Monetary policy hypotheticals

At today’s Inflation Report press conference, BoE Governor Mark Carney dismissed one question by refusing to say whether the MPC might have cut rates in the hypothetical situation in which the yield curve had not flattened and provided stimulus.

It’s worth pointing out that in an ideal world monetary policy makers would answer as many hypotheticals as humanly possible.  Since these would help describe the monetary policy reaction function.  That would make policy more predictable.  And it would make it more potent, as news that came in would work more strongly to influence expected future rates than when policy reactions are harder to follow.

An embrace of the hypothetical would also help the accountability process.  If we knew in advance how an oil price shock caused by supply changes would have been treated, we can see whether the BoE follows through;  and, if not, whether the change of plan is based on sound analysis, or looks like expediency.  Knowing that they faced such scrutiny, policy would be less vulnerable to erratic or expedient changes of course.  And knowing all this, observers would have improved confidence in policy and the framework.

Of course, what’s concerning is that a distaste for hypotheticals is rooted precisely in wanting to preserve maximum discretion.  The capacity to be able to rationalise everything you do when you do it as the optimal response to events at that time, unconstrained by any prior public positions you may have taken.

Is it possible that one day we might have an MPC member who, responding to a question from a journalist, said ‘well, as you know, I feel it of paramount importance to embrace hypotheticals like that in order to clarify our reaction function and thereby improve the efficacy of policy’?

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Is monetary policy adventurism by politicians ok?

Two instances.

Today, the spectacle of Donald Trump, competing for the Republican nomination in the 2016 US Presidential election, accusing Janet Yellen’s Fed of skewing monetary policy deliberately to help out President Obama.

Or John McDonnell, expressing the view that the Bank of England should be taken back under ‘democratic control’, and the many implicit critiques of the BoE’s quantitative easing program contained in the proposal to supersede it with QE ‘for the people’ [unlike its predecessor, which was judged simply to help the better off].

I’ve blogged many times over about how I thought Carney should have stayed out of political issues [and in fact Janet Yellen’s comments on inequality were overstepping].  Is it likewise taboo for politicians to criticise independent central bankers?

No.  That’s their job.  Running or holding electoral office, they must be entitled to comment on whether all levers of policy are being used appropriately, whether the lever-pulling is delegated to highly paid nerds or not.

I don’t agree with the substance of Trump or McDonnell’s criticisms of their respective central bank’s monetary policies.  But they have every right to make them.

Monetary stability depends, I think, on continued central bank independence.  And that in turn depends on a collective agreement across the parties not to fire warning shots at the central bank for political gain only, for fear that that would make observers expect the central bank to tilt policy to placate its critics.   Trump’s comments tonight could be read in this way.

But I don’t see a way to legislate in favour of this kind of monetary-stability encouraging collective agreement.  Not without unacceptably impinging on the freedom of action of actual or would be political representatives.  And since both Trump and McDonnell’s points, even if not right, are at least in principle conceivable, and arguable, they would anyway be admissible.

What about politicians part of the current government?  They are operating the ultimate lever of monetary policy, which is the monetary policy framework itself.  Whose custodians ought to follow due process.  Which should mean abstaining, in my view, from making speeches criticising central bank policymakers, or encouraging monetary policy in a particular direction.

Personal conduct and policy issues would be dealt with by the accountability framework.  In the UK that would mean Treasury Committee, the BoE’s court of Governors.

However, there’s nothing stopping participants of the Government from making such interventions, except good sense.

Codifying this further would infringe on the same freedoms we welcome the opposition having.  Participating in a government is a nebulous concept, as collective responsibility waxes and wanes.  Government members have – and ought to have – the freedom to oppose their own ’employer’ from time to time to a greater or lesser extent, by speaking out, rebelling in Parliamentary votes, or even resigning their party whip.  By the same token, this means the freedom in principle to oppose the Government’s stance on monetary policy.

In short then, monetary policy adventurism is fine.  We just have to hope it’s done in the right spirit, and acts as a positive discipline on monetary policy and the monetary policy framework, and is not something that undermines them.

