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.

 

Steve Williamson’s scepticism about empirical and saltwater macro

Steve writes wide-rangingly, taking issue with several aspects of empirical macroeconomics.

Steve goes for the modern VAR literature, which seeks to identify monetary policy shocks, and measures that these shocks have effects on real variables, and that their effects on all variables take time to their full effects.

He rightly points out that we might be concerned how VAR researchers identify those shocks. But, can we dismiss all of them?

The methods I know about comprise;  short-run timing restrictions embedded in the VAR [eg Christiano-Eichembaum-Evans];  long-run restrictions [Blanchard-Quah];  sign restricitions [Uhlig and many others];  narrative methods of identifying monetary policy shocks [Romer and Romer];  monetary policy surprise measures [Rudebusch; heavily criticised by Sims himself, but still] constructed from the gap between rate expectations and outturns;  external instruments [Stock and Watson, Mertens and Ravn…].

With the exception of the Uhlig work on sign restrictions, [contradicted by other, later work in a similar vein] I thought it was the case that this work found non-neutrality of monetary policy shocks.  And that there was a reasonable consensus about the lags.

We can quibble with probably all of the papers in this large literature individually, but I find the overall conclusions persuasive.

Moreover, all of the work tries to use theory to some extent to identify those shocks, and that ought to reassure someone like Steve.  For example, the early Blanchard-Quah work uses the insight that satisfactory models have the property that ‘nominal’ shocks should be neutral on real output in the long run.  Narrative measures are explicitly motivated by the theoretical distinction between expected, systematic changes in policy, and the rest.  Even timing restrictions are theoretically motivated – though perhaps most contentious.  And sign restrictions are restrictions that come from theoretical models.  Rarely are data allowed simply to ‘speak for themselves’.

Steve also seems to question whether the shocks that VAR researchers crave are interesting:  the proper concern for us being the consequences of a particular systematic rule for monetary policy.

In reply to this:  the unsystematic shocks, which if central banks had been doing their jobs properly in history would simply not be there, since they have no reason to be there [caveat:  save for reasons of experimentation], are the unfortunate accidents that allow us to identify the parameters of the underlying structural model [including those in and out of the policy rules in place in the past].  Once this is done, we can then evaluate what the effects of alternative systematic policies would be, and try to work out what the best one to adopt is.

Another part of Steve’s pessimism about empirical macro connects the irrelevance of ‘long and variable lags’ in a world where there is open and communicated forward-planning by policymakers, and private agents that may form expectations about future central bank actions.

I don’t see a fundamental problem here.

For a start, provided we accept that history is nonetheless full of monetary policy shocks, [with randomness in early vintages of data, why would it not?] we can characterise all this forward-lookingness in a model [for the sake of argument, say the NK model], and see what a shock does in that model, and compare it to the counterpart in the data [the VAR].

Second, if we think think that there are unsystematic announcements pertaining to future events – what the literature terms ‘news shocks’, we can try to identify those too.  And several have.

 

Spencer Dale on the new economics of oil

Duncan Weldon alerted Twitter to this very nice think piece by my old boss, now at BP.

One of the points he makes is how new reserve discoveries have been outpacing oil consumption.  And he uses that to question whether  the old Hotelling model of oil as an ultimately exhaustible resource is now not right for the job.

I wonder.

First, Spencer is making a practical point.  In principle, oil is an exhaustible resource nonetheless, given the pace at which current biomass generates it, relative to current consumption.

Second, as Spencer discusses, we might presume that sooner or later the world will get its act together to make sure that not all the carbon-generating fuel that we have is consumed, to limit climate change.  In which case, new discoveries don’t add to the amount of oil that can and will be consumed.

There’s a lot of uncertainty about how soon and how effective collective action will bite.  And there is the possibility that clean technologies may expand what’s burnable.  But right now, a rational oil price-setter/discoverer would surely start, at least from a precautionary principle, with the view that we won’t find a way to burn all of that oil.

