Monetary policy delegation rebounded, and an odd trade-off

Back in the day, monetary policy economists and practitioners discussed the benefits of delgating monetary policy to an independent central bank.

There were two kinds.

The first was to remove an ‘average inflation bias’.  Think of a two period game.  In period 1, the government says to an all encompassing trade union ‘we are going to give you 2 per cent inflation’.  Unions bargain for 4 per cent nominal wage increases to cover productivity and expected inflation.  Once those contracts are locked in, the government surprises the economy with 4% inflation, compressing real wages by 2% and boosting employment, which it thought would help with the next election.  However, knowing the government’s trustworthiness, or lack of it, in advance, the union would bargain for 4% plus productivity.  This forced the government’s hand right from the off to generate 4% inflation, or suffer a real wage increase and lower employment.  Delegation to an independent central bank prevented the surprise inflation.

A similar argument held for how the government had an incentive to under-smooth inflation shocks, even once the question of the average level of inflation was resolved.   If it promised to curb them greatly, it could manipulate inflation expectations advantageously.  Delegation was supposed to sort that too, leading to lower inflation variability [and a better trade-off between that and output variability].

Armed with these theoretical results, the observation of lower and apparently less variable inflation in the 90s and 00s was therefore put partly down to this delegaion and assignment.

However, with hindsight, it’s possible to see that the whole thing has rebounded.  By being too ambitious to curb the inflation bias, setting inflation targets that were too low, governments lowered the resting point for central bank rates too far, leading to the zero bound trap being encountered after the 2008/9 crash [with a close run before in the early 2000s, and of course Japan falling foul much earlier].  At this point, monetary policy instruments, conventional and unconventional, having lost their firepower, the job of stabilizing the economy rebounded back to the government, along with the old credibility problems that went with it.

The experience also highlights a peculiar trade-off.  The more you try to squeeze down inflation at the point of instrument assignment, the less successful delegation ultimately is, [the more likely the zero bound trap is fallen into subsequently].

If you don’t believe that central banks need to smooth business cycles, or you think they do more harm than good by trying, you’re likely to think of this not as an unfortunate consequence of targeting too low an inflation rate, but as a stroke of good fortune that leads a society deluded by New Keynesian macro into following the dictum of the Friedman Rule, whereby interest rates are pegged at zero and the penalties for holding non-interest bearing money are eliminated.

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Dismantling and devolving the pernicious union

In recent blog posts, I have been advancing ideas that respond to the frightending dysfunction in the UK polity.

1.  Separation of Northern Ireland, Scotland, and Wales into individual, independent countries embedded into the EU, and England levered to tether itself as a non member in name only, or rejoining at some point.

2.  Membership of the euro and aspects of the ‘ever closer political union’ that the UK has thus far been exempted from.

Using the same logic, regional devolution would help achieve and accentuate the same ends.

I am not a fan of regional devolution.  Devolving tax raising and spending powers impairs risk sharing and risks municipal corruption and cronyism.  I am not convinced that regions are better placed to trade-off whatever special insight they have into their local problems with the aggregate national interest in the supply of public goods.  But anything that can tame the powers of the mal-functioning national parties and executive has to be a good thing.

In the limit, chop the country up into entirely independent regions and have them embedded in the EU.  The break-up of the union would still leave a relatively empowered England able to do harm to its neighbours and itself.  [England has about 56m of the 66m population of the UK].  Dismembered into North, Central and South East and Cornwall, and the consequential parochialism in their politics reducing their collective heft, less harm would be done.

None of these regions would support a nuclear deterrant or a significant standing army.  All would be dependent on the wider European and NATO structures.  The pressure to submit to the rules of the single market for each of the constituent regions would be very great.  Perhaps every 50 years something like the nationalist virus that has infected the UK would take hold of one of the regions, putting it in conflict, or perhaps even for periods outside the EU.  But this would be of much less consequence, affecting fewer people, and much harder to sustain.  With greatly reduced power would come a reduced level of responsibility that the lowest decile of politicians by capability – who are are currently seeing fill the great offices of state and the Opposition – could live up to.

These things I guess are not going to happen, and, borrowing David Cameron’s old insult aimed at UKIP, you might think me a ‘fruitcake’ for proposing them.

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Brexit: the mutually inconsistent views of the desirable anchor and the stormy constitutional sea

One feature of Brexit from the perspective of those who see political and economic benefits to remaining a member of the EU is that there is no safe, perpetual compromise position.

There are soft versions of Brexit in which almost all the economic benefits of membership are reaped [for example by remaining in the single market and customs union].  But once we leave it becomes much easier to take further steps away from the EU, and the UK’s economic trading relations, regulatory environment and even to an extent political rights become unethered and more subject to the ebbs and flows of domestic politics.

For Remainers, EU membership is an economic and constitutional anchor;  anything short of this is casting off.

Some Leavers saw things exactly the other way round, of course.

They either feared, or manufactured fears of Good Ship UK Political and Social Norms being dragged by an ever more powerful EU polity, itself a changing entity with the potential for new members to accede.  Membership of the euro, an EU army, EU wide budgets, funding for future bailouts;  obligations to take some of those who migrate into the EU.

