The Governor’s eyebrows and the climate

This post is a repeat of many before, and consolidates Tweets from yesterday that were picked up in the FT story by Ferdinando Giugliano.

We’ve now had speeches from the BoE urging inclusive capitalism [Carney], on the benefits of volunteering [by Andy Haldane], and, recently, on urging government action to prevent climate change [Carney again].

This latest speech on the climate is, in my view, another example of overreach.

In that speech Mark Carney not only explained how long-term climate risks could impact on finance (which is fine), but also urged government action to prevent it (which is not ok, whatever the merits of that government action).

As always, there are three broad concerns.

First, the BoE, under fire for its handling of the economy before and during the crisis, and loaded up with many new responsibilities, must be sensitive to charges that it is already too powerful and unaccountable and too complex a body to manage well.  Overreach of this sort risks a bout of wing-clipping by some future regime that thinks the Bank has too much to do already, in which things it really should be doing are taken off it.

And it risks criticism of lack of focus, should any of its core goals not be achieved, even if such misses were unavoidable.  [Jonathan Portes’ critique gets at this, paraphrased as, ‘since you are missing your inflation target, this is no time to chide others for not hitting their climate target’.]

Getting involved in issues outside its large remits complicates the debate over critiques like those from the new Labour team that the BoE should pay heed to poverty and inequality, which most sensible people would also regard as off-limits.  If climate is on mission, then why not these other things?

Finally, there is a risk of politicising the job.  In the sense that, if a government expects the next governor to speak widely on matters of social concern, they will be selected so that their views on these other matters fit with government policy, and not on their expertise, and capacity to marshal that of others, on money and finance, which ought to be the sole qualifications for the job.

If urging action on climate change is part of the job, what next?  Why not issue a plea to OPEC to make sure the taps are kept turned on to aid monetary and real economy stability in the West?  Or urge support for a middle East peace settlement to eliminate the risks of military and migration catastrophe that would also threaten the UK and its financial sector?  Or push for multilateral nuclear disarmament to clip the tails of asset price distributions?


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Unrevised inflation should put to bed the monetary and fiscal revisionism

The latest vintage of UK GDP released by the Office for National Statistics has revised up growth rates through the post crisis period significantly.  It’s caused some to speculate that this vindicates George Osborne’s ‘austerity’ policies, and others to wonder whether MPC voting might have been different.

But, note that the history of inflation, which we measure independently, and probably much more accurately, has not been revised.

Very roughly, given how the BoE views the world, this means that it will treat the revisions to GDP as pushing up both demand and supply in equal measure, leaving the output gap unchanged.

Why is that?  Well, simplify the monster that is COMPASS [the BoE’s model] a little to its basics, and you have the NK Phillips Curve, which says that inflation=inflation_t+1+something*gap+shock.  The inflation series are unchanged.  So something*gap+shock is unchanged.   Which means that unless the shock is revised in exactly the opposite direction, the gap is also unchanged.

You’ll be relieved to know that life for the policymakers is taken to be more complicated than that.  But this thought process will be at the root of what they do.

So there will be no great signal for monetary policy here.  And, likewise, there is no great signal for the efficacy of past fiscal policy.  Clearly there is news about the history of the natural rate of output.  News that should calm some of the soul-searching about why productivity dropped so much more in the UK than, say, the US.

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Is Labour right to review the BoE mandate?

This is the question posed in Robert Peston’s blog today.   My answer:  yes and no.

No, also, because while no mandate, certainly not the existing BoE one, is likely to be word-perfect, there should be a pretty high bar set for conducting a review, and there should not be too many of them.  The reason being that if frequent reviews became the norm, we would inject unwelcome macroeconomic uncertainty.  Obviously, there is a balance to be struck.  The whole point of retaining the power to set goals, and delegate just instrument control, is to be able to reset them at some point.