But the science of climate change would seem to make Hotelling’s model of exhaustion, or some version of it, as relevant as ever.

Discovering more oil whose burning we ban would be like discovering oil in the middle ages.  During those times there were no doubt frequent discoveries of seeping oil and gas, but since they had few known uses, they could not relieve the energy scarcity at the time, which would have involved the quantity of burnable wood.

Jeremy Warner on the Charter, and sanctions

Two comments on this piece by Jeremy Warner in the Telegraph.  Jeremy remarks:

“there is no purpose to law without sanctions, and this one appears to have none beyond the extra capacity for embarrassment if it is broken.”

First, I suppose it’s hoped by the charter’s authors that successfully adhering to it will lower the cost of borrowing, other things equal.  So the sanction is higher taxes [fewer votes, more restless right wing MPs] for the same amount of public spending.

I’m not so sure the Charter can or will be adhered to, and whether trying might not lead to more uncertainty, rather than less, but leave that aside for the moment.

Second, the reputational costs Jeremy mentions are not to be sniffed at.  These seem to have served us reasonably well in the case of the legislation isolating the Bank of England’s monetary policy decisions from political interference.

Why the fiscal charter is not right

Ultimately I am against this charter for the same reason that I am against moves to legislate that the Fed should follow, or be monitored relative to a monetary policy rule.

Macroeconomic fiscal policy is, crudely, about weighing the demands of vigorous application of the stabilisers (automatic and otherwise) today, against the need to preserve room for doing the same at some point tomorrow.   Where this requires keeping the ratio of public debt to GDP from going above some limit beyond which the cost of debt finance might be expected to spiral, and inflation stability and the capacity to deficit finance to counter recessions would be undermined.

Most of the ingredients here are a matter of at least some controversy.  The likely safe limit for the debt-GDP ratio.  The size and frequency of recessions and financial crises.  The robustness of monetary policy objectives in the face of an otherwise necessary, extreme fiscal stimulus.  Crucially, the path of potential output – even the appropriate concept of potential output – about which the purpose of fiscal policy here regulated is to stabilise actual output.

For that reason, I don’t see how any sensible legislation could frame a fiscal rule like this.

The government have tried, but it falls down on many counts.  To give one example, the definition of ‘normal times’ when the surplus rule applies, is framed in terms of the annual growth rate of GDP of 1%.  Yet one thing almost all economists would surely agree on, is that the appropriate definition would be in terms of the difference between actual output and potential.  I can see why the legislation does not involve this concept, because it is such a conceptually and empirically elusive thing.  But I am not convinced that the solution to legislate in terms of growth rates is better than pure discretion.

Current circumstances seem to be exempt.  But imagine a repeat, 10 years hence.  After seven years more, interest rates are pressed against or close to the zero bound.  The economy is growing again, consistently, but many think that output is still below potential, and inflation is substantially below target.  A surplus in such times would be hazardous, to say the least.

To press on with this single example, its conceivable that a surplus might be needed even if the growth rate of output is less than 1%.  There is no economic law that potential output is an inevitable straight line process inexorably enriching us by 2% per year.  Sustained falls in output can be caused by falls in potential output, and during these times it may be necessary to have tight fiscal policy, where the loose fiscal policy allowed by this charter would be futile, inflationary and counter-productive.

As many others have pointed out, the shift from the previous version of the Charter to include public investment is perplexing.  It’s possible to sympathise with a political economy view that democracies, in which the unborn do not vote, may have a tendency to ‘invest’ without real expectation of future returns, simply as another form of covert, current spending.  But the Office for Budget Responsibility’s old terms of reference seemed adequate defence against that.  Likewise, it’s possible to sympathise with the view that public investment decisions should be made on a long-term basis, and that such investment should not rise and fall frequently with the tide of the cycle.  However, on occasion, the demands of macroeconomic crises will trump that desire.  And it may be reasonable now to expect real finance costs to be low for a very long time [look at long-term real rates now for instance], and that deficit finance to take account of this bounty, on projects that generate genuine future returns [meaning future tax revenues] would be justified for a long time to come.

