Carney: will he stay or will he go?

When he was recruited to the BoE Governor’s job in 2013, Mark Carney let it be known that he would not serve more than 5 years of the 8 year term.  Lately, he has made it clear that he is more open to staying beyond 5 years.  Much journalistic amusement has been had with the conjecture that this change in tone is related to the victory of Trudeau in the Canadian election, which would appear to rule out an opening in high political office for Mark Carney any time soon.  Is there anything in all this of substance, except for gossip?

The 8 year term hoped for by the Government was a well-intentioned reform.

The old, shorter, 5-year terms had two disadvantages.  First, there is the suspicion that a Governor would spend time in the first term currying favour with Treasury bosses so as to secure re-appointment.  Politically awkward hikes in interest rates, or a curtailment of easy credit by means of new macro-prudential levers, for example, could be avoided to make sure of another 5-year term.  Whether it worked like this or not, merely the expectation that it might was damaging.

Second, longer terms reduce the proportional amount of time that a Governor is viewed as either a wholly or partially lame duck.

Towards the end of each term, it would naturally be harder for a Governor soon to be leaving to drive through change, or begin any new initiatives.  Those responsible for implementing it would know that there was a fair chance that the plans would be scrapped anyway under the new regime, or that they would not get their full reward for their implementation.  All but the most saintly and driven of Governors might succumb to the temptation to lighten their workload by avoiding such managerial effort, knowing that it might all be in vain.   So, longer terms cut down the amount of time, proportionately, that the middle management spends in this limbo.

Suggestions that Carney might serve out his single 8-year term are not just part of the entertaining central bank tittle-tattle.  There is a serious point to it all, and, other things equal, it’s probably good news.

More on the Germans.

Simon Wren Lewis responds to my post about [his post on] the extent to which we can pin the ultimate blame for the Eurozone crisis on bad German economics.

He sympathises somewhat with the notion that prior to the Euro, fiscal freedoms, which were subsequently given up, were abused, but suggests that that prior experience would have suggested a stability and growth pact but whose limits were qualified to allow for some counter-cyclical policy.

In a sense, given that the fines were limited, and the SGP was largely ignored, it is moot what the SGP actually comprised.

But, that aside, I think it’s within the range of rational judgement to have decided against allowing that extra component of discretion, for such  is the nature of judging the state of the cycle.

To give a topical example closer to home, Simon himself has written regularly suggesting that he thinks that the UK output ‘lost’ post-crisis relative to pre-crisis trend is recoverable.  If I were Germany thinking of a new monetary union with the UK, and I thought Simon was going to be on the fiscal council, I’d anticipate I would be in for some heated debates about fiscal policy in that context.

Leaving aside who is right, you can imagine the reluctance to expose oneself to a fight over output gaps that would have at its root concerns about the tragedy of the fiscal commons.

At any rate, it would be interesting to try to formulate what such a policy might mean;  capturing the flavour of optimal counter-cyclical fiscal policy, but constraining it somehow to avoid prior abuse.

Simon takes on my argument that central banks should not be configured to prohibit monetary financing in the event of a default.  Such prohibitions, he argues, are meaningless, or, if they are not, are harmful.

Meaningless or not they are built into every legal system that I know about.

The limitations are there to create the expectation that there will be fiscal discipline not to use the printing presses, and thus that inflation will be whatever it is promised to be.  And the benefit of that is that the economy is not exposed to high and volatile inflation, and the fiscal authority can raise money at lower cost.

Simon seems to presume that default would always be the worst option.  That would be so if inflation wasn’t costly.  But very high and accelerating inflation – the sort you need to do monetary financing when people know what you are up to – is, I maintain, ruinous.

I can’t be sure I am right about the effectiveness of these measures.  Central bank independence may simply have been caused by the insight that money financing and inflation were bad, rather than causing low inflation.  But I’d settle on the conclusion that these prohibitions have been worth a try.

