The May Inflation Report was understandably dominated by the debate about the economics of Brexit.
I thought that the BoE ducked a chance to be transparent about the consequences of a vote to Leave. It chose to condition its forecast on a vote to Remain. Carney linked this to a long-standing – but actually not always wholly adhered to – policy of ‘conditioning on government policy’.
Taking Carney’s words at face value, the Bank have not even produced a forecast conditioned on a Leave vote, so there was no forecast to communicate.
I find this hard to defend.
Charles Evans of the Fed’s FOMC spoke earlier in the year about how, in the vicinity of the zero bound, an increase in the uncertainty about the future state of the world warrants a precautionary loosening.
The likelihood of being wrong about the future increases on either side. But the costs for your goal variables increases disproportionately on the downside, because there is not ample room to loosen. Following a policy like this entails contemplating an overshoot on your most likely view, in order that on average you hit your target. How much of a loosening is required would of course require one to forecast without conditioning on one particular outcome.
We can take the MPC’s decision as one reflecting a view that one can dismiss out of hand this precautionary argument. But that is also hard to defend if you have not debated it and mounted a rebuttal. Most of the machinery that Evans uses [modern macro models, importance of expectations….] our MPC also uses. Where do they differ on this point and why?
Carney described the implications for policy of a Leave vote as being ambiguous. There are forces pushing both ways, he said. Sterling would fall, pushing up import prices for a while, and the shock to confidence would constrain the supply side as investment fell. But here I felt this analysis was less than frank. The MPC have rightly largely been looking through the effects of the appreciation on headline inflation over the last two years. One would expect and hope that they do the same (in reverse) following a drop in Sterling in the event of a Leave vote. And the supply side effects alluded to are likely to be very small and slow-moving; the counterfactual path of the capital stock would only be fractionally different between Leave and Remain votes over the forecast horizon. It seems to me very far-fetched that the sign of a likely interest rate change is ambiguous.
Vote Leave were furious with Carney for intervening in the way that he did. But all of what was said on Thursday was very squarely within the MPC’s remit. Some of their chagrin might have been avoided, however, if the Bank had not already overreached its mandate with the publication earlier of the BoE’s report on the implications of EU membership for its concerns. That report included much waxing lyrical about the benefits of longer term membership [“dynamism” etc], not relevant to the Bank’s concerns, and that could have been avoided with a report with a narrower focus.
Part of the Leavers ire is about competence, namely that Carney should avoid sparking a ‘self-fulfilling’ currency crisis, and should have instead simply stated that the BoE would do whatever it takes. I am firmly on Carney and the MPC’s side here. Such risks are balanced by the risk that markets take fright in the face of apparent complacency. And are anyway trumped by, and perhaps even reduced by being open, transparent and frank about what lies ahead.
It’s a blogging ambition to try to go a while without mentioning the BoE publishing interest rate forecasts, but this will have to wait.
Not having such a forecast is particularly troublesome at these times. We are presented with a forecast conditioned on Remain, but that results from an interest rate path which is the market’s forecast of what will happen to interest rates balancing the probabilities of Remain and Leave votes!
It is not as bad as all that, since Carney presented with the now customary verbal forward guidance. But still, what is so beneficial about concealing their interest rate forecast that justifies jumping through hoops like this? At some point I hope that those who directly hold the Bank to account step in and ask them to think again.
Finally, Carney was asked about the extent to which the MPC are using judgement to lean on their model forecast. We got confirmation that they are [not a surprise, this always happens, and rightly so] but not by how much. As I’ve suggested before, the Bank should be transparent about this, making its model and data available for all to see, promptly, and so that how firmly the MPC are overwriting the model can be scrutinised and interrogated. It is part of helping everyone hold them to account, understand their forecasting tools, and their own forecasting acumen.