The speech Mark Carney should have given but didn’t

Folks.  I found myself in a tricky position when I arrived.  The bosses in Whitehall were really taken with this thing about keeping interest rates lower for longer, and, frankly, since there was no way they could loosen fiscal policy, they were in the mood to try anything.  They had backed themselves into a corner by saying that there was going to be no more fiscal loosening.  And though the economics of this sucked, the politics was clear.  And maybe, at a stretch, you could understand it, since it was a legacy of the pretty scary times they started out in back in 2010.  So HMT were really hoping to get more stimulus through Forward Guidance.  They knew I was into it and we hit it off.

They made a good show of being cautious about appearing to change the monetary framework, commissioning a review.  But they knew what I thought already – I’d gone on record about it -and we both knew what the answer was going to be.  Except, when I got here I found that there was a majority against any more monetary stimulus.  I was hoping to persuade them but I couldn’t.  It’s a little tough to accept, since I started out thinking that this was what was going to ‘secure the recovery’, but the reality is that the other MPC members think the recovery is in safe hands.  So our review is an in principle review.  I think that many of my colleagues accept that if we needed more monetary stimulus, it would be worth having this tool in your kit.  However, most think that we don’t need to try to engage in ‘lower for longer’ right now.  But we are not going to leave things there.  I have managed to persuade my colleagues that we should be more open about future interest rates in general, and about what we are trying to do with our policy instruments.  The former Governor had strong views about this, but we think it’s time for a change.  The Reserve Bank of New Zealand have been publishing interest rate forecasts for two decades without any difficulty.  The Scandinavian central banks are facing challenging times, as market forecasts of what they will do have differed from official ones for some time.  But on balance we feel that this has proved educative.  Why shouldn’t those forecasts differ?  And the debate there has focused on the economics of how the conjucture will play out, not the competence or credibility of the institution.  So, this is what we will do from now on.  Moreover, we are going to explain more about how we arrive at our policy plans.  For instance, although everyone has got the idea that the central bank should stabilise the real economy, as well as inflation, we have been totally silent, and, frankly, evasive, up until now about just how much weight we should put on each concern.  There’s no great clarity in the literature about this, but previous regimes have tended to hide behind this observation to avoid taking a punt.  But without taking a punt, frankly, it’s impossible to know what should be happening to your policy instruments.  [How were all those votes cast before, you might very well ask yourselves, and how did our Treasury bosses tolerate handing over all that power without even specifying what we should do with it, or asking us to be clear about that?].  So, taking that punt, we are going to go for two to one weights in favour of inflation.  The consensus in the modern macro literature is for weights much higher than that.  They have to do with the models’ assumed very high costs of invalidating the forecasts of firms whose prices can’t adjust period by period.  We think those very high costs probably over-egg it.  After all, no-one seriously believes firms will not change prices no matter what.  Those comments need a proper dive into the technicalities to explain them properly, and we’ll do that, but for now take it on faith.  Two to one might change, as we learn more about what that means for our policy plans.  Having set out (actually for the first time!) what our objectives are, we next need to present you with some tools we use to decide on our plans, and to help you reflect on how we do it too.  To begin with, we present a range of simple policy rules, the coefficients of which have been honed to achieve the best on the two to one weights objective, given how we see the economy.   And, just to probe things further, we’ve repeated the exercise for slight changes of the two to one weights assumption around our base case, and interestingly, also for a two to one assumption replacing price inflation with nominal wage inflation.  (One of the predictions from these models is that central banks should care as much about nominal wage inflation as price inflation).  Obviously, these rules can’t capture all the complexity of what we think we face, particularly now.  And you can see our central forecast for interest rates differs from what all of the rules suggest.  But we go into reasons for that in our Inflation Report.  To reinforce these openness steps, we are providing all the code and judgements applied to the Bank’s suite of forecasting models that are used to produce each forecast.  That way you’ll be able to check that we are being honest, and see how we use and abuse these models.  Amongst other things, you’ll be able to see important things like what the assumed effect of the Funding for Lending Scheme is; what the assumed effect of changes in capital requirements made by FPC is;  the assumed effect and transmission of quantitative easing.  So you can get an idea how all the different instruments interrelate.

So, the upshot is, we are not engaging in Forward Guidance as other central banks have chosen to use the term, ie we are not trying to keep rates lower for longer than you would guess we would based on normal modes of setting interest rates.  That’s because there is a majority against injecting more monetary stimulus.  We have all of us agreed that there may come a time in the future when this kind of policy would be effective.  Probably, the best time to do this would have been when it became clear that interes rates were going to fall a lot after the Lehman’s Crisis.  That was when the yield curve was still projecting steep rises from their trough, fairly soon after the crisis hit.  So there was a lot to be gained by flattening that curve.  Some of my colleagues pointed out that embarking on this policy now, so long after interest rates have already been pinned at the zero bound, would be to do so at exactly the time when this policy would have least effect.  So, we are not doing Forward Guidance.  But we are entering a new era of transparency about what we do.  This will make monetary policy ‘more effective’, in the following specific sense.  It will make it easier for you to judge whether we are keeping our promises and acquitting the important duties assigned to us.  It will bring the technology of holding central banks accountable up to the standards now expected of modern democracies.  It will hopefully guard against people worrying that we have gone soft on inflation, because you’ll have a better idea what we are doing, and why allowing inflation to be consistently higher than target for so long is still the right thing to do, despite our remit.    It’s extremely important for us that our new policy is not confused with the Woodford lower-for-longer policy, and that for that reason we will completely eschew the ‘Forward Guidance’ language.  This is semantics.  But important semantics.  Because we don’t want to mistakenly inject monetary stimulus we collectively judge not to be needed.  And, more importantly than that, if we are to keep lower-for-longer Forward Guidance as an effective tool for the future, we don’t want to blow it by somehow riding on the coattails of other central banks and pretending what we are doing is like what they are doing.   If we did that, and we were found out by close questioning that there were no more monetary stimulus, we might get a reputation for trying to spin our policies for things that they were not, which would be an extremely hazardous thing to carry forward into the near future.  Although my colleagues are against more monetary stimulus now, they recognise that we might have to rethink in the future.  For example, there are great risks of things working out in the Eurozone badly over the next couple of years.  If that happens, we will need every monetary stimulus tool at our disposal, and our reputation for plain speaking intact.  That would be the time to present a tool that we label ‘Forward Guidance’.  And when we do, we want people to take us at our word that more stimulus was intended.  If we presented a ‘no-stimulus’ Forward Guidance policy now,  there would have been a risk that people thought this was Mr Carney rising to rescue the recovery and then finding out that I wasn’t doing anything at all. Down the road, when the recovery really needed rescuing, and we launched the ‘kick start Forward Guidance’, they might then think we were trying to pull a fast one again, and wrongly conclude that we were in fact sitting on our hands again.  This would be a hoax on the scale of trying to pretend that buying gilts with electronic money was some great new stimulus policy, when all that was going on were some fancy open market operations!

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