Prospect Panel on international tax reform

ICYMI a paragraph by me on international tax reform in an expert panel published by Prospect Magazine, also including other people who actually know about this stuff.

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Simon Wren Lewis on central bank independence

Simon is a member of Jeremy Corbyn’s economic advisory team, and participating in a review commissioned by John McDonnell on the Bank of England’s mandate.

So the fact that he sees fit to pose the question ‘can central banks make 3 major mistakes in a row and stay independent’ is significant.   That is, you are interested in forming a view about what kind of economic platform Labour will run on if Corbyn survives in post as Labour leader until the 2020 election.

It’s clear that Simon thinks the case for central bank independence is for many, moot, though he himself is in favour.

He writes:  ‘I think a set-up like the MPC is a good basic framework for taking interest rates decisions. But I find it increasingly difficult to persuade non-economists of this.’  We are left presuming that these ‘non-economists’ are those whose team he joined in Corbyn’s Labour Party.

Simon’s blog has the Bank of England charged with making 3 ‘mistakes’, the corollary of which is that perhaps the central bank should no longer be independent.

I don’t think Simon makes a case that is at all persuasive.

In short, as I tweeted earlier, I think that it’s highly contestable whether the mistakes Simon identifies were indeed mistakes.  And even if they were, it does not follow that central banks should have their independence curtailed.

Independence was introduced to shield monetary and financial policy the pressures of short-run electoral expediency.  Removing independence removes this shield, for no gain in terms of avoiding future ‘mistakes’.

Mistake 1 is that the Bank of England failed to foresee the financial crisis.  There is certainly truth to this, though the Bank is wont to point to repeated warnings in BoE-ease in its Quarterly Bulletins, and other vehicles, in the run-up to 2008.

But, taking this lack of foresight to be true, most of the economics profession failed in the same way.  One or two notables (my favourite being Rajan’s Jackson Hole speech) did not, and made intelligible, reasoned and prescient interventions.  Many of those who, ex post, look like they saw it all coming, did not, and as Noah Smith and others have commented, can be dismissed.

In the UK, we can take it that the bulk of the UK establishment, including the Treasury, likewise failed to foresee what was happening, because they did not intervene to alter the regulatory stance and framework in the way that was begun once the failings became known.  So, if we had run a counterfactual history in which the Bank of England had simply enacted whatever the Treasury had asked for, I don’t see that the instrument settings, or the legislation, would have turned out any different.

Are there memos lurking somewhere in which past Chancellors were urging higher interest rates or more punitive regulatory stances?  I doubt it.  [Note that anyway I would suggest that it would have been damaging and futile to try to head off the financial crisis with tighter monetary policy].

Mistake 2 was that the Bank of England did not protest sufficiently about the tightness of fiscal policy imposed by the Coalition government post May 2010.

Assume for a moment that the BoE should have protested.  Do we think that a monetary policy body that was not independent would do any better?  The Coalition did what they did because they thought it was the right or expedient thing to do.  Would they have been swayed by private advice by civil servants?  Would that advice be any more likely to be forthcoming?  I doubt it.  So it does not follow, in my view that mistake 2 is a case against independence.

However, I think it’s contestable whether there was a mistake at all.

I take the view that, initially, Coalition fiscal policy [at least its aggregate stance] was perfectly reasonable, until it had become clear that the UK was not to be put in the same basket as the other troubled sovereigns.  Subsequently, on risk management grounds, looser policy might have been preferable, but not [ex ante] to generate higher demand, but to provide for tighter monetary policy which could have allowed for future cuts if needed.  The large and protracted undershoot of the inflation target subsequently looks like a bad mistake, but, ex ante, the case – made by the BoE – that this was largely due to surprises about the extent and persistence of the pass through of Sterling, and weak commodity prices, seems fair enough to me.

Further, even if the Bank had disapproved of Coalition fiscal policy, speaking out against it could have undermined the efficacy of monetary policy in the future.  Without a specific commission to do so in its mandate, there would be the risk that future MPC members would be selected for their favourable stance toward the Government in general.

What might follow, if you accept that there was a mistake number 2, is that the mandate should be amended to provide for explicit comments from it on whether its ability to meet the inflation target was being hampered by government fiscal policy.

Mistake number 3 is that the Bank of England has been too pessimistic about the supply side of the economy, setting correspondingly too-tight monetary policy.  I have dealt with this partly in my response to mistake number 2.  But a few more remarks.

First, the 0.5 floor was not set, initially, as a matter of monetary policy conservatism, but because it was judged that cutting rates below that floor would not be stimulative [because of the difficulties it would cause for bank balance sheets].  This view about the floor to rates was amended back in March 2015.  So the charge that this floor signifies conservatism applies only since then.

Second, there is the implication that the BoE did not apprehend that potential output was itself a function of the level of demand, and thus its own policy stance.  In fact, it did, right from the off, during the crisis, and this possibility – it surely has to remain just that – was mentioned frequently in its communications, and discussed at length in private.

