Haldane on coping with the zero bound.

This speech is an interesting overview of the difficulty that faces monetary policy mandate designers in this era of low equilibrium real interest rates.

AGH tilts towards reforming monetary institutions to allow for substantially negative interest rates, rejecting permanent use of QE, or a rise in the inflation target.

In the past, I’ve plumped for raising the inflation target to 4%.  Or more particularly, HMT setting the inflation target, perhaps on instruction from a third party, every 5-10 years, based on an assessment of the equilibrium real rate, which we might well expect to move around further.

A few points on AGH’s cost-benefit analysis.

Andy points out that inflation is costly, and so an extra 2 percentage points of it is proportionately more costly.  Yet it seems to me that allowing negative interest rates on digital cash increases the cost of 2 per cent inflation somewhat.  Formerly, consumers get zero interest on their notes and coins holdings, while they depreciate at an average of 2 per cent a year.  With occasionally negative rates, these ‘shoe-leather costs’ of inflation increase a bit, proportional to the time spent below zero, and just how negative they go.  A reminder:  during the dark days of the previous crisis it was commonly thought that rates would ideally have gone down to about negative 7% or 8%.

Second, I query the judgement that eliminating cash and using negative rates would be less damaging to the credibility of monetary institutions than bumping up the inflation target.  Ultimately, in the absence of good models of how reputations are won and lost, this argument is really about trading hunches.  But mine is that there is a risk of a serious WTF moment when the no-cash system is explained, or people find out that they actually have to pay large sums of money simply for the privilege of having it.  Anecdotally, we know from many models of money that equilibria where money is valued are quite fragile – specifically, it’s quite easy to write down models in which it is not.

It’s worth noting too, that the MPC ran substantially above-target inflation for some years during the crisis, and, despite the warnings of some, the faith that central banks were still targeting 2 was not much diminished.  An open, pre-announced, and well-explained move to 4 per cent [in my view once we have shown we can hit the current target, and not before] would not be fatal.

Third, AGH is dubious about making more use of QE.  This is interesting in the context of the current debate, in which since the departure of Mervyn King, one senses, despite protestations by others to the contrary, that there is a shift in sentiment against this instrument.

Haldane is worried about the intermingling of monetary and fiscal policy [a worry that has come to the fore recently with the debates about Quantitative Easing for the People].  These worries are legitimate, but not insurmountable.

Two finesses might help.

First, there is no need in my opinion for QE to involve the creation of reserves.  One can simply have the DMO issue short-gilts and trade them for long.  QE becomes a twist.  The twist part of QE was always the part that was most convincingly effective anyway, via its squeezing of the term premia.  Think of current QE as a two-step.  First, the creation of reserves to buy a short gilt;  second, a swap of a short for a long.  The first is just conventional monetary policy, which will have no effect at the zero bound.  [Leave aside the detail that rates stopped above zero and we have IOR]. Unless it meant some lowering of interest rates in the future to accommodate the correspondingly higher money.

A second finesse would be to make policy announcements take the form of instructions from the MPC to HMT for them to undertake the twist themselves.  Since the BoE is already insulated from the fiscal effects of QE through the indemnity, this is a natural next step, if worries about intermingling weigh heavily.  This etiquette could be used to underpin a more vigorous credit easing [ie issuing gilts to finance purchases of private sector assets].  And it might also help the DMO avoid conflicts such as one might argue we had this time, between what its right hand is doing [issuing long gilts like crazy during the crisis] and what it’s [BoE operated] left hand is doing [hoovering them up via QE].

A final point to note is that AGH does not mention that the armory could be supplemented by more vigorous use of discretionary changes in conventional tax and spend fiscal instruments at the zero bound.  Although Haldane considers changing the inflation target, which is on the face of it is HMT’s business and not his, discussing conventional fiscal policy like this was probably thought a step too far.

Full-blown fiscal councils of the sort recommended by Wren-Lewis are considered too much for democracy to swallow by some [not me].  But there is a half-way house.  One writes down an agreement ahead of time that in the event that the zero bound threatens or is hit, HMT and the BoE would discuss together, in an open and minuted forum, an appropriate, discretionary, fiscal response, explaining the loosening and the nature of the subsequent tightening later down the road to repair the debt/GDP ratio.  Ideally, both parties would agree at the launch of this institution on rough orders of magnitude, linking additions to the deficit to estimates of the missing interest rate stimulus, to be referred back to as and when this tool is activated.

 

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Fed tightening, asymmetric risks, and possibility of negative rates.

A quick comment on this thoughtful post by the great JP Koning, whose posts on monetary econ and finance have become regular reading for me since I found him on the internet.

JP makes the point that the possibility that rates could now safely go negative changes the calculation in the Fed’s mind, eliminating one particular concern that might prevent it from raising.  The concern, articulated by many, Krugman and others, is that if a rise proves to be the wrong choice, there is insufficient room to reverse course and cut to counter the ensuing slowdown.  Clearly, if rates can go negative, then there is more room to cut.