It’s probable that the Corbyn team recognise this, but yet feel that the magnitude of the BoE’s departure from a policy it would have preferred is such that a review is necessary.  [Hence, the prior, less qualified desire take back ‘democratic control’ over monetary policy, and to devise a new quantitative easing that prioritised ‘the people’].  The desire is to point the finger for the trajectory of the economy through the crisis at monetary policy.  In my view, that analysis is wrong.  The culprits were fiscal and regulatory policy.  The small quibbles I might have with the way things are don’t warrant another review so soon after the last one.  And we should remember in this regard that HMT itself conducted just such a review in 2015.

No, also, because, if one edits out the urges to get the BoE to care about all kinds of things it can’t do much about, and instead replaces these with the more legitimate question about wheher the BoE was sufficiently mindful of the stability not just of inflation, but also of the real economy, we discover that this is indeed emphasised throughout the recent 2013 Review.  The UK’s mandate is one of ‘flexible inflation targeting’.  And, moreover, prior to the Review’s publication, it was judged to have been interpreted as such.  For me this means that the BoE is being asked to do what monetary policy can and should.

Some might have the appetite to use a remit review to push for the BoE to be given a target for nominal GDP.  But, as I have said before, I don’t think this is worth the trouble either.  Nominal GDP growth targets, in practice, would not deliver policy much different from what we have had.  Levels targets, advanced as a way to help deal with the zero bound to interest rates by engendering commitments to reverse a recession, are not justified because the benefits that derive from them rely on the extremely unrealistic assumption that policy can be taken to be acting under commitment, and that people in the economy have rational expectations.  Both preclude weighing other factors;  that the weight on some components of GDP shoudl be larger than others;  that policy should consider nominal wage inflation, the real exchange rate, and so on.  So, the remit is not worth changing on this account either.

But there are some things to discuss that might warrant action, even if these don’t need to amount to a review of the mandate.  I mention them in case readers think I am out to defend the BoE at all costs.

For example.

1)The BoE could be urged to be more transparent about the MPC’s plans for interest rates.  Such plans must have been formed, if the MPC is to have voted coherently over today’s interest rate, and the case for concealing these plans, or at best forcing us to infer them indirectly, is in my view weak.

2)More transparency too could be urged on the BoE to make available working versions of its model, and with judgements applied by MPC to produce the forecasts.

3)We could ask the MPC to explain more precisely just how it trades off the stability of real and nominal things, and how it weighs – as it should – concerns about nominal wages, the real exchange rate.

4) And we could ask it to update us periodically about how it sees its ‘reaction function’ – how, ahead of time, it plans to respond to different kinds of events, and the benchmark policy rules that might inform such a plan.

5) We could also tighten up and clarify that the MPC itself has the responsibility to decide not just ‘how much’ assets are bought under QE, but also ‘which assets’.  Formerly, the BoE executive reserved the right to decide ‘which’, a division which some MPC members [Blanchflower and Posen, for exmaple] were unhappy with, since it precluded credit easing in the early stages of the crisis, when the BoE executive were against it.

6) More radically, we could institute that when the floor to interest rate binds, or looks likely to, HMT and the BoE consider a discretionary fiscal stimulus jointly, to make up for the missing monetary policy stimulus, with the former working out how, in the context of whatever other fiscal rules are followed, that maps into a trajectory for clawing back the incurred debt in normal times.  This stimulus would, of course, be financed using conventional borrowing, and not via money creation.

7) We could consider beefing up the scrutiny of the policy decisions and economic analysis conducted by the BoE, using published reports commissioned from 3rd parties as the basis for Treasury Committee hearings, rather than such scrutiny hinging on the agility of TC’s non-specialist MPs in the ring with the BoE’s executive team.

8) Raise the inflation target from 2-4, with 5-10 yr reviews of developments in the equilibrium real interest rates.  [After a period where we have demonstrated we can hit the current target again]. [And h/t Dan Davies who spotted that I had forgot this item].