But I don’t think Simon can be sure either.  He writes that central banks would always be swept away in the determination to avoid default.  But this was not true of the past.  Many countries wind up defaulting without hyperinflating.  And it figures:  hyperinflating defrauds your own citizens.  Defaulting typically spreads the burden onto foreign creditors who can easily be cast as the enemy.

Simon also addresses my discussion of OMTs being a bluff.  [See also some excellent, critical comments on that post by Malcolm Barr from JP Morgan].  But I’ll save that for another post.

 

The Eurozone crisis. Was it all bad German economics?

Simon Wren Lewis [here and here] pulls together his critique of the role of German economics in the Eurozone crisis.

The Eurozone institutions had  3 flaws.

First, the ECB was [at least initially] prevented from acting as a lender of last resort to member states governments.  Second, the Stability and Growth Pact prevented sufficiently counter-cyclical fiscal policy.  Third, monetary policy was too conservative, with too much of an emphasis on inflation control, relative to the stability of real activity, perhaps an inflation target that was too low [remember the ‘close to, but below’ wording], and these things contributing to the premature raise in interest rates in 2011.

The charge is that these institutional design problems reflected bad economics in the head of the German economic and policymaking elite.

This thesis has a lot to be said for it.  I think Simon is right that old-fashioned monetarist economics, and excessive monetary and fiscal conservatism lives on to an unfortunate degree in Germany.  [See my own tirade on this].

But I don’t think it’s the whole story.

Regarding the first ‘failing’, that of there initially being no promise to act as purchaser of sovereign bonds of last resort.   It’s debatable whether this is a failing.

The notion, debated much in the blogosphere, is that it’s desirable and credible to have the central bank promise to act as purchaser of last resort, in order to stave off market runs on sovereign bonds.  However, providing that financing has a cost.  The money creation needed will generate inflation whose costs may be recognised to be too high [expected money printing is not an efficient way to do government financing].  Following this reasoning, the promise won’t be believed.  And if it is carried out, it may be more harmful than a default.  This is why there is an attempt at a legal bar in the UK and other countries [and Germany before the Euro].  [One which I hope Simon does not suggest – in his role as contributor to the BoE remit review led by Labour’s John McDonnell – is qualified.]

And because such lender of last resort purchases are problematic, I’ve argued before that as far as the ECB is promising to roll out OMTs for Italy or Spain or France, this is a bluff.  There would be no support – rightly – for unlimited purchases on such a scale were things to come to that.

The second and third failings relate to the foregoing of strongly counter-cyclical monetary and fiscal policy in the Eurozone make-up.

In the non-German EZ member states, monetary and fiscal instability/freedom had often been a curse, and not a blessing.

Such countries had seen many episodes of high inflation, resulting from an abuse of the monetary freedoms later given up;  episodes of fragile exchange rate fixing, with no say in monetary policy at all.

They had also seen decades of less than optimal fiscal policy, with sustained over-borrowing and abuse of the fiscal freedoms craved now.

The memory of the efficacy with which monetary and fiscal freedoms were used lived on in the hefty pre-Euro spreads between German and other sovereign bonds.

In some countries – Portugal, Spain, Italy, Greece, Cyprus – this lack of monetary and fiscal discipline was symptomatic of an acute political-economic malaise.  As an outsider to this literature, I can’t do justice to it.  But an example is what Kalyvas and other political scientists term ‘clientilism’ and corruption;  the use of state resources to reward pressure groups on the left or right who had helped win the election.

These pressures arguably distorted monetary and fiscal policy, applying a too-short horizon, over-reliance on the inflation tax, and offering influential jobs in monetary and fiscal policy to political clients rather than those most competent.

The Germans’ insistence on the Eurozone’s actual design may have been a strategy to ensure that what ever caused these abuses in the past were not going to cause a problem for ECB monetary policy.

Rewinding history a little further, the Germans’ own institutional design, which they insisted be reflected in the Eurozone, is plausibly seen as a response to its own experience of how political dysfunction [which, if we want to get into a blame game, we can lay at the doors of the victorious allied powers at the end of WW1] leads to bad monetary and fiscal policy.