Third, would rolling back independence cure monetary policy of ‘supply-side pessimism’?  I doubt it.  If it did, would we get better policy?  Or would we get an optimism/pessimism that was a function of the electoral cycle?  Simon clearly wants looser policy now, and so a bit more supply side optimism would do it for him.  But would that be helpful in a few years, when monetary policy is no longer at risk of being constrained?

Simon’s mistake number 3 actually contains what I would classify as a separate mistake number 4, the failure to appreciate that, in the vicinity of the zero bound, the best way to hit the inflation target, on average, is to contemplate and engineer an overshoot.  I think Simon is largely right on this.  There are dissenting voices in the Fed – notably Charles Evans.  But none in the BoE’s MPC.  I don’t think it follows that rolling back central bank independence is a good idea.  Since many economists dispute that the overshooting policy would be a good idea, one presumably would have monetary policy informed by the same spread of views inside the Treasury, or a subservient BoE.  At the zero bound, one could reap the benefits of ‘boom=good’ that would occur to the politicians, but away from it, this would be harmful.  Much better to clarify what’s anticipated in the mandate, at the zero bound.  And not to reappoint those who take what you think is the wrong view of the matter.

All this said, I do think it’s fair enough to debate the merits of independence.  Given the huge and varied powers now vested in the Bank, and the intractability of the problem of providing it with adequate formal scrutiny, one should probably err on the side of over-debating it.

For that reason, even though I am not convinced by Simon’s arguments, it’s to be welcomed that they are out there.

Times Op-Ed on raising the inflation target

Here’s a link to my piece in today’s Times, written jointly with Richard Barwell of BNP Paribas.

Bloomberg getting dotty

This editorial from Bloomberg calls for the Fed ‘dot plots’ to go.

It notes that the dot plot does not contain individual FOMC members’ forecasts of what they think is going to happen to rates, noting disparagingly that instead, it merely plots what individual members would want to do with rates themselves if they were in sole control.

But what is so bad about that?  If I want to figure out how the FOMC itself is going to vote as a body over the future, I want to know what votes they would cast individually, at each point, on the assumption that the economy pans out as each thinks it will.

Charting what individual FOMC members forecast would happen to the collective vote would not nearly be as useful.  This would be a chart of what each FOMC member thought the current dot plot chart would look like, summarised in a line for their forecast for the winning vote.  We don’t really want to know everyone’s forecast of everyone else’s votes.  We want to know how each member plans to vote.   Far better to ask the voters themselves to declare how they intend to vote!  It’s not without good reason that political opinion polls spend more money asking people how they will vote than asking who they think will win [who they think everyone else will vote for, in other words].

Bloomberg chides the dot plot for begging to be misinterpreted as a commitment to a path for rates.  It might be.  But it doesn’t seem to be doing such a great job if Bloomberg itself realises that it is not a commitment.  In fact, I’d say the dot plot was in that case winning the battle, since it would surely be financial writers who are the most susceptible to getting this wrong.

Pulling back and concealing the forward-looking nature of monetary policy, keeping secret its plans, is giving up on a process of education about the reality and difficulties of modern central banking.  Taken to its limits, we would be left with the old early 20th century model of ‘don’t worry, the economy is safe in our hands’.

A more likely point of retreat would be the old system of arguing in the minutes over a verbally codified dot plot, crammed with rigid words like ‘measured, steady, neutral’.  The same as we have now, only more confusing, handing rents to the circle of Fedwatchers who can decipher the code.

This is not to say the dot plot is perfect.

As I wrote many times before, the Fed – like any central bank – ought to be able to agree a collective projection of interest rates too.  And they could do more to tease out the extent to which differences in the dots are due to different reaction functions, different views of the transmission mechanism, or different views of the state of the world.

 

Joining the dots

I read today that James Bullard is disaffected with the dot-plots, and considered pulling out of them unilaterally, reserving his dots for himself.

I think this would be a mistake, for several reasons.

At some level, a communication strategy has to be a collective one.  It would be undermining of the monetary framework to fail to achieve a common purpose at the level of deciding how to communicate with the public.

That goes for those wanting more rather than less transparency too.  In the UK, the Monetary Policy Committee have decided not to reveal what they think they will do with their instrument, nor any dot plots.  A hypothetical MPC member in the UK who wanted, against the opinions of all the others, for the committee to produce interest rate forecasts, could produce their own dots without breaching contract.  But would sabotage policy as a whole by doing that.

A common concern is that there is a loss of credibility as the dots move around.  Maybe so.  But if so, that reflects a misunderstanding of what it is to be a competent policymaker by those adjudicating on ‘credibility’.  The outlook can change a lot from month to month, and so, correspondingly, should the best policy response in the future.

Naranya Kocherlakota writes about the dot plots, but comes down against replacing them with a collective interest rate forecast, my preferred solution.  He is concerned – a view echoed across the central bank community – that such forecasts will be interpreted as commitments or promises.