With the exception of 6), however, none of these matters need be described as a remit review.  They are debates about the operational framework of monetary policy.  Even the issue of raising the inflation target does not itself need a ‘remit review’.  The number 2 is confirmed by letter, each year, under the current framework.  So 8) would simply need a process for producing a review of what should be in that letter.


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How many Corbyns have you had today?

Two recent blogs on Corbyn, in case you missed them.  Someone responded to one of these posts:   ‘My first Corbyn of the day.  Must cut down.’

If you haven’t exceeded the recommended number of Corbyns today, click through below.

On the Spectator Coffeehouse blog, here.

And on the Guardian business/economics blog, here.


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Martin Sandbu and Silvio Gessel

Here Martin picks up on the Haldane speech about negative rates, and some of us that criticised him for supporting that option to escape the confines of the zero bound.

MS rightly points out that one would not need to abolish cash altogether, describing a scheme that goes back to the originator, Sylvio Gesell, where cash has to be ‘exchanged’ or as originally envisaged ‘stamped’, to show that the relevant tax has been paid on it.

However, under such a system, if I understand it correctly, we would carry around portfolios of notes that were all worth something different from their par/face value, prorportional to the time elapsed since the last ‘exchange’.

So cash’s usefulness as a medium of exchange would be sorely tested for all except those endowed with exceptional ability in the mental arithmetic of compound interest.  There would also be another verification needed, not just to check that the note is not a forgery, but that the time until next exchange is what the bearer claims it to be.

Those in favour of negative rates might not balk at such a problem.  The bound on rates would be the average mandated tax on cash, plus something that quantified the extra inconvenience of managing cash balances coming from the difficulty in evaluating their worth.  More bang for your negative rates buck.

However, when we have such simple alternatives as proper forward guidance, credit easing, and disciplined use of discretionary fiscal policy, my inclination is to confine a cash reform like this to academic discussion for now.


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The leftist Brexit urge is irrational

Picking up a point I tweeted about a few days ago, and, I think, also pointed out independently by Chris Giles….

It’s a curious thing that the right in the UK may want to leave the EU if David Cameron does not succeed in watering down labour market and social protections that bind the UK enough.  Yet, if he does, this will prompt the UK left to want to leave.

And thinking about it the left’s desire to leave seems irrational.  If rights get watered down, there’s still the option of topping them up locally.  And the watered down rights that remain imposed centrally by the EU act like a guaranteed minimum.  If the left were to vote to leave, in a strop, this would expose their workplace constituents to the rise and fall in their own fortunes.  In years of electoral wilderness (say, for example, hypothetically, the next 25 years), the right could chip away at these rights so that they were below the minimum that remaining members of the EU enjoyed.

The right’s desire to leave is more internally coherent – even if I don’t support that either.  From their point of view, there is no recourse to local watering down if the centrally imposed minimum level of protection is not sufficiently low.

Perhaps this will all be academic.  Peter Doyle pointed out to me that if Corbyn makes the Labour Party unelectable, this will lessen the need for Osborne and Cameron to worry about the right of his own Party, and make them bolder in campaigning for us to stay in an EU with no more than cosmetic reform.  For they can swap the deserting Tory UKIP voters for those on the right of the spectrum who would usually vote Labour.  Electorally, the latter are likely to be more decisive, since that switch would trigger a rush of marginals to go blue.

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Haldane on coping with the zero bound.

This speech is an interesting overview of the difficulty that faces monetary policy mandate designers in this era of low equilibrium real interest rates.

AGH tilts towards reforming monetary institutions to allow for substantially negative interest rates, rejecting permanent use of QE, or a rise in the inflation target.

In the past, I’ve plumped for raising the inflation target to 4%.  Or more particularly, HMT setting the inflation target, perhaps on instruction from a third party, every 5-10 years, based on an assessment of the equilibrium real rate, which we might well expect to move around further.