Nth blog on BoE political adventurism, hosted by the Independent

ICYMI Ben Chu hosted this on the Independent website.

The Phillips splatter

The web has been full of Philips curve sarcasm and trolling recently, following comments from the Fed about the uncertainties in the relation between the output and unemployment gap and inflation.

But those not immersed in this should realise that the latest macro models used in central banks and outside – which have many other faults – do not hinge on such a simple bivariate relationship.  They all embody the view that both wages and prices are sticky.  And this is what gives monetary policy both its traction on real quantities, and the definition of its purpose.  And in turn, this stickiness is what gives real disequilibria their traction over inflation, in the short run.

But at any point in time we might expect there to be shocks moving around the natural rate of unemployment and the natural rate of output such that observed correlations between any two variables, like inflation and unemployment, were forever in motion themselves.

I recall that it was often tempting for central bankers to decide to simplify this muddled tale back in terms of old Philips Curve language.  But this is a hostage to fortune, since correlations inevitably move on.  When they do the false question ‘what do you do know your model has been blown out of the water?’ has to be answered.

This isn’t to say there are no genuine ponderables.  But they are not about Philips Curves any more.  They are about if prices are sticky [small vocal community of RBC like economists still making many deep and profound points on this score] or even whether stickiness really generates non-neutrality of monetary policy, and, of course, about the validity of the whole DSGE machinery.

Mark Carney’s intervention on the EU exit decision

Mark Carney extolled the benefits of staying in the EU in a speech delivered alongside a staff report explaining how exit would affect the ability of the BoE to deliver monetary and financial stability.

Repeating a theme familiar to readers of this blog, I don’t think any of these interventions were necessary, and that they would better not have been made.

Even in the context of the leak of the existence of an internal project to study Brexit, all that need have been undertaken and disclosed was a dry report on the BoE’s contingency plan to deal with the referendum period, and its plans for dealing with the transition to a possible exit.  And that would really boil down to stating the obvious, that the BoE stood ready to lend and inject liquidity where appropriate.

This latest intervention included, we have, in the last 2 years, listened to BoE officials opine on the future of the voluntary sector;  on the desirability of ‘inclusive capitalism’;  urge action to mitigate climate change; and now, implicitly, urge Britons not to vote for Brexit.

The Bank is led by clever economists and financiers who have interesting things to say about all aspects of public life, no doubt, but there are disadvantages to speaking on topics outside the mandate.

First, the BoE already has an enormously powerful role in the state, powers delegated to it so that ‘democratic control’ [as John McDonnell termed it] over day to day monetary and financial policy is not possible.  Appearing to encroach even further on political life risks stoking hostility towards the Bank that would ultimately erode support for the independence it properly enjoys now.

Second, it attracts unwelcome attention over the amount of resources it has and how it is using them.  How many studies into monetary and financial policy do these speeches cost?  If you were a think tank or an ESRC grant applicant on the economics of EU trade and banking, you might feel aggrieved that the funding that this BoE sojourn into your territory could have been better spent diverted to you as a specialist in the field.  Or if you were an EU sceptic you would simply prefer that HMT had taken back a larger share of the seigniorage that the BoE lives off.  Operational independene requires, at some level, budget/resource-use independence.  Preserving that in the face of a sceptical polity means bending over backwards not to mis-use the money and freedom you have currently.

Third, senior officials politicise their offices by these interventions.  In thinking of the next appointments, politicians might decide, if they think Carney’s successor is going to weigh in on climate change, to choose someone politically like-minded, rather than someone simply expert in money and finance.  And those jockeying for position for that job may feel obliged to behave politically in order to gain advantage, rather than focusing on their economics.

Fourth, the Bank speaks with authority on matters within its mandate that is partly conferred by convincing us that it has no political axe to grind, and it is simply giving the best technical advice.  Interventions like this erode that authority.  Journalists already pointed to the neat coincidence between the views of Carney and Cameron and Osborne on EU and EU reform.  This could create a cynicism around future financial or interest rate policy decisions that appear to make life easier for one set of politicians over another.