However, although rates have gone negative, it’s clearly the case that there is still a lower bound to rates.  In our standard model this will be equal to the marginal cost of managing cash.  In real life it will be connected with the same, real life counterparts.  If you think about the size of historical cycles in interest rates, [adjusting for the slow run changes in inflation regimes that have gone on], the Fed might want, in an ideal world, to be able to raise rates to say 10%, and cut them to -8%.  [I recall discussions at central bank conferences that -8% was a typical estimate of the amount of missing stimulus in 2009].  Say, at the outside, market rates could be tempted down to -1.25%.  That’s still a lot of missing stimulus to generate asymmetry in the risk calculation the Fed makes.

The story isn’t quite as stark as I have painted it, because there is the possibility of doing more quantitative or credit easing.  But i) there are still controversies about just how effective that might be and ii) there may well be political constraints on growing the Fed balance sheet even further from its current swollen state.

We might well also wonder whether a correction in rates following a mistaken rise would really need to be so large as to use up all the missing stimulus that the Fed was deprived of in the early stages of the financial crisis.  Surely this would not be another Lehman’s moment? Surely this time would be different [more moderate]?  Well, probably.  But then rates are starting out much lower to begin with.  So there does not need to be anything like another Lehman’s moment to push the desired Fed rate well below even -1.5%.

Richard Murphy, Bank Rate and bank margins

Here Richard Murphy points out that a rise in Bank Rate would lead to a rise in margins.  This is a fair argument.

Indeed, the main reason why MPC decided not to cut rates closer to the zero floor in March 2009, a view it held to until February this year, was that further cuts would eat into bank profits.  This was undesirable because it would either destabilise some institutions, or simply cause them to raise rates on some of their products.  The reason for this view was that banks had sold tracker rate mortgages which fell as Bank Rate fell, yet interest rates on deposits were, naturally, bounded at zero.  In theory banks could have charged for deposits in other ways, but that was likely to be politically awkward.  Some falling mortgage rates and constant deposit rates meant lower margins.

My view was that it was not a good idea to mix interest rate policy – which works not simply through banks – with what at that point was a retail bank financial stability policy.  Rates should have been cut lower, and offsetting policies, where they were justified on systemic grounds, contemplated.  [In truth, it wasn’t really ‘my’ view, but one formed by talking to a couple of other clever people at the time who can’t be named].

But, likewise, just as I thought rates should have set this consideration aside on the way down, I don’t think interest rate rises should be delayed on the grounds that they may cause this mechanism to go in reverse.  There many reasons not to raise rates now, but this isn’t one of them.

In fact, one might see this simply as the unwinding of a distortion on bank balance sheets cause by the need for super low interest rates for macroeconomic reasons.

There is a broader question about why banks expose themselves in this way.  Presumably, it was simply because, like the rest of us [and the Treasury included, who set the 2 per cent inflation target] no-one forecast zero Bank Rate would ever be necessary.  The hope would be that either banks learn their lesson;  or some action [like raising the inflation target at some point] was taken to lower the chance of a zero bound episode.  Or some regulatory intervention to prevent exposure to zero rates is considered.  Or, perhaps all three.

There’s also an issue for competition policy, of course, in figuring out whether margins averaged over the cycle are bloated.  But, once again, that’s not something to address with the instrument we use to achieve the inflation target.

On the desirability of NGDP targeting

Strangely, for many people, that title qualifies as clickbait.

It’s actually the title used by this paper, and has attracted quite a bit of attention in the popular econ media, eg on Twitter, appearing in my timeline several times.  Partly because of the viral interest in nominal GDP targeting spread by the ‘market monetarists’.

I want to emphasise only that this paper does not show that nominal GDP targeting beats how the Fed or the BoE’s MPC, or the BoCanada would interpret ‘inflation targeting’. They would view their mandates as providing them with a mandate to do optimal policy, as best they see it, with the quantitative target for inflation defining the expected rate of inflation over the long term. In the UK, a Treasury review of the BoE’s mandate in 2013 interpreted things in just this way, which in the profession we’d call ‘flexible inflation targeting’.

Nominal GDP targeting can beat other constrained policies [not least because it’s not that dissimilar to ‘flexible inflation targeting’, which is optimal in the New Keynesian model] but rarely wins in general. Then again, neither does it lose by much. My beef with the NGDP lot was never that this was a dumb policy, just that it’s not right to think it would change much about the world, in particular that it would magically solve problems we experienced during the crisis, or cure booms and busts semi-automatically, forever.

As a parting shot, this paper should serve as a reminder to NGDP/MMT magpies whose googling finds it of just how policy evaluation should be done.  It’s a quantitative thing, involving setting out a model and trying policies out, and scoring them somehow.  If this isn’t too self-contradictory, it’s not done by repeatedly bashing readers over the heads with wordy blogs.

How Corbynomics’ nationalisation consumes fiscal ‘space’

One of our objections to Corbynomics was the plan for renationalisations.  We asserted in our letter that this consumed fiscal space.  What was meant by that was that the cost of finance for governments, after a certain point, will depend on the amount they borrow, and there will in fact a limit beyond which borrowing lowers the price of the sovereign’s bonds to zero.  Borrowing to fund nationalisation limits potential borrowing for other purposes, given this limited fiscal space.