A few points on AGH’s cost-benefit analysis.

Andy points out that inflation is costly, and so an extra 2 percentage points of it is proportionately more costly.  Yet it seems to me that allowing negative interest rates on digital cash increases the cost of 2 per cent inflation somewhat.  Formerly, consumers get zero interest on their notes and coins holdings, while they depreciate at an average of 2 per cent a year.  With occasionally negative rates, these ‘shoe-leather costs’ of inflation increase a bit, proportional to the time spent below zero, and just how negative they go.  A reminder:  during the dark days of the previous crisis it was commonly thought that rates would ideally have gone down to about negative 7% or 8%.

Second, I query the judgement that eliminating cash and using negative rates would be less damaging to the credibility of monetary institutions than bumping up the inflation target.  Ultimately, in the absence of good models of how reputations are won and lost, this argument is really about trading hunches.  But mine is that there is a risk of a serious WTF moment when the no-cash system is explained, or people find out that they actually have to pay large sums of money simply for the privilege of having it.  Anecdotally, we know from many models of money that equilibria where money is valued are quite fragile – specifically, it’s quite easy to write down models in which it is not.

It’s worth noting too, that the MPC ran substantially above-target inflation for some years during the crisis, and, despite the warnings of some, the faith that central banks were still targeting 2 was not much diminished.  An open, pre-announced, and well-explained move to 4 per cent [in my view once we have shown we can hit the current target, and not before] would not be fatal.

Third, AGH is dubious about making more use of QE.  This is interesting in the context of the current debate, in which since the departure of Mervyn King, one senses, despite protestations by others to the contrary, that there is a shift in sentiment against this instrument.

Haldane is worried about the intermingling of monetary and fiscal policy [a worry that has come to the fore recently with the debates about Quantitative Easing for the People].  These worries are legitimate, but not insurmountable.

Two finesses might help.

First, there is no need in my opinion for QE to involve the creation of reserves.  One can simply have the DMO issue short-gilts and trade them for long.  QE becomes a twist.  The twist part of QE was always the part that was most convincingly effective anyway, via its squeezing of the term premia.  Think of current QE as a two-step.  First, the creation of reserves to buy a short gilt;  second, a swap of a short for a long.  The first is just conventional monetary policy, which will have no effect at the zero bound.  [Leave aside the detail that rates stopped above zero and we have IOR]. Unless it meant some lowering of interest rates in the future to accommodate the correspondingly higher money.

A second finesse would be to make policy announcements take the form of instructions from the MPC to HMT for them to undertake the twist themselves.  Since the BoE is already insulated from the fiscal effects of QE through the indemnity, this is a natural next step, if worries about intermingling weigh heavily.  This etiquette could be used to underpin a more vigorous credit easing [ie issuing gilts to finance purchases of private sector assets].  And it might also help the DMO avoid conflicts such as one might argue we had this time, between what its right hand is doing [issuing long gilts like crazy during the crisis] and what it’s [BoE operated] left hand is doing [hoovering them up via QE].

A final point to note is that AGH does not mention that the armory could be supplemented by more vigorous use of discretionary changes in conventional tax and spend fiscal instruments at the zero bound.  Although Haldane considers changing the inflation target, which is on the face of it is HMT’s business and not his, discussing conventional fiscal policy like this was probably thought a step too far.

Full-blown fiscal councils of the sort recommended by Wren-Lewis are considered too much for democracy to swallow by some [not me].  But there is a half-way house.  One writes down an agreement ahead of time that in the event that the zero bound threatens or is hit, HMT and the BoE would discuss together, in an open and minuted forum, an appropriate, discretionary, fiscal response, explaining the loosening and the nature of the subsequent tightening later down the road to repair the debt/GDP ratio.  Ideally, both parties would agree at the launch of this institution on rough orders of magnitude, linking additions to the deficit to estimates of the missing interest rate stimulus, to be referred back to as and when this tool is activated.


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