There are lots of misguided views of monetary policy out there.  That central bank forecasts are ‘bad’ if they are wrong ex post.  that inflation is set by the monetary authorities.  That the Fed needs ‘Auditing’.  That counter-cyclical policy is corrosive and coddling.  Policymakers fight against those misconceptions rather than giving into them.  Likewise, they can fight against the incorrect view that the instrument forecast is a promise.

Of course, the fight is a subtle one to wage, because, the point of publishing the path, which itself is not a promise, is to communicate what the Fed is promising, namely, to do what it can to achieve its goals, and adhere to a particular reaction function – a data-contingent plan.

‘You promised us four hikes by 2017!’ commentators might cry.  And the answer would be:  well, ‘yes and no’.  We looked at our model and our reaction function, and computed four hikes.  But all we promised was to keep computing.

Rajan’s pie in the sky

This from Rajan, Governor of India’s Reserve Bank is worth a read.

It opines on the need for more monetary policy coordination, something I think is pure pie-in-the-sky, and so much so that I presume the words are there just to explain how difficult a place the world can be in which to set monetary policy, and not that he really expects anything to come of it.

Rajan is clearly not a fan of the Fed’s program of quantitative easing.  He would classify this as a ‘red’ policy.  Something which has only marginal benefits for those that undertake it, and malign side effects – particularly capital inflows that produce asset price bubbles – for emerging economies.

A project syndicate op-ed may not be the place to do this, but he doesn’t address the voluminous event study literature showing how QE reduced yields.  I’m no fan of QE either, but there is a lot of work now that cannot simply be dismissed out of hand.

The way the Fed and other central banks would see it is that the counterfactual is for the US/UK/Eurozone to be stuck with very low growth and deflation for decades.  A circumstance that could hardly benefit emerging markets.  Indeed, there is emerging evidence that the liquidity trap can be contagious.

QE may well have generated capital inflows to the EM countries.  But three points to note here.

First, this offsets only some of the dominant force of this capital being exported ‘uphill’ to richer countries, to realise returns that are higher only net of risks due to politics and expropriation of one form or another.

Second, if QE instills confidence by reducing the risk of being caught forever in the liquidity trap, it may well encourage capital out of EM countries, not push capital into them.

Third, the precautionary response of EM countries should be to adopt tight prudential standards – how EM banks fund themselves, and their lending practices – which will have the same effect as capital controls, without many of the attendant costs.

The uphill countries would presumably welcome this.  Although it would diminish the exchange rate effect of QE for them, it would amplify the effect of compressing yields on uphill, private sector assets.

Solving deflation with a monetary starting-over

Several times in monetary history, a government has tried to stem hyperinflation by re-denominating its currency.  Pesos become ‘New Pesos’. Naira become ‘New Naira’.  Lev become ‘New Lev’.

This allows the authorities to cross off a few noughts on the notes, making mental arithmetic easier.  And to signal that the monetary regime is starting over;  that the new notes will be printed at a much slower rate than the old ones.  It hasn’t always worked.

But it has, sometimes.  Whether the re-denomination had much to do with the successes is harder to say.

But in principle, if it worked, a similar logic ought to be available, in principle, for a country stuck at the zero bound battling deflation.

The government/central bank simply announces that the currency will be withdrawn and re-denominated, and that the new one will be printed at a rate that ensures inflation is on target.  For good measure, to reinforce the psychological impact, the authorities could add a couple of noughts, as a strange inversion of the old nought-removal associated with stemming hyperinflations.  To ram home the point, and to reduce the chance of falling back into the same trap, the new target might be raised above the old one, perhaps, as I have argued before, to 4 per cent [a trick which, unlike the redenomination, could not be undertaken more than once].

It would take time to issue the new notes and coins.  But while these are coming on stream, the old ones would be declared worth x times the new notes to come.  Where, as explained above, x could be 100.  New notes and coin are issued all the time, so this need not be so costly.  In fact the new notes and coins could be designed, cunningly, to resemble the old ones in dimension, so that all the cash handling machinery is not made obsolete.  So long as they have the words ‘New’ written clearly somewhere.

As well as having a cousin in the old anti-hyper inflation policies, this idea is related to proposals to eradicate the zero bound.  Those include separating out the unit of account from the medium of exchange.  That proposal involves declaring a new unit of account, and a trajectory for the exchange rate of it against the medium of exchange, so that there is, in effect, a tax on holding the medium of exchange [allowing negative interest rates to prevail].  In transition to the new notes and coins, the proposal mooted here would involve the co-existence a new unit of account [New Pesos] and the old medium of exchange [old Pesos], although at a fixed exchange rate.

It might work ‘too well’, frightening the populace into thinking that if a couple of noughts can appear overnight, perhaps a few more will creep in over time.  But in that case, the policy will not have come to naught.  Conventional interest rate policy could be used to tighten.

This would be something of an experiment, and could not be undertaken lightly, given the fragile nature of the trust that underpins a monetary system.  But it may be no more radical or hair-brained, and perhaps less so, than abolishing cash, helicopter money or even quantitative easing.