For these leavers, rightly or wrongly [in fact wrongly], Brexit was the anchor and continued membership was casting off.

This is at least part of the reason why the issue is so divisive and intractable.

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Asymmetric radicalization of Leavers and [most other] Remainers

A striking feature of the post Referendum period is the radicalization of Leavers.   Amongst leading protagonists, many supported remaining in the EU’s single market during the campaign.  Subsequently, the focus shifted towards leaving the single market and customs union in order to fulfil a revised definition of true Brexit by enabling an independent trade policy.  Now, control of the Governing party rests with a faction that openly embraces leaving the European Union without a deal, outriders deployed to dissemble about constructs like ‘managed no deal’, or ‘WTO deal’.

The radicalization has not just been on the part of the Leaver oligarchy.  Polling suggests that about 40% would choose no deal over Remaining in the EU.

There has been no parallel radicalization on the Remain side.  The initial position on the Remain side was to preserve the status quo of our membership with the European Union, subject to some largely cosmetic modifications to freedom of movement negotiated by Cameron in the 2015/2016 pre-referendum period.   There is no popular movement for entrenching our membership in the EU by dropping our exemption from the process of ever closer political union, for example;  there is no movement for taking the UK into the Euro and foregoing independent control over monetary policy.

What accounts for this asymmetric radicalization?

Two explanations I can think of are that the radicalization is more apparent than real.

The first is that, at least on the part of the Leaver oligarchy, they always wanted the more radical Brexit options.  Appearing to want the softer Brexit options was a charade to attract moderate voters in the referendum.  Once the referendum was won, these moderate voters could be dispensed with.

A second possibility is that the radicalization reflected the unravelling of sincerely sought, but inconsistent features of Brexit.  Brexit itself was about the confronting of a series of demands, with an offer from the EU.  That process revealed what was and was not going to be feasible.  The kernel of Leave was always underpinned by a desire to leave at all costs if necessary, and this kernel was revealed by the process of the EU explaining to us what was not going to be possible.

For my own part, I have undergone something that one might describe as radicalization.  The UK polity has shown itself to be far more fragile than most would have thought possible before 2016.  Both major parties are siezed by different varieties of racism and economic populism,  and regularly dissemble to the public about Brexit and other matters.  [Viz Labour’s offer of a ‘jobs first Brexit’;  the Tories early and lately embraced mantra of ‘no deal is better than a bad deal’].  The approaching deadline of October 31 has thrown up ambiguities in our informal constitution over the powers of Parliament, the Courts and the executive, which are being actively exploited by the latter.

In light of this, slowly depriving ourselves of autonomy by submitting to ever closer political union seems like a good thing.  If autonomously wielded policy levers are going to be pulled for ill, better not to be able to pull them.

I would even suggest that joining the European Monetary Union looks more attractive than a few years ago.  The problems with the euro are well documented.  The conservative biases and inflexibility built into the monetary policy mandate and policy deliberation;  the lack of fiscal union and the bias against counter-cyclical fiscal policy, both in major states like Germany and the instituion of the Stability and Growth Pact.  However, if the UK were embedded in this union, it would raise the costs of extricating ourselves from the EU greatly and make it less likely [caveat – it would of course politically antagonise the leave constituency].

These are versions of the arguments used by some constituents of the former Communist bloc in Eastern Europe for accession into the EU and the euro.  Unable to generate healthy institutions domestically, they could free-ride on the stability conferred by the imperfect and unwieldy coalition of Western European countries.  Before this, similar arguments were of course used to argue for membership by the ‘peripheral’ countries of Greece, Spain, Italy, Portugal.   Those countries had been plagued by decades of monetary and financial mismanagement, and joining in with the EU’s political and monetary integration was about tying the hands of domestic policymakers so that they could not continue this mismanagement.

The UK has to be seen in the same light now.  Old analyses of otherwise well functioning polities conducting independent versus Euro monetary policy miss the new larger picture:that Euro membership would involve a swap of worse monetary and fiscal policy for some measure of basic institutional stability that we otherwise will lack.  Seen this way, this is not ‘radicalization’, but figuring out a new optimal solution for the UK subject to a revised view of us being less able to function independently.

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The changing calculus of Scottish Independence

Much was made of the first poll in favour of Scottish independence.  The calculus is changing.  I would argue that for a variety of reasons, independence is now more attractive.

Relative to 2014, the first benefit is removing Scotland from the influence of two polar opposite, but pernicious political offerings, from Labour and the Tories.  During the 2014 referendum, major parties in the UK all pretty much lived within the rules of acceptable discourse, and were led by groups with different, but relatively pragamatic visions for ther UK.

This is no longer the case.  Both major parties are infested with varieties of racism;  Labour, antisemitism, and the Tories, Islamophobia.  Both parties are led by cabals of ideologues.  The Labour leadership is held by a faction of anti Western Marxists, held somewhat in check by an unhappy and beseiged more moderate Parliamentary Labour Party.   The Tories are run by national populists, shadowing the ever more extreme agenda of the far right, now in the form of the Brexit Party.   There is a sensible faction, but this is a much weaker rump than the sensible faction of Labour.

