On Friday, Bank of England Chief Economist Spencer Dale is set to respond to twitter questions posted to #AskBoE. This seems like a useful time to recap on previous posts on the fiasco, as I see it, surrounding the launch of forward guidance (FG). All this has been said before, by me, and others. But there is no harm in repeating questions that are begged, especially when they don’t get answered the first time.
1. Forward guidance presumably must have been a ‘inject no more’ stimulus policy, otherwise how would the hawks agree to it?
2. If it was a policy to inject no more stimulus, why bother with all the smoke and mirrors? Was it worth risking faith in the monetary framework to inject no more stimulus? Or risking that this was seen as a sop to a Governor-elect that had already declared himself in favour of a stimulatory forward guidance before taking up post, and would be embarrased to find he could not have it?
3. If it was a policy to inject no more stimulus, it was mighty unfortunate, as it looked a lot like other forward guiding central banks’ policies, which were designed to inject more stimulus. The similarity was hazardous and confusing.
4. If it was a policy to inject no more stimulus, what does it mean that FG was meant to make policy ‘more effective’?
5. If ‘more effective’, by contrast, does mean, ‘more stimulative’, and yet FG is meant to inject no more stimulus overall, where is the compensating tightening to leave the net stimulus the same?
6. If ‘more effective’ does mean more stimulating, where are the quantifications of the impact of reducing uncertainty on the macroeconomy? Most people would expect such effects to be very small. What prevents them from being small in this case? Have the MPC reflected on the reaction to FG and deduced that all the benefits from reduced uncertainty about policy have accrued as planned? If so, what evidence do they have to substantiate that. If not, what do they intend to do about it?
7. How can Governor Carney’s initial press conference which was full of almost hyperbolic language about securing the recovery be squared with an ‘inject no more stimulus’ version of FG?
8. If the intention was to inject more stimulus, how can Carney’s answer to Faisal Islam’s question in that same conference be squared with that intention?. Recall that he asked Carney whether FG should be considered a monetary loosening or not. Carney pointedly avoided saying it was, and instead described it is an attempt to make policy ‘more effective’.
9. If ‘more effective’ does not mean ‘more stimulative’, what does it mean? Why is it so important that it is ‘more effective’ if it is not stimulatory? Why does adopting a framework that is allegedly ‘more effective’ warrant the cost of all the confusion and uncertainty about the MPC’s long run intentions regarding the inflation target?
10. If FG is not meant to be more stimulatory, how does that square its launch and evaluation relative to the initial request by HMT, the intention of which can clearly be read as a request to evaluate an instrument for stimulating the economy that the BoE had not yet deployed, in contrast to the Fed and the Bank of Canada. (They did not say: FG seems to have been very effective in stimulating the economies of the US and Canada. Can you evaluate the equivalent policy tailored so that it does not stimulate at all, and get back to us in the August Inflation Report?)
11. [Aside: I wonder what HMT make of FG, if in fact it is not supposed to be more stimulatory?! Presumably it’s something of a disappointment. All the charade of a formal review of a policy option that amounts to clarification?]
12. The MPC are right to defend themselves against the accusation of a flop when the yield curve disagrees with them. But they have yet to explain what they had forecast the reaction of the yield curve to be, and how they intend to respond to it. [Watch for an answer to Chris Giles’ well-aimed #AskBoE question on this].
13. How have the MPC coped with the extreme unreliability of their model (and all like it) when simulated under constant interest rates? Where are we to find the extra uncertainty, for example, in the Fan Chart?
14. If FG was meant to be more stimulatory, how do the Hawks justify it? What changed their mind? And just when the economic data was hotting up so clearly? That data was deflty, if (for me) unconvincingly, described as a hotting up of demand and supply that were perfectly in harmony (and thus inflation-neutral). But really, what else happened?
15. If what changed their mind was the ‘unwarranted’ tightening in the yield curve, why have such factors not been mentioned before, nor any description of their effect on the policy decision been presented? As Chris Giles asks in his #AskBoE tweet, are subsequent movements in the yield curve ‘warranted’ or not? How much difference do the MPC estimate the unwarranted tightening made to anthing, eg, inflation?
