Mark Carney used his Mansion House speech to talk up the yield curve and the Sterling exchange rate, warning us that interest rates might rise sooner than markets think. On the face of it, this seems like a pretty regular central bank thing to do, an old-fashioned wiggle of the Governor’s eyebrows. However, I didn’t like it. It’s a return to old-style smoke-and-mirrors monetary policy communication.
First off, was he speaking for himself or the majority on the MPC? Were these comments a pre-release of the next MPC minutes? If so, why? Why couldn’t he wait for the next MPC minutes to come out, when MPC deliberations are set out more clearly? By acting out of the normal protocol, was he signalling that markets were misinterpreting events by more than normal? If he wasn’t, didn’t he realise that this would be one way to read him? What did the words actually mean anyway? They could mean: we haven’t changed our strategy, or our view, but markets seem to have changed their minds. Or they could mean: we have changed our strategy, and I’m giving you advanced notice. Or they could mean: we haven’t changed our strategy, but the data have heated up in our view more quickly than market seem to appreciate.
We also don’t know what is in the MPC’s mind about the likely path of other instruments the Bank of England controls via the Financial Policy Committee. Are rates set to rise faster than markets think because these other instruments are to tighten slower than markets think? [Unfortunately there aren’t traded instruments that allow us or the Bank to figure out precisely what people think about FPC instruments]. Have the MPC organised with FPC a joint path for all the instruments? At such a pivotal moment for monetary policy, it would seem opportune to do so.
These ambiguities suggest to me that at such an important moment the Bank should refrain from remarks like this and simply publish their forecast of future rates. Then all would be clear. What is achieved with these coded words? What would be risked with a less coded interest rate forecast? What, in fact, is so urgent that it couldn’t wait until the next Inflation Report? And if it was sufficiently urgent, given the gravity of what he was communicating, why not commission an update of the forecast to make clear how the MPC see things to have changed?
In the same speech Carney repeated his claim that Forward Guidance had helped secure the recovery. Recall that Forward Guidance was initially not intended to inject any more monetary stimulus than MPC planned in August 2013, but to clarify that rates wouldn’t rise quite as quickly as markets thought then, implying quite a small tweak down in long rates. Well, tweaking long rates would take a while to have any effect, and wouldn’t have much of an impact anyway. In the context of a very large, mature literature on the real effects of monetary policy changes [for which Sims won his Nobel Prize], it is peculiar to claim that such a small change in the UK could have any great effect. It’s not even certain that the long rate ‘tweak’ persisted, and it would not be surprising if it had not, given how the initial launch was fluffed, [in the confusion over what it meant that the recovery could be secured by a policy that meant no more stimulus: recall Carney’s awkward exchanges with Andrew Tyrie at Treasury Committee over this]. A lot was made of the hoped for reduction in interest rate uncertainty then, but this also flew in the face of all the evidence about how much a tiny bit of interest rate uncertainty reduction would affect real spending. [An effect substantially smaller than the effect of the small tweak down in long rates on real activity.]
An unfortunate contradiction that arises is: Carney’s words say that policy might have to be tightened sooner than we think. But the effect of saying this is that long rates rise now, and policy effectively tightens now. An intended prediction about a future policy tightening becomes an instantaneous policy tightening. This is unavoidable, and not Carney’s fault, but it does mean that such a policy change has to be thought through, sanctioned by all the policymakers concerned, and clearly explained in all its detail.
Given that Carney must have known what his words would do to yields and the exchange rate, how does such a speech fit in, procedurally, to the system MPC set up themselves under Forward Guidance 2? Are we now to figure that as well as the quarterly review of the 17 guidance indicators, there will be future open mouth operations conducted without any review against these measures? Indeed, does this speech signal a new modus operandi, where the formal system of indicator monitoring is dropped, and we simply get updates on a hidden interest rate forecast through events like this? I doubt the proper indicator monitoring is to be replaced by Forward Guidance 3 just yet. But such determined talking sits oddly with the existing framework.
Some reacted to this speech interpreting it to be a breach of a promise, damaging monetary policy credibility. [See this, for example, in the Wall Street Journal]. But I think this is going over the top. Forward Guidance wasn’t ever meant as a Woodford style interest rate policy where there was a promise to keep interest rates lower for longer than would have been expected given historical experience. In so far as it was a promise, it was a promise to keep on setting interest rates how they were always set, but with a communications strategy designed to make it clearer, and ensure that markets understood better what would happen. We might scold Carney for a breach of MPC protocol, but there was not enough in it to detect a change in interest rate behaviour, and there would have been no motivation for it. However, the very fact that some reacted in this way illustrates the danger of operationally off-piste interventions like this.