This post takes a look back at the Treasury’s review of the Monetary Policy Committee’s Remit, published in March. This might seem like old news. But it is soon to be highly topical, as one of the outcomes of the Review was to instruct the MPC to publish an evaluation of the practice of forward guidance in its August Inflation Report. This wasn’t the only interesting thing about it though, as I will try to argue.
The Remit is dead; long live the Remit
One of the triumphs of (at least the text of ) the Review was that it resisted any major change in the Remit. UK monetary history is a sorry tale of successive broken promises and macroeconomic instability. The financial crisis was the first serious test of the current framework, and there is something to be said for stability for stability’s sake. There were many (in my view erroneous) calls for changes to the Remit – for example to instruct the MPC to follow a nominal GDP target – and these were resisted.
Why that clause in brackets emphasising textual stability? A key aspect of the Remit is the extent to which the MPC are allowed to trade-off stabilising inflation and real activity. There was some ambiguity in the old remit, since it appeared to give primacy to the inflation objective (the ‘subject to’ clause). As the crisis hit, a shock that drove output down and inflation up, some accused the MPC of an excessive focus on inflation, and some accused it of setting aside the inflation target. In the Review, the Treasury emphasised that the MPC should be weighing up these sometimes competing goals, and, moreover, that the MPC had correctly interpreted its Remit in the past. (In the course of doing this, they wrote a remarkably lucid survey of the state of knowledge about what monetary policy should do that should be compulsory reading for undergraduate monetary economists).
However, in accompanying interviews and briefings, a different message was allowed to emerge, one more politically expedient: that the Treasury had changed the Remit to give the MPC more scope to stimulate the economy and go for growth. Putting out interviews that were not consistent with the text of the Review was taking a big risk with the monetary framework. The message seemed to be ‘if you want to know what the MPC’s Remit is, listen to what we say, not what we write’. The risk was that this would inject uncertainty into guesses about what MPC’s goals would be, because of the different Treasury interpretations of their own Remit, and because of the possibility that there would be future oral Reviews along the way. From the outside, it looked as though the Treasury were trying to reassure markets and economic commentators with their conservative (small c) text, but at the same time to say what the voting public at large wanted to hear by emphasising the going for growth message, at a time when there was none, a fact that one guesses they wanted to lay at the door of monetary policy.
Instrument but not goal independence
A second triumph was that the Bank’s views were not solicited. This helped emphasise that though the Bank retains instrument independence, the Government, as the elected body, reserves the right to choose the Bank’s goals. This is also timely, coming as the Bank re-assumes other financial stability responsibilities. Any suggestion that the Bank was also being included in the process of deciding on the goals of monetary policy could lead to a future backlash, some political constituency for clipping the Bank’s wings, perhaps to the point of undermining the operational independence of monetary policy too.
For this reason, I thought it was unfortunate that Mark Carney was questioned about his views on the Remit at Treasury Committee, (and that he chose to answer). Likewise, it was unfortunate once the Review was published, that the Treasury revealed that the previous and current Governors ‘approved’.
Forward guidance: trespassing on the MPC’s operational independence
The Review took the unusual step of instructing the MPC to evaluate the practice of offering forward guidance on interest rates, a step I think was very unwise. One of the strengths of the monetary framework was that though the Treasury reserved the right to decide on the MPC’s goals, it allowed the MPC to decide how to achieve them. The Review trespassed on the MPC’s operational independence. There is text in the Review emphasising that it is for the MPC to decide whether or not to undertake forward guidance, but most readers will surely see that as being simply for show. The real intention, one is likely to guess, is to raise the cost of not doing forward guidance considerably. The Review was published in the context of appointing a Governor who had undertaken forward guidance in Canada, and had also made it clear he was in favour of the same happening in the UK, and at a time when others were presumed to be against it. The impression conveyed was of the Treasury using the occasion of the Remit Review to do everything it could to get further monetary stimulus.
Coordination failures: having sorted MPC vs FPC, what about fiscal policy?
The Review devotes time to instructing that the MPC and the Bank’s new Financial Policy Committee must seek to ensure that their actions are well coordinated. This is very welcome; clearly, and especially at a time when the financial system remains in poor health, monetary policy decisions affect financial stability, and decisions made by the FPC on macro-prudential policy will affect lending and therefore growth and inflation. However, the elegant reassurance offered on this topic is rather hollow when there is no discussion of the other coordination problem in macroeconomic policy: the coordination of monetary and fiscal policy.
A kind of fiction underpins the status quo on monetary and fiscal policy. The fiction is that beyond a once and for all setting of the automatic stabilisers, the government stays out of stabilisation policy, sets fiscal policy to meet supply side and distributional goals only, and stabilisation is instead left to the MPC, who therefore have no active strategic player to coordinate with. A better description of reality would be: a succession of Governments only ever stated its fiscal rules vaguely, changed them periodically, and abused them in the interim. Discretionary fiscal policy was used to macro ends. Through some combination of bad luck and this bad behaviour, finances were in dire straits when the Coalition took over. The Coalition felt it had to refresh a promise not to engage in discretionary fiscal stimulus regardless of what happened in the macro economy. This promise was unfortunate and not credible anyway. Unfortunate because precisely at the time when discretionary fiscal policy would have been most useful (at the zero bound) it was ruled out. Not credible because there were surely some circumstances that would force a change in course (as indeed we found out). We just did not know how extreme those circumstances would be at the outset, and the deliberately opaque and obviously false assertion that there was to be no turning no matter what simply served to increase the risk that behind the scenes more mischief was being made, defeating the worthy purpose of establishing fiscal credibility.
In an ideal world, the Government would recognise that the automatic stabilisers are there in part to help with macro stabilisation – i.e. to help achieve the same Remit the MPC are striving for. And it would recognise that from time to time further discretionary fiscal stabilisation is appropriate – for example at the zero bound to interest rates – and is on occasion applied to these ends. Of course, no such framework could be offered now by this Government as signing up to it would look like admitting that the opposition were right.
I say all this myself not believing that any further fiscal stimulus would be appropriate. But that’s not the point. First, many do wish for more fiscal stimulus. A proper framework within which such policies could be scrutinised and evaluated would help that debate. Second, the Government itself has changed a vague and incredible plan in ways that look like discretionary fiscal stimulus, and it would be better (I mean would reduce the risk of markets taking fright at fiscal developments) if the use of fiscal policy for MPC Remit purposes were more clearly encoded. The Remit Review was a missed opportunity in that regard. These are points Simon Wren Lewis has made for many years, in different ways, by arguing for fiscal councils.