The MPC will shortly publish its August inflation forecast, and its evaluation of the policy of ‘forward guidance’, commissioned back in March by the Treasury (an action I previously noted was tantamount to saying ‘how about looser monetary policy, folks?). One presumes from today’s policy decision (to leave all instruments on hold) that there was no consensus for with Odyssian forward guidance, injecting further monetary stimulus by promising to keep rates lower for longer than would have been guessed at from previous MPC behaviour.
So that leaves Delphic forward guidance – just being clearer about your interest rate forecast, given how you expect the economy to develop. Stephanie Flanders recently posted on forward guidance on her blog, making the interesting point that perhaps there would be no point in such guidance, since the forecast and MPC intentions are already pretty transparent. As she put it, one might respond to the first words of the oracle: “have they told us anything that we didn’t already know?”
Well, here are some arguments why, actually, maybe we don’t know all that much, and reasons why the MPC could do some transparency housekeeping. There are some arguments against the transparency steps implied by what follows, but they have already had enough of an airing, and so far held sway, so I am not going to repeat them.
First, MPC, and particularly it’s former chair, Mervyn King, have, in continually stressing that they ‘face one ball at a time’ [UK cricket speak for not deciding on future rates] confused what might be read from the MPC’s forecast of inflation under market expectations of interest rates. Those who make their living trading bonds, and bringing about the prices from which we infer market expectations of interest rates, what are they saying to themselves? Are they saying: ‘we don’t believe this stuff about facing one ball at a time, we think they do have a plan, and this is it’. Or are they saying: ‘we do believe the one ball at a time rhetoric. But we think that this is how the bowling and batting is going to play out.’ Or a third possibility: ‘we think they do have a plan, it’s just that the plan changes every period.’ Who knows. But surely the one ball at a time talk made it harder to guess what would happen, and putting an end to it is going to make life better.
Second, MPC have said nothing about either what kind of monetary policy rule they might use as a guide-post for policy [unlike FOMC members who often pointed to Taylor rules, or the Swedish and Norwegian central banks, who refer to them]. This reluctance to make use of more explicit analyses of policy rules is perplexing because the MPC’s tendency to set rates in a way that adhered to such rules (in more normal times) was probably not that different from other central banks. Even with rates pinned to the zero bound such analysis would be valuable, because one could gauge the extent of desired monetary easing, if only the zero bound would allow it.
Third, MPC have not been at all clear on how they trade off inflation vs fluctuations in real activity. For this reason it’s hard to know how they would respond to any given inflation forecast, and how they would view paths expected by the market. If you don’t know what the MPC are trying to achieve with monetary policy, how can you guess what they will do? One surely supposes that they have articulated to themselves and to each other precisely what they are trying to do [otherwise how could they discuss their disagreements about interest rates and QE?]. In which case it is perplexing that such discussions have not been made open to outsiders, who need to know what will happen to monetary policy, or who seek to try to verify whether MPC are doing a good job or not. It might be argued that it is hard to know precisely how goal variables should be traded off, and that for example the academic literature doesn’t give a very compelling steer, and even that this trade-off might have to vary from one situation to the next. But still a view on this has to be taken, surely, in order to take any policy decision at all, And if it has been taken, the argument for concealing it from the outside world is very weak.
Fourth, since the morphing of the financial crisis into a sovereign debt crisis that threatened to break up the euro area, and still does, the MPC have excluded the risk of this happening from the fanchart, on the grounds that it was not possible to quantify it. It is therefore hard to read what their true beliefs about the mean values for inflation and growth are for a given interest rate path. The position MPC took on this I thought was spurious. The inference that they can quantify other risks with more precision (eg the risk of our own banks not resuming normal lending) is hard to defend. Regardless, MPC could think about taking a robust approach to policy which is a way of proceeding if risks are genuinely entirely unquantifiable. Such an ommission would be coherent if it were uncontroversial that monetary policy would not need to respond to the waxing and waning of this break-up risk, but only to it actually happening. But this is not the case.
Fifth, messages from the forecast are hard to interpret because of the convention of taking government fiscal plans as given. For political economy reasons, the MPC does not want to be observed in the business of making forecasts of fiscal policy that differ from the plans of the Government. To do so would look like it was advising on fiscal policy, or the competence of the government to make plans, which is outside its remit. But this means that MPC’s beliefs about its own likely future actions, which must be conditioned on its beliefs about the likely path of fiscal policy, are less easy to read from the inflation forecast.
Sixth, the connection between the MPC’s likely future votes, which are a trajectory of the majority position out into the future, and the inflation forecast itself, which is meant to be a ‘centre of gravity’, is completely obscure at present. (What is a centre of gravity anyway, in this context?) MPC disagreements about interest rates or QE are difficult to map into disagreements about the forecast. For a brief period, while DeAnne Julius and Sushil Wadhwani were on the MPC, when the Inflation Report carried a ‘Table 6b’, explaining how they dissented from the forecast, it was easy to map between disagreements over interest rates and disagreements over the forecast, but never since. Do individual MPC members articulate to themselves and each other, clearly, how their forecasts differ from the ‘centre of gravity’? If so, why are they concealed from the rest of us? If not, why not? How could a dissenter be so sure of their vote, to within 25 basis points on Bank Rate, or £25bn on QE, without having formed such a forecast?
Seventh, the MPC has never been clear about its views about the output gap or the natural rate of unemployment. It has also sought to make sure that outsiders cannot reconstruct its own forecasts, with insufficient details about the MPCs main model, or other models, and the judgement imposed on them, disclosed for outsiders to be able to evaluate what the forecast means, and thus what they (or the MPC) would read into a difference between forecast inflation and the target.
Eighth, the MPC adopted the practice of conditioning on the market expected path for interest rates, yet on fixed amounts of QE. This fixed path for QE is inconsistent with what the MPC have said would happen to QE (which is that it would be unwound at some point when it became clear that interest rates were on a probable even trajectory away from the zero bound, sufficiently probable that there would be no risk of having to resume asset purchases again).
Some of these transparency deficits are of more practical significance than others. But together they surely make it hard to figure out what the inflation forecast foretells for monetary policy, and one could therefore hope that instigating Delphic forward guidance would be a step along the way to making things clearer.