On Twitter, I wondered out loud whether it might be possible to frame legislation to restrict what BoE officials speak on in public.  I don’t imagine it would be easy to do this, especially in a way that could not then be abused by the government itself.  But it might be worth thinking about in the context of the Labour BoE Mandate Review conducted by McFall/Blanchflower/Posen/Wren-Lewis.

Krugman on Japan

Here PK recommends, working through – pretty uncontroversially – the logic of the standard New Keynesian model, that Japan should try another burst of expansionary fiscal policy to raise inflation.  But that it should actually do it with enough force and persistence to get inflation to a higher target, so that this leaves room for a compensating monetary stimulus when, eventually, the necessary fiscal consolidation comes.

A few comments.

First, it may be that with debt/GDP ratios already so high the mechanism by which fiscal policy works to achieve this is not by raising demand, the output gap, and therefore inflation, but via the fiscal theory of the price level, or unpleasant monetarist arithmetic – creating the expectation that no politically acceptable plan for taxes and future spending would exist that could possible pay back the debt without either seigniorage or default.

That’s not to say that this should necessarily discourage the Japanese authorities from following PK’s prescription.  Times may be sufficiently desperate that such desperate measures are called for.  Sims warned that such may be the consequences of the Fed’s balance sheet expansion, and I am sure that there were those – looking over their shoulders at the Japanese situtation – who thought, privately, ‘so much the better’.

In that respect – given that things are so bad, in other words – it was odd not to hear PK’s views about alternatives.  The two most prominent being to engage in helicopter drops, or to introduce reforms such that the zero bound to interest rates is lowered.  Both of these measures I have warned against, but only in the context of the US/UK/EZ situations which don’t yet appear so dire.

Helicopter drops, implemented by the BoJ creating the necessary electronic money for cheques to be sent to Japanese households, may achieve the necessary stimulus without saddling the economy with the need for future fiscal consolidation.  They would therefore not require that inflation was raised beyond 4 per cent for that purpose.   Although there is reason enough to go to 4% anyway, to avoid a future recession tipping the Japanese economy back into the liquidity trap.

Cheques in the post would, as I have complained previously, risk that the expectation emerges that the authorities get a taste for winning elections this way.  But, right now, that risk would almost seem to be a benefit, not a cost.  And the authorities in Japan have plenty of institutional memory to draw on to prevent this expectation derailing monetary and fiscal affairs later on.

Likewise, the risk of a ‘wtf’ moment as citizens grappled with one of the means of reforming the institution of cash [either outright abolition, or something trickier] to allow for negative interest rates, is, in Japan, to be set against the more urgent need to escape what seems otherwise to become a permanent situation in which there is no monetary policy instrument with which to smooth the business cycle.

So, while PK’s prescription is fair enough, why not give something else a go?  If not instead of a fiscal expansion, perhaps in combination.

John McDonnell’s BoE mandate review

JM writes in the FT about things to be considered under the rubric of a mandate review, conducted for him by Danny Blanchflower, John Hall, Simon Wren Lewis and Adam Posen.  He writes that ‘operational independence’ is ‘sacrosanct’, which is an encouraging form of words given his earlier views that the Bank of England should be taken back under democratic control, and the view implicit in supporting such things as ‘Quantitative Easing for the People’ that BoE crisis policies had been working against ‘the people’.

A few remarks about some of the details that JM explains will be considered, which I have blogged about before.

First, raising the inflation target.  JM points out that the target could in principle be set higher or lower, but no one would support lowering it after the experience at the zero bound.  Raising it is one way to reduce the chance of such episodes in the future, and I would support that.  But not any time soon.  Only once we have shown convincingly that we can escape the zero bound and hit the current target.  And, strictly speaking, this is not something that is currently formally encoded in the mandate, the actual number attached to the inflation target being something that is confirmed by letter each year at the time of the Mansion House speeches.