All this is not to say I am against legislative constraints on the macroeconomic aspects of fiscal policy.  On the contrary, I am in favour.  But I think they should, [as they did until now] follow the model of the Bank of England.  Delegate, as far as democratic niceties allow, to an expert, independent body, a set of objectives, and give them the discretion to pursue them, rather than tie them to inappropriate and, therefore, ultimately non-credible rules.

In this case that could mean expanding the role of the OBR to comment on the appropriateness of the fiscal stance.  Not just in so far as it bears on long-term sustainability, its current mandate.  But whether, given a government defined objective, it weighs appropriately those competing demands, the demand to stabilise vigorously today, vs the demand to preserve the capacity to do so in the future.  In support of that it would form a view about the appropriate debt/GDP ratio, the output gap, the evidence on the likely size and frequency of recessions and crises [and what strain on finances fiscal stabilisers such crises would put].  Perhaps even and independent view of the efficacy of monetary policy tools that are the alternative.  Such legislation could even go so far as to stipulate that in the extreme event that interest rates are constrained at zero, the fiscal stance could be decided, or at least discussed openly with the Bank of England’s Monetary Policy Committee.

As some have pointed out, this Charter should not be considered a left-right issue.  Even fiscal hawks should be concerned not to legislate in this fashion, just as monetary policy hawks, frightened about inflation stability, should not try to tie a central bank to a monetary policy rule that is not foolproof.

More Koning on future marginal liquidity services

JP comments on my last post commenting on his post, and this post responds.

He notes that while a technological innovation that reduces the need for money, or the liquidity and convenience services that come from holding money, would have no effect on the actual marginal liquidity services enjoyed at a point when interest rates are zero, [because zero rates means that people are sated with money], nevertheless, if rates are expected to rise in the future, something will happen to future money demand.  But what?

Without doing it properly [read with pencil, paper and Matlab], I can’t know for sure.  But, at a guess, not much in the NK model.  Technological innovation will reduce real money demand at all levels of interest rates.  The central bank will follow through with any previously computed optimal trajectory for nominal interest rates following [eg] a shock to the natural rate, but will note that this rate leads to lower money balances throughout.  Those lower money balances would have no other consequence in this model, however.

 

Is monetary impotence due to monetary innovation? On JP Koning.

JP poses this question in yet another thought-provoking post.

I’ll offer one thought, from the standard New Keynesian model of money, interest and prices.  In this model, the fact that money confers liquidity services is captured, rather crudely, by assuming that we are all like coin collectors and get pleasure from holding real money balances.  JP’s thought experiment is undertaken in this model by wondering what happens if you slowly reduce the amount of pleasure all of us coin collectors get.

Woodford explains the title of his textbook ‘interest and prices’, in particular, the virtual absence of money, in his opening salvos, by pointing out that central bank control over interest rates, and thereby over the whole economy, does not depend on this ‘pleasure’ being of a certain magnitude.  In fact, the simple version of the model he studies is one in which this pleasure is conjectured to be infinitely small.  Monetary policy’s leverage here depends on money’s role as a unit of account.

Looked at this way, the tendency for the economy to get stuck in a liquidity trap in response to shocks to the natural rate of interest (for example) should not depend on the liquidity convenience (pleasure!) we get from money.

Another way we can interpret JP’s question, though is this.

Suppose that a shock to the natural rate comes along, requiring an extended period of interest rates at the zero bound [and perhaps other stimulus too], to return inflation slowly to target.  But then on top of that there is some monetary innovation lowering the liquidity services to money.  [Apple Pay?!]  What would happen then?  Looked at through this model, nothing at all.  Because the fact that interest rates are already at zero shows that these liquidity service benefits have already long been exhausted.

Here I have assumed that the monetary reform does not change the asymptote of these liquidity service benefits as real balances get very very large.  All that happens is that the monetary reform changes the profile of