The second benefit follows from the first.  Both major UK parties economic offerings depart from sound economic policy.   Scottish independence potentially offers a respite from alternating Marxism and economic populism.

Further benefits require us taking the perspective of the former UK unit.   One relates to part of the calculus that has worsened since 2014.

At that time, leaving the UK would not have meant any significant change in trading relationships with the rest of the UK and Europe.  Now, on the plausible assumption that Scotland would be accepted as a member of the EU, Scotland would swap avoiding Brexit, and retaining continuity of membership of the EU single market, for breaking its single market with the UK.

However, conditional on leaving, and if Northern Ireland or, more remotely, even Wales were ultimately to leave, this would increase the economic pressure on the UK to stay within the customs and regulatory orbit of the EU.  [Because trade with those in the EU single market would form a larger percentage of Egland’s trade than it does with the current UK as a whole].  Of course a caveat to that is that if Northern Ireland leaves, then the current impasse over the backstop would be sorted, and the England/Wales rump UK, or England alone, would be politically free at least to pursue FTAs with the EU and other countries.

Continuing with the idea of taking the perspective of constituent parts of the UK as a whole, not just Scotland, it strikes me that if the Union were to be dismembered entirely, this would not, as before, be a tragic weakening of a potentially positive force in the global economy and polity.  By contrast, beset by the economic and political evils offered by either of the current major parties, the England or England/Wales rump would be defanged somewhat and able to wreak less harm.  The ideal outcome, taking on board the assumptions made thus far, would be for the separate and weakend parts all to be embedded within the EU.  Scotland leaving the UK would be the first step along that route.

There are other costs and benefits of independence, of course, but they are as they were before.  The issue of Scotland’s currency, post independence, and whether it could set up a credible independent central bank, and whether it would ultimately be coerced into joining the Euro.  Scottish public finances once the subsidy from the rest of the UK is withdrawn.  And questions about the health of politics north of the border given the current hegemony of the SNP.


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Lewis Goodall’s ‘Remainers are rubbish’ conclusion.

Lewis Goodall, Political Correspondent for Sky, wrote a thread on Twitter today concluding with a familiar line that Remainers are not good at politics.  They ‘may as well pack up and go home’.  They are ’embarrassingly bad at politics’.   The mental connection made is with the commentary that first began in the aftermath of the Referendum victory for Leave by recalling the spectacle of a babble of liberal economists talking conditional forecasts on the one hand, and Leave posters with ‘take back control’ and ‘let’s fund our NHS instead’ on the other.

But this is not a good characterisation of recent events.  Such as it is, the ‘Remain alliance’ is a creature of its largest member, the Parliamentary Labour Party.   That organ is in turn a creature of its leadership structure.  That structure is comprised of individuals and influences that are [from the perspective of Remain] at best indifferent to Brexit, and at worst inclined towards it.  Perhaps the same can even be said of its attitudes to a No Deal Brexit and the chaos that might follow it, incriminating Tory incumbents and capitalism itself, both of which the Labour leadership have spent a lifetime explaining that they want to displace forever.

So judging this alliance on how well it is going about ensuring that No Deal does not happen, or that the UK Remains, or only exits on very Soft terms, is not appropriate.  Tortoises don’t see their days as being about collecting acorns, so we would not mark them down for failing to do so.

By contrast, Johnson’s new Government do have a singularity of purpose about leaving the UK and without a deal if necessary.  They are no better at politics than anyone else.  It’s just that they all want the same political outcome.

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Not entirely negative about Positive Money

Positive Money and I have had an exchange of blog posts on FT’s Alphaville about their suggestions for what the successor to Mark Carney, Governor of the Bank of England, should and should not do.

I remain deeply opposed to any move to get the Bank of England involved in climate change mitigation, or any attempt to interfere with credit allocation in pursuit of a policy to re-engineer industrial composition to suit that or other political objectives.  Likewise, we should not set the Bank objectives to target the level of inequality.

However, I do think that having the debate is important and ultimately productive.

It’s uncomfortable reading, and while the debate is happening, it feels like an unwanted increase in the probability that the central bank will be further politicized and the mandate broadened.

But in a democracy, the decision to hand over powers to an unelected, technocratic body, cannot be once made and never reviewed.

The credibility of monetary and financial policy ultimately rests on consent.  If it becomes apparent that the powers wielded aren’t consented to, then the suspicion will emerge that ultimately what people do want instead will come to pass, and people will not believe central bank promises.

This consent has to be continuously sought.  A key means of doing this, obviously is public debate.  Attempting to actively avoid and suppress such debate risks making it seem like the mandate is designed in opposition to the interests of those whose consent one needs.

Of course, echoing my own theme about what the Bank of England should and should not do, renewing this consent and fuelling the debate is not the job of the Bank!  (A reason why I am uncomfortable about exercises like the Citizens’ Panel, which seems to sponsor debate in this area.)  The Bank’s job is to do what it has been told and no more.

But it is the job of Governments and civil society at large.  So, although I don’t agree with much of Positive Money’s proposals, I welcome their letter and the conversation it provokes.


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