Why?  Surely if the government is borrowing to take ownership of a perfectly good revenue stream, in the form of a large company like a railway franchise, there is no problem?  This was put to me by Jonathan Portes in email correspondence, and appears also in a footnote to Simon Wren Lewis’ response to the pro and anti-Corbyn letters.

The reasons are these.  First-off, our signatories took the position that the state is more likely than not to damage these company operations through incompetence and failure to incentivise them.  So the revenue stream is depleted in expected value terms by the purchase.

Second – and here I speak for myself only – these revenue streams are uncertain, and that uncertainty itself puts strain on government finances, for the same reason that household contents insurance ends up costing us money.  It was pointed out to me privately that in order to measure this strain, we have to figure out how the revenue streams acquired covary with the other streams of inflows and outflows to the government coffers.  My rough answer to this is that those covariances are unlikely to help, and will probably amplify, since one expects that these companies will correlate somewhat with overall tax revenues positively.

Third, aside from questions of efficiency, most states have a history of subsequently appropriating the organisations concerned for other purposes than revenue generation.  [This is usually cited as a benefit by old-fashioned socialists like Corbyn].  Benign versions of these non-profit motives are usually that the firm is used as an instrument of progressive policy.  (Benign, that is, if one thinks the existing set of transfers bring about an insufficiently progressive outcome, and can’t be done in a better way than nationalisation.)  Less benign versions are that they are used as vehicles for patronage, industrial policy, or hidden social security.  Either way, and almost definitionally, this appropriation costs money, and that depletes the government’s fiscal space.

Fourth, one has to raise the spectre that, however competent or innocent of ulterior motives the state might be, markets may not have the same high opinion of the likely outcome of nationalisation as the government itself, so fiscal space – read cost of borrowing – may be erroded by this pessimism alone.  Presumably, ruling out an international bond market conspiracy [a big leap for many who seem to support the Corbyn camp], such space would re-emerge after a substantial period of good behaviour or good performance by the new state owners.

Of course, to believe that the concept of fiscal space has meaning, you have to be a member of the club that believes that even if you are a sovereign with an independent printing press at your disposal, you can’t simply run those presses to cover any fiscal difficulties you might have.  At least not if you recognise that seigniorage generates inflation, and inflation is, beyond a certain point, something costly to be avoided.  Corbynomists often  deny this, and many times in supporting ‘People’s QE’ this view surfaces.

Looking at their mental processes regarding this policy, one can see it as a kind of fiscal ignorance leading to a bliss in which one can borrow to renationalise whatever you fancy, with no downside.

FT letter denouncing Corbynomics

Here’s the letter, organized by Paul Levine and myself, to appear in the FT tomorrow, and here’s Chris Giles’ story about the letter.

Thanks to those who signed, [dubbed by Danny Blanchflower ‘mindless theorists and right wing nut-jobs’], and the many who were supportive but whose positions don’t allow them to make potentially political interventions like this.

Needless to say, our motivation wasn’t political.   It was ire that the mantle of ‘mainstream’ was being offered by the ‘letter of 41’ and claimed by Jeremy Corbyn.  Who Labour elects as its leader is the business of its broadly defined ‘members’.   But we and our signatories don’t wish to have the median economist position misrepresented.

Small point.  The ‘targets’ sentence in the letter is losing people a bit.  This is to be read as ‘renationalising will probably make companies worse not better’.  [The ‘target’ is the target of the renationalisation, ie a company.  Sorry.  Terrible drafting by me in this case].

Post script:  Ethan Ilzetzki at the London School of Economics, and Duncan Melville, Chief Economist, Inclusion [signing in a personal capacity only, and not on behalf of his employer], also wished to sign, but we got this message too late for the FT deadline.

Anyone else who is supportive or not is free to comment below.

Post-post script.  The Guardian, which ignored Paul Levine’s initial letter [reproduced in an earlier post below], ran a sceptical opinion piece about our letter in Commentisfree, by Tom Clark.  This was pretty dirty:  the first ‘economists’ letter was reported uncritically as from ‘economists’, and their views were not questioned.  Our letter, signed by people, unlike with the first letter, all of whom were economists, gets criticised for being written by hide-bound…. economists.  [Plus the usual rubbish showing no understanding of what PQE/QE is, or what money is, etc, etc…].  To respond to this, we penned a letter in response, which they did publish, and here it is if you want to read it.

ICYMI Paul Levine and I are organising an anti-pro-Corbynomics letter

In case you missed it, I’m organising, with Paul Levine at Surrey, a letter to express the anti-Corbyn view, to counter the misleading impression given by the ‘letter of 41’ published in the Guardian.  If you are a practising economist and think you might want to sign, contact Paul or I and we will show you a draft.  We have 43 so far.   Notice that Paul already wrote a letter on the topic, pointing out how misleading the letter of 41 was on the matter of Corbyn’s anti-austerity being ‘mainstream’.  The letter was ignored by the Guardian, but I reproduced it in an earlier post.