A curt summary of my remarks – few of them new to those who read this blog – at this year’s Centre for European Reform conference at Ditchley Park, on the topic of ‘Brexit and the economics of populism’.
In short, there are no lessons to be learned. The defining, lesson -earning event was the financial crisis, not Brexit. The same macro challenges that emerged after that are still here, demand the same reform and posing the same puzzles. There are some specific instrument setting issues, post-Brexit, of course.
Before the crisis, the consensus was that business cycles had all but been extinguished; that performance relative to the past was due to improved policy; and that independent central banks, wielding just interest rate policy, plus automatic fiscal stabilisers, would always suffice. In the background financial stability was guaranteed by the incentives markets provided for participants to self-monitor.
2008 revealed to us that large recessions were not abolished, but in fact likely, that the good performance between 1992 and 2008 was mostly good fortune, not due to better policy, that the zero bound was not of merely academic interest but a reality, and that asset purchases were needed too, and perhaps also cyclical financial policy, and certainly that we needed discretionary fiscal stimulus measures on top of the automatic stabilisers. We of course realised that financial stability was not guaranteed.
Fiscal policy during the crisis was too tight, more clearly after 2012 when it became clear the UK would not be judged to be ‘like Greece’ by financial markets. The missing stimulus was not huge. Remember inflation overshot by 3.5pp or so in the early phase of the crisis, and the subsequent undershoot was not small, but was not that large either by historical standards. And fiscal policy had to bear in mind [and still does] the need for potential further injections into banks if the crisis intensified, weighed against [and still weighing] the risk of making this more likely if policy was too tight.
But looser fiscal policy, rather than changing the demand profile radically, would have offered a safer mix of monetary and fiscal policy, allowing for less monetary stimulus, so that more could have been injected later on if needed.
Overly tight policy was surely partly the product of a history of unsound fiscal frameworks, and the lack of a reputation for promise-keeping. Against this backdrop policy approaches became the focus for political brand warfare, rather than technocratic argument.
Ideally, I’d prefer a delegated counter-cyclical macro fiscal policy, in the style of a Wren-Lewis fiscal council. But this seems hopelessly unrealistic. So my small step in this direction is to recommend, again, the following. If the Bank of England judges there to be a missing stimulus [most naturally at the zero bound to interest rates] it quantifies this. The Office for Budget Responsibility [OBR] comments. HMT reflects and can take or ignore the advice but must explain itself either way. If it takes the advice it devises fiscal measures to implement, and a plan to unwind later. The OBR comments on the consistency of the plan with long-term fiscal sustainability.
What about the monetary framework?
The post-crisis and pre and post-Brexit challenge is dealing with historically low real interest rates, which mean very low nominal rates consistent with inflation at target. That limits the amount of conventional stimulus that can be applied to counter a recession. To combat this I urge that the inflation target is increased to something like 4%. This would raise the average nominal interest rate by about 2pp. We’d set about achieving this target once the current one was demonstrably hit, and not before. In such a world, managing deleveraging and the uncertainties about the prospects for currently very weak productivity would be much less perilous [in the sense of there being lower costs of too tight policy].
Recent criticism of the Bank of England’s policies and officials have depressed me greatly, and responding to that a number of small reforms seem pertinent. That the granting of permission to do asset purchases becomes automatic, not discretionarily granted. Noting that HMT can anyway take monetary policy back under its own control for short periods if necessary. I’d also make it that MPC, not the BoE executive [as currently] decide on which assets are bought. These small reforms would avoid speculation, which the government’s own recent insinuations allowed to develop, that the BoE might be thwarted easily.
I’d urge Treasury Committee to commission regular reviews of monetary policy from qualified third parties, to head off and marginalise individuals on TC or elsewhere who feel inclined to offer their own advice about interest rate setting. And I’d prefer some device, if it could be found, to constrain BoE officials from talking off topic. If there had been no speeches about climate change, inclusive capitalism, volunteering, and the like, Carney could have faced down the incorrect criticism over the Bank’s stance on the economics of Brexit even more securely. Although, I repeat, I think they called the analysis of Brexit correctly, Carney and Haldane allowed themselves to be portayed, if the Brexit culture warriors wished, as their natural political foes.
As to the specific instrument setting problems post Brexit: We will need somewhat looser monetary and fiscal policy to head off weaker demand than otherwise, and the increased likelihood of sharp contractions associated with any of the risks around the many significant events along the route to Brexit actually crystallising. We have already seen some of this from the BoE, and we will get our first installment from the Treasury at the Autumn Statement.
That said, I’d caution against too much Brexiting regarding macroeconomic policy, in the sense of trying to be too ambitious at flattening out the business cycle. For a start, many seem to have concluded that Brexit was more about culture than economics. And we simply don’t understand business cycles or the effects of our policy instrument well enough to do a great deal better than we have.