Second, buying private sector assets via quantitative easing.  This could be a matter for a mandate review, to the extent that currently the BoE’s power to do this rests on discretionary exchanges of letters specifying permitted assets and the limits to QE purchases.  So one could imagine formalising this to eliminate the need for that discretion.  Another aspect that might be attended to is to make it clear that the decisions about what assets are bought are a matter for the whole MPC, whereas during the crisis the BoE executive reserved for itself this decision, leaving only the decision about ‘how much’ for MPC votes.  This, in my view, had its origin in the analysis that it was only the quantity of money created that was important, not what it was spent on, an analysis I did and do not share.  Exactly what assets are bought at a particular point in time should not be proscribed in the mandate, and ought to be left an operational decision for MPC.

Regional MPC members.  This would be a retrograde step.  Multiple committee places should be there to allow for controversies to play out about the appropriate diagnosis of the aggregate economic state, and the aggregate monetary policy.  And they should not be there to set up a tug of war between regional members trying to tilt interest rate decisions towards their own regions.  Data collection [and adding up!] is the way to ensure appropriate regionally constituted aggregates.  And Parliamentary accountability mechanisms can be used ex post to ensure that monetary policy is set strictly to meet aggregate conditions and not tilted in favour of any region.  Regional data is mostly secondary in the monetary policy process, the main exception being that regional mis-match in labour or product markets can cause frictions at the aggregate level [for example raising the natural rate of unemployment].  Those who point to the Fed as an example to follow are mistaken.  The regional set up there is an anachronism made such by the enormous changes in regional activity in the US now.  And the regionalism there is not really reagionalism anyway.  The multiple local Feds, in my view, mostly serve as a way to generate competing talent pools that produce potential FOMC members.

Formalising the trade-off between inflation and other things.  This is a reference to the explicitness of the ‘dual mandate’ that binds the Fed.  I don’t think that there is a case for change here.  First, the 2013 HMT review made it clear that the BoE should be a flexible inflation targeter, and in fact accepted that it always had been [as the BoE usually described itself].  This mandates it to give the appropriate weight to stabilising real things, as well as inflation.  Second, formalising a real stability mandate is tricky, theoretically.  Optimal policy might well involve stabilising nominal wages, as much as prices; and on the real side involve important quantities like the real exchange rate, and could weight differently the different components of GDP, as well as including deviations of unemployment from the natural rate.

I’d also want to head off the inference anyone might draw from the mandate review that it was adopting an inappropriate weight that has led to the extended inflation target undershoot [which JM refers to as context for the review].  On that undershoot, a few points.  First, inflation is inherently hard to control, so protracted over and undershoots are to be expected.  Second, we should remember the protracted overshoot in the early phase of the crisis.  Third, I doubt there is a convincing case for concluding that monetary policy is too tight and second-guessing the MPC’s analysis over the last few years.  Fourth, if there is anything suboptimal about the undershoot, its root is most likely to lie in the difficulties of stimulating the economy via moneary policies at the zero bound, and the insistence of the fiscal agent on relatively tight fiscal policy.

NGDP targeting.  I’ve blogged a lot about this before, and haven’t the heart to repeat it here.  Very briefly.  Growth targets would not make a whole lot of difference.  Levels targets rely on being a rational expectations nutcase, and even then would probably be incredible.

A final comment.  The mandate review perhaps springs from a general sense that the policy decisions made by the Bank under its mandate are not subjected to enough scrutiny.  In that respect the debate that the reivew will prompt is to be welcomed.  But it is worth thinking about whether the accountability framework for the Bank does its job well enough.  The Bank itself is so formidably resourced that it can easily bat off comments at Press Conferences, or even energetic questions by MPs on the TC.  And the occasional policy reviews commissioned by the Bank’s Court may well not be enough.  What could be done to improve this?  A lot is at stake here, for, inflation is ultimately always and everywhere a phenomenon tied down by political consensus.  The outcomes hoped for in a BoE mandate, even if already written adequately [I think it is already written adequately], may be frustrated if insufficient policy scrutiny undermines a consensus that the BoE is using its delegated powers for the common good.