almost overnight.  More intriguingly, it seems to be working.  Not in the sense of being a beneficial policy.  But in encouraging people to deposit the old notes for something that will be worth something after the deadline.

Why is this intriguing?

Well, a contrasting story, told to me first by former Governor of the BoE Mervyn King, is of the late Sadaam Hussein’s attempt to demonetize the then autonomous area governed by the Kurds, and protected by a Western-backed no fly zone.

Sadaam, who was having a spot of difficulty financing his activities through conventional means, needed to print lots of notes, but sanctions prevented him from buying Swiss-printed dinars.  So, partly for this reason, and partly to try to destabilise, Lenin-style, his adversary, the legal tender status of old notes was revoked.

Kurds were invited to make their way to the central bank of Iraq in Baghdad and swap the old notes for new ones.  But for reasons we can guess at, they did not think it beneficial to cross the de facto border into the rump of Iraq, or find someone to do it for them.  Instead Kurds held onto their old ‘Swiss dinars’, (so-called because they were printed by the Swiss firm De La Rue).  They refused to be demonetized, in other words.

These stories remind us that more generally the decision about what is or is not money is a social and collective choice, not one maintained solely by fiat.

The Kurds ignored Sadaam’s edict.  Not just, or I would surmise, even mainly out of nationalist fervour [the old notes were not ‘theirs’ after all], but because individually, and collectively, it was judged economically advantageous.  Perhaps the expectation arose that at some point a local central bank would be established and the notes would be redeemed [for other bits of paper of course] or Sadaam deposed.  In India, note holders might have pondered whether the demonetization would stand or be revoked at some point.  Instead it seems that they think they have to give into it.

Governments submitting to dollarisation after debasing their own currencies make the same point.  A government gives local currency legal tender status and prints loads of it. Individuals decide to use dollars instead.

These stores provide a caveat to several varieties of what is essentially the same question [what should money be?] that pop up.  For example:

Ken Rogoff debates whether central banks should stop issuing large notes.  And the caveat in the back of our minds should be:  is de-issuing feasible, and will it be accepted?

And Ben Broadbent mulled over whether the central bank should offer its own digital currency.  The caveat here being:  ultimately, this may be decided by society at large, and by markets:  by forces outside central bank control, in other words.

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QE: leads to looser or tighter fiscal policy?

A recent Goldman Sachs piece on the UK holds the view that the BoE’s recent resumption of asset purchases will permit and prompt UK fiscal policy to be looser, postponing consolidation of the deficit.  The mechanism at work is that, comforted by the knowledge that there is a large buyer with a deep pocket for the debt, yields are lower, and this in turn makes the government more comfortable about borrowing, the yield reduction providing more fiscal space.

I don’t hold this view.    But it is interesting to think it through, because it gets at what QE is, and what outsiders seem to think it is.

The way I see it – and the way I think both the government and the BoE see it – is the following.  The reduction in yields acts as a substitute for lowering the short-term interest rate, and, supposing this to be adequate to bring about a desirable path for inflation and the output gap, would allow tighter fiscal policy than otherwise.    One of the arguments made by the government’s critics uses the same logic in reverse.  That line of thought – repeated recently in Paul Krugman’s blog – wishes for rates to be higher as a precaution to provide more room for a future cut to respond to future recessionary shock.

The ‘fiscal space’ argument used to suggest that QE permitted looser fiscal policy isn’t relevant, in my opinion, now, because the UK, at a debt to GDP ratio of about 85%, is a long way from the point at which markets might worry about default, and require corresponding premia to compensate [a point which is not, as Robert Peston recently mentioned in his blog ‘conventionally taken to be 90%’].

I can think of two arguments that might lead you to think that QE made no difference to fiscal policy.  One is that hypothetically, a recession is so deep that fiscal policy is led to loosen on a trajectory that is as generous as could be risked, given available fiscal space, the duration of the shock, and the likelihood of another.  Whatever QE is tried is on too small a scale to change the need for maximally stimulative fiscal policy.  You could just about run this argument as a description of UK fiscal policy 2010-12.  But some would disagree.

A second ‘irrelevance’ argument is that QE is ineffective.  Bernanke joked that QE didn’t work in theory, something taught us many times over, by Wallace, Krugman, Aurbach and Obstfeld, Eggertson and Woodford and others.  Empirical studies of QE find variable, but reliably positive effects on impact.  But this is not proof that its effect endures.  A monetary stimulus that is not a stimulus and is recognised as such would not have any effect on the fiscal authority’s behaviour.

Two ‘QE is financing’ arguments that have more legs, but which the authorities will deny until they are blue in the face, are these.

First, QE is helicopter money in stages, and by disguise.  Both government and central bank recognise that conventional fiscal space might be running out, and so the central bank buys debt that otherwise the market might not bear.  There is lip service paid to selling it back, but that never happens.  We will have to wait quite a while to get a chance for the authorities to rebut this conspiracy theory conclusively.

A second financing argument is that QE tilts the yield curve in such a way that the Treasury, for its own purposes, takes advantage, and skews issuance.  The intention at the outset was that the UK’s Debt Management Office would not do this.  But as I blogged some time ago, you can see evidence that its customary practice of consulting with market clients over what they want issued would have given them cover to do just that.  Summers also worried that the US Treasury was ‘undoing’ the Fed’s QE by tilting issuance towards long end debt.

[Sorry for not providing links:  voice recognition software can’t do this!]



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