Concluding, Simon is right to point the finger at the economics in the heads of German policymakers.  However, the monetary and fiscal conservatism they built into the Eurozone was certainly explicable given the dysfunctional monetary past of Germany itself and other countries too.  And, who knows, perhaps even a decision that has a coherent rationale;  perhaps an enlightened New Keynesian in those pre-Euro negotiations over the design of the Eurozone might have recognised that the monetary and fiscal freedom prescribed in that framework were not as feasible as they appear in the institutions-free versions of those models.

 

Data nirvana. A thought following the Bean Review of UK statistics

One point coming out of Charlie Bean’s excellent interim review of the Office for National Statistics in the UK is that the ONS should provide better access to the underlying micro data behind our statistics.

Here are two reasons why a data nirvana of complete access is desirable.

First, aggregates are constructed – necessarily – under a very delicate set of assumptions.  To give an example, price indices that embrace apples and oranges will use assumptions about optimising consumers and a particular utility function to motivate weighting sub-indices by shares of expenditure in the sub-index in total expenditure.  Other data constructs might invoke the assumption of perfect competition.

These and other assumptions would, in an ideal world, be easily taken apart and modified by academics or data-users with a potentially better alternative;  or one that is better suited to some other purpose.

Second, frequently, information from sub-aggregates that goes into compiling an aggregate flows in at different times.  Early releases of the aggregate are often completed using forecasts or model and judgement-based assumptions to fill in the data that are missing at that point.  There may be other parts of the data production process that involve formal or informal filtering like this.  Like outlier and error detection.  Or judgements invoked to reconcile competing data sources [like the output/income/expenditure data on national accounts].

Complete access would allow users to experiment with their own alternatives for solving these filtering problems, one that the ONS themselves may not always be the best at, or where their solution may not be best for a particular user’s purpose.

A third reason – really a generalisation of my first two points – is that the optimal data series/index will depend on the use to which it is put.  The CPI is not the best index for me to use to track evolutions in the purchasing power of my salary over time, since my expenditure patterns don’t match those of the average respondent to expenditure surveys.  Other CPI indices could be optimised for preserving the purchasing power of benefit recipients;  or maximising the ability to forecast future values of the conventional CPI itself.   The possibilities are many.

This kind of Nirvana is difficult to achieve because it risks some breach of anonymity, particularly in the case of business respondents, who may be large enough to identify easily.  To the extent that data collection – particularly data quality – requires cooperation, and that cooperation requires a credible protection of anonymity, so that information isn’t used for commercial advantage, full access is problematic.

The ONS do have systems for researcher access, using remote terminals that allow users to dive into the data and run code on ONS servers, checked before release for anonymity threats.  But the systems are cumbersome and expensive.

 

 

 

How the BoE makes the Office for Budget Responsibility’s job harder

At risk of this blog degenerating into a broken record, if it has not already…

Today at Treasury Committee, Robert Chote and Steve Nickell were grilled about the Office for Budget Responsibility’s forecasts for the UK economy and government finances.

The conversation turned to the matter of whether the OBR agreed with the forecast for interest rates implied by financial markets, on which their macro forecast is conditioned, and on which the BoE also condition their forecasts.

This was yet another illustration of why it would be better if the Bank of England’s Monetary Policy Committee both formed and then disclosed its own best view of what it was going to do with interest rates.

Quite rightly, Steve Nickell pointed out that [paraphrasing here, without the transcript] ‘we are not in a position to form a view about rates that is superior to that of the markets’.

But, how strange!

One delegated authority of government, charged with setting monetary policy – the Bank of England – has to form a view about future rates in order to discharge its duties properly.  But because it thinks that disclosing that view would be a poor communications strategy, another delegated authority of government – the OBR – charged with monitoring fiscal policy, can’t have access to that view in order to do its job of holding the government to account over fiscal policy.  And must instead rely on the market path for future interest rates.  A path that Deputy Governor Ben Broadbent recently explained is not a terribly good indicator of what the MPC will actually do.

And so those left wondering just what will happen to government finances, and whether the Chancellor’s plans hold water, are less the wiser as a result.

