Today was an exciting day for Bank of England junkies, in fact for anyone who gets off on central banking and monetary policy communication [cue to those of you who don’t to quit reading this]. The Monetary Policy Committee ‘updated’ its guidance, putting aside the unemployment rate threshold of 7 per cent that had so far been the point that would trigger at least considering an interest rate rise. The reason being that unemployment fell much faster than was anticipated back in August 2013 when the threshold was set, yet for reasons that do not push the MPC to be even close to thinking about raising rates now. Instead, in an extra-ordinary step towards monetary policy transparency, they have set out 18 forecast concepts that will help them and those monitoring them to figure out whether the economy is evolving as expected or not, and, if not, what is likely to be done about it.
The increase in transparency is to be applauded. It rather knocked me for 6. [Cricket terminology]. As I tweeted today, many of us in the Bank wrote inches of memos explaining why this would be a good idea, [as have many writing in the public domain too], but to absolutely no effect. Those members of the Executive Team or the Monetary Policy Committee to which we had access were either resolutely opposed – always seeing the wisdom in arguments extolling the costs of transparency – or thought it was a non-issue. Now, with the change of Governor, all these objections are swept aside, and those previously immovable committees, staffed by people that substantially overlapped with those whom I worked for, are fully on board. Well, good for them. There must be a special clinical term to describe the emotion you feel when you push for something ardently, yet have absolutely no impact on anyone with any influence, and then it suddenly happens anyway without you being involved. Whatever one might call this affliction, Chris Giles’ money supply blog served as a good antidote. There he explains that the information the BoE are publishing about its latest forecast was just what they had refused to release following his Freedom of Information Request, and had been backed in doing so by HMT and the Information Commissioner.
Although today was largely a triumph, I don’t think we should forget the mess that gave birth to the new Forward Guidance. I won’t go over all of this again [read these if you are interested]. But it does cast its shadow somewhat. To recap very briefly. Carney was determined to introduce Forward Guidance, which at that point meant a way of lowering interest rates out into the future, beyond the point at which the zero bound was binding, to loosen monetary conditions now. He was overtaken by the heating up of the data between when he made that clear [before he took up post] and also by the objections of the majority of the MPC to injecting more monetary stimulus. An agreement was needed that made it look like Carney had got his way, but yet was something that MPC colleagues who did not want more stimulus could agree to. The agreement was problematic because there was much confusion following its launch over whether it was meant to induce more stimulus or not. Carney’s August Press Conference translated as ‘this will kick-start the recovery’. But behind it lay the majority view that monetary policy was about right (save the mild tightening in the yield curve, smaller than many previous movements that had not warranted comment). And the launch was accompanied by some unquantifiable words about policy being ‘more effective’, and even some completely unfathomable words about it being intended to ‘explore the scope for… stimulus’. FG was NOT meant to indicate lower rates than would normally be consistent with its reaction function [whatever that was, it never tells]. Though they had adopted the language of this lower for longer Zero Lower Bound Policy devised by Woodford, they meant to do something different, and much less drastic.
These mistakes cast their shadow because much of the media commentary is about the short-lived nature of forward guidance. David Smith from the Sunday Times even puts the change in the same bracket as changes in the historical monetary regime. When the reality is the objectives have not changed, just the procedures for changing the instrument used to achieve them. If the MPC had simply said back in August that they wanted to be more open about their view of the economy’s future, and what they intended to do, they could have done that [they could have opted for today’s Inflation Report in August] without seeming to change their operating framework twice in 6 months. All that we would remember is that transparency increased, and what a good thing it was. There would be no talk of targets or thresholds or triggers or guideposts or knockouts.
Looking ahead, not all that could be done has been done on transparency. Carney was asked in today’s press conference why the MPC did not simply publish its interest rate forecast. His reply was that he didn’t like to do this because it mixed up the monetary policy reaction function with the state of the economy. That is absolutely true. But it’s also the reason why that forecast should be published. The rest of the forecast variables published also mix up [translate ‘are affected by’] the reaction function and the state of the economy. But the MPC are not suggesting they withdraw those numbers. Publishing the forecast will help us understand how to disentangle the separate influence of the reaction function and the state of the economy on the forecasts, not hinder it. While they are at it, the MPC should tell us how they quantify their monetary policy objectives [they surely do do this, don’t they, otherwise how could they possibly decide what they are going to do with their instrument?]. And they should tell us what their reaction function looks like; provide the simple rule uses to construct the forecast, and some words explaining how good an approximation this is to how they think about what they do with the interest rate. Further, they could release the code used to produce the forecast, which would underpin the laudable wordy explanation of the scenarios in the forecast, and help outsiders understand how the MPC use their model tools and judgement to form their view. So, a big step today, but much to be done.
Yet hang on. In this same press conference today Mark Carney explained that ‘forward guidance was not forever’. This threw me. It harks back to the language that this is just a special policy framework to cope with the zero bound, which goes back to the confusion about whether or not this was meant to be a Woodford style ‘lower for longer’ policy, which is appropriate exactly and only at the zero bound, or not. We are told not. (Yet we suspect that’s exactly the policy Carney personally would have wanted.) In which case, if forward guidance is therefore only about clarifying the path for future rates, why would we ever want to return to a situation where less information published could yield the same clarity about future rates? That’s exactly what seems to be implied by saying the BoE will drop forward guidance. Are we going to get to a state where the MPC is happy to let the yield curve wander around affecting monetary conditions as they tweak the short rate? How so?