16. If FG was a ‘no more stimulus’ policy, and instead just about making policy more effective, (which we will assume for the moment just means, ‘better presented’, or ‘easier to understand’, but not implying any first-order difference in terms of stimulus), but yet the yield curve tightening was unwarranted, what was supposed to be the response to it?
17. If FG makes monetary policy more effective now, why was it not introduced before? Why did it take the request of the Treasury and the appointment of Carney to look into it?
18. One presumes that before Carney arrived, there was a majority against using FG. What persuaded those who were formerly against FG to support it subsequently?
19. The MPC must have realised that there would be a risk that if nothing further were said, it would look as those that were formerly against FG had not in fact changed their mind, but were simply falling in behind the new Governor, matching popular press accounts of how the MPC works, contrary to the doctrine of individual responsibility that has reigned thus far. What can the FG flip-floppers say to outsiders to explain their change of heart?
20. In the absence of any explanation for why those formerly against FG subsequently supported it, there is a risk that observers would conclude that perhaps instead FG was simply never discussed.
19….. in which case, supposing it wasn’t, such an outside observer might wonder why it wasn’t discussed? Were those supportive of FG before simply not given an opportunity to discuss it? If not, why not? Or were they too timid to raise it? Were they putting aside their preferences in favour of the former Governor?
20. In communicating FG, the Bank describes it as enabling the MPC to ‘explore the scope for economic expansion without putting price or financial stability at risk’. What does it mean to ‘explore the scope for economic expansion’? Did the MPC not guess that such a term has no recognised meaning amongst professional economists, let alone amongst those ‘down the Dog and Duck’? In what sense was previous policy not able to undertake such exploration without its attendant risks?
21. If FG was simply about clarifying what the MPC were already doing, (the corollary of FG not being equivalent of injecting more stimulus, and therefore not being about ensuring interest rates were ‘lower for longer’ a la Woodford), why all the fuss about staging posts? If FG was simply about such clarification, why not (instead) make reference to the kind of rules that outsiders might use to try to forecast what MPC are doing, and compare what they actually do to those? Why not explain how the MPC weigh its competing short run goals of inflation and real economic stability? For example, why not tell us how much more worrisome is a deviation of inflation by one percentage point relative to deviation of unemployment from its natural rate by the same amount? If MPC have an answer to this question, why don’t they tell us what it is? What argument could justify concealing their calculations about this from us? (For that matter, what do the MPC’s custodian, the Treasury, think MPC should be doing? Why are they happy for this to be kept from us?). If they don’t, how on earth are they setting monetary policy? How can they be confident that the course they have set is going to achieve the best combination for their goal variables?
22. FG is about expectations management. This brings to the fore the question of what the MPC believe about how those expectations (of what it is going to do, of inflation, etc) are formed? So what do they believe? Academic work on forward guidance is set in the context of rational expectations (an assumption that means that agents in the model know all there is to know about the model). MPC have distanced themselves from this work (in explaining that FG is not about lower for longer) and would anyway presumably distance themselves from the extreme assumption of rational expectations. But they have replaced it with what? And could the MPC tell us how they think expectations are amenable to MPC’s comunication and policy decisions? Have these views been formalised and ecoded in the simulations underpinning the MPCs estimates of the likely impact of forward guidance, thus replacing the existing assumption in COMPASS, the Bank’s suite of forecasting models? If not, how have they arrived at their view about the length of time it will take to reach the ‘staging post’ of 7 per cent unemployment?
One could go on. It need hardly be said that this episode is laced with an unfortunate irony. Forward guidance is, as the name suggests, about trying to explain what you are going to do in the future, ie, it is about using communication to enable others to understand better than they would otherwise be able what you are going to do. Unfortunately, as I see it, FG has achieved exactly the opposite. It looks, mechanically, to be a ‘no more stimulus policy’ from the outside. Yet there was somehow an agreement struck that it could be presented as the opposite. And that there would be no intervention to stem the tide of media coverage interpreting FG as the thing that would rescue the economy from the doldrums. FG was no more stimulus for the hawks, but appears to have been spun as lots more stimulus for the media, or at least that is how it looks. And in risking that this was how it looks the MPC put in jeapordy its reputation for plain speaking. (This is why I called it ‘Fudged Guidance’.) With inflation measurably, and, on balance, justifiably higher than target for some years now, and expected to be so for at least another two, now was not the time to tamper with its reputation for plain speaking.