 

Barwell-Yates Times Op-Ed on BoE’s interest rate candour deficit

Here’s a link.  Familiar points for anyone already reading this blog, but this time with the masterful drafting skills of Richard Barwell, my former BoE colleague, now senior economist at BNP Paribas.

[‘Candour deficit’ term stolen from Gavin Kelly’s pieces on the Goverment’s lack of transparency about its fiscal plans].

Political history of the rearrangement of financial chairs [ps to previous post]

As a post-script to my previous blog on the UK history of the financial crisis, it’s possible to reflect that the carve out of the FSA in 1997 from the Bank of England, and the subsequent re-incorporation of [most of] it as the PRA in 2012 had other imperatives [than the role of the old architecture in old events].

The 1997 carve-out must have been partly guided by the priority assigned to giving independence over monetary policy to the Bank of England.  Handing so much new power to an unelected institution required a counter-balance to make it politically acceptable.  So some things were taken away:  supervision and debt management.

Part of the reason too, in my assessment, is that it allowed Labour to look like it was solving a problem created by the previous government’s neglect.

And this too must have crossed the minds of the Coalition government’s masterminds when it re-incorporated supervision back into the Bank of England following the 2010 election.

Rearranging chairs is easy to propose, and was a way to pin the blame for the crisis on New Labour’s neglect of financial stability, and its rash 1997 chair-shuffling.  Something had to be seen to be done.  Institutional change was something.  So institutional change had to come.

You can see the same debates rehearsed on a smaller scale within the BoE itself.  Mark Carney’s Mais lecture, at which he launched the reform of the BoE’s structure into a matrix [management], was a case in point.  Organisational sub-units, previously lined up behind the Bank’s ‘core purposes’, had neglected ‘synergies’.  So these sub-units were shuffled.  And into a formulation that looks uncannily like the one BoE old-timers remember that ruled before 1994, when the late Eddie George and Mervyn King tore up a matrix management structure, which they declared had lost focus, and replaced it with one that aligned sub units with core purposes.

[I guess all I am doing is re-capitulating Dilbert, actually.  Though now I say that, I cannot lay my hands on the cycles of management structure cartoon that came to mind.]

The financial crisis was caused by lack of insight, not lack of institutions

I had an interesting exchange on Twitter this morning with Rupert Harrison, formerly George Osborne’s chief of staff, now Managing Director at Black Rock, and tweeting under his own name.

He wondered out loud whether the financial crisis might have been prevented if we had already had the Financial Policy Committee up and running.

My own view is that the crisis was caused by a failure of insight, not a failure of institutions.  The key problem was the failure to apprehend the risks building up in the system, and to realise that we had therefore chosen the wrong place on the trade-off between regulatory tightness and growth.

Today’s institutional architecture I wager would have fared just as badly, staffed with the economists with the same misapprehensions, and the same over-confidence in the tendency for financial intermediaries to self-regulate.  [I’m not blaming others here, I was just as deluded].  And overseen by a Treasury peopled by economists taking the same view, and headed by politicians inhabiting a political consensus over light touch regulation that derived from the same incorrect economic analysis.

If today’s institutional architecture has its advantages, and the pre-crisis architecture was lacking, that itself is a manifestation of this changed insight.  But I wonder how important it is.

Rupert pointed out on Twitter that the Financial Services Authority, once carved out of the BoE, had lost its focus on the macro aspects of financial stability.

That may be true, but I wager that it was mostly due to the fact that these maro aspects weren’t considered relevant – because of the same prevailing economic analysis of financial stability – and not because they had offices now further from their monetary policy specialists.

Recall too that FSA was carved out of the BoE in the first place because it was thought – not without good cause – that the BoE had lost its supervisory focus and discipline, lines of responsibility muddled in an organisation that had many things to do.

The latest reshuffling of the regulatory chairs – bringing supervision back under BoE control – may be optimal.   Or it may simply recreate the old problems of the past.  Manifest in successive management studies tilting backwards and forwards on the question of prioritising synergies versus specialism and focus.  [Note to self to read the next Mais lecture and McKinsey Review].

