Do monetary policy committees present an insuperable barrier to Odyssian forward guidance?

One kind of forward guidance – consciously eschewed by central banks during the crisis – was dubbed ‘Odyssian’.

The idea was that, deprived of being able to move the short interest rate by the zero bound, central banks would attempt to lower the long rate by promising to keep the short rate in the future lower than would normally be thought consistent with the inflation target.

The name derives from the Greek tale of the warrior instructing that his hands be tied to the mast of his ship as it sails within earshot of the song of the sirens, so that he could later resist their otherwise fatal attraction.

The corollary was a commitment to overshooting the target later.  The benefit of doing this was that provided a stimulus by lowering the real rate [nominal rate minus expected inflation], boosting demand, raising inflation now.  An overshoot later would be more than compensated for by a smaller undershoot now.

An objection commonly made is that the committee structure of MPC decisions precludes such a commitment, because current committee members have no means of binding their successors.

Two points.

The first was suggested by Richard Barwell at today’s MMF conference on monetary and financial policy.  He suggested – I may have garbled this – that the Chancellor could simply stipulate that once an Odyssian commitment was made, subsequent MPC recruits could not change the terms of that commitment.  The commitment would not be unconditional anyway, and would be data contingent to some extent, but their job would be to feed in the data into that commitment strategy, and not to re-evaluate.

Second, note that although committee members do turn over, expected turnover over a 5 year period, say, would be much less than 100%, with external MPC members serving typically renewable 3 year terms, and internals serving usually renewed 5 year terms.  A sufficiently large majority now might not be able to regulate the distribution of future rates so that it entirely conformed to one consistent with a follow through on the commitment, but it could tame that distribution of future rates quite a bit in that direction.  It would be wrong, therefore, to assert that Committees in themselves make Odyssian forward guidance impossible.  They would merely dilute it.

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2 Responses to Do monetary policy committees present an insuperable barrier to Odyssian forward guidance?

  1. Jean says:

    Hi tony,
    Interesting! but my understanding is that the main obstacle to Odyssean forward guidance is its time inconsistency and that committee based decision may exacerbate this problem.

    Even if Reputation concerns can help to sustain forward guidance in theory (as long as there are other time inconsistency issues that the central banker would like to solve once the liquidity trap is over) they are of little help in case of a committee with short-lived tenure. The argument that the chancellor can nominate new members with a mandate incorporating the forward guidance objective is not so clear as well. First, what is the ex post incentive of such a nomination? The government optimal decision is also time inconsistent. Second, the multiplicity of actors (committee members, chairman, government…) may dilute the capacity of private agents to identify who is effectively reneging on past promises and hence who has to be blamed for/punished!

    • Tony Yates says:

      Fair points – I’m assuming that commitment is possible in principle if there were no turnover, and pointing out that provided turnover is <100 per cent over the relevant time interval, the durability of some of the members helps tilt the distribution relative to discretion. Your point about the government is also a fair one. But then one can equally ask what is the incentive not to tear up the whole regime. If you accept that this would be costly, then ex ante they could agree to the practice of appointing committed forward guiders.

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