Ian Martin pointed to the failures of the old Tripartate grouping of the BoE, HMT and the FSA, and the Memorandum of Understanding on which it operated.  What a mess it looks like now.

Well, maybe.  But we can apply the same critique to this view.

The same 3 people [now Carney, Bailey, Osborne] will still have meetings, and essentially about the same topics [should we put taxpayers money at risk to rescue/lend, or not?].  They will sit on chairs that have different labels, and the minutes will have different headers and footers, but will those labels really make a difference?  I speculate ‘not much’.

Though what will make a difference is the lived experience of the near total collapse of finance in the last decade.

 

Reply to PK: Financial frictions pushed against deflation

Here Paul Krugman muses on how well standard macro models did at predicting the after-effects of the crisis.  He highlights how the prediction that the expansion of central bank balance sheets would NOT lead to runaway inflation was encoded in those standard models [it’s the zero bound, stupid], contrary to the permahawks’ scare-mongering.

But he asks why there wasn’t deflation given the large contraction in output.

A few answers.

First, it’s not over yet, at least not in the UK, where headline inflation [which overstates true by maybe 0.5pp/year] has been around since February 2015].  So there’s still hope that further deflationary catastrophe might rescue this prediction of the models.

Second, models of financial frictions bolted onto standard DSGE models show how contractions in credit can throttle supply, putting upward pressure on inflation.  These frictions have eased now in the UK and the US, with spreads falling back to more normal levels.  But initially they could have been part of the story of bouyant inflation.

A third explanation that can take up the slack now that financial intermediation is working more normally is ‘hysteresis’.  The tendency for large demand-sized contractions in output to impair potential output, perhaps through the eroding of the skills and labour force attachment of the unemployed, or the deterioration and scrapping of the capital stock.

 

Tayloring a criticism of Fed policy

Adam Posen and John Taylor have exchanged posts on the Fed Oversight Reform and Modernization Act.  The AP criticism of the Act, in a nutshell, is that discretion is better than rules:  that the Act would constrain the Fed to follow policy procedures declared in advance, that might later prove inappropriate.

JT rebuts this by pointing out that the Act does not make any rule that the Fed declares binding on itself.  It simply forces the Fed to declare such a rule, and explain how it uses it and why it deviates from it.

However, JT’s rebuttal seems like pure legalism.

We know from his writings that he thinks Fed policy would have been better if it adhered to the prescriptions of a Taylor Rule, or something close to it.  JT views quantitative easing as a dangerous act of discretion.  It’s not clear what he makes of the international evidence that QE appeared to lower long rates on impact.  But at any rate he considers the uncertainty generated by embarking on QE to have had a negative effect on activity, once that must presumably have swamped any stimulus via long rates, (and be greater than any uncertainty generated by the private sector wondering what on earth was going to counter the enormous recessionary shock, if not monetary policy.)

We also know that he supports the Act because he thinks it will make policy less discretionary than it was in the past, and more Taylor-Rule- like.  A re-run of the recent financial crisis under the Act would tilt Fed policy towards what he would have preferred.

This is precisely what Posen [and Krugman, and myself for that matter] object to.  Whether literally binding or not, Taylor knows that the Act will increase the chance that future FOMCs feel constrained by their prior rule declarations.

If JT didn’t consider this the effect of the Act, what possible benefit could it have?  And if this is the effect the Act would have, then, if you think QE and credit easing policies, and the subsequent zero interest rate policies were stimulative and beneficial, then the criticism stands.

Taylor goes against the modern consensus that central banks should have goals given to them by Parliaments [ie have no goal independence], and be held to account for achieving those goals, but have instrument independence, and discretion to operate monetary policy as best as it sees fit to achieve those goals.

He leans on the theoretical literature which accords benefits to committing to rules for instruments.  But these benefits accrue mostly because of the assumption of rational expectations, and their confinement to a fairly narrow class of DSGE models.  `Even without discarding the unrealistic assumption of RE, the crisis has taught us, surely, that know much less about the other bits of the model than we thought when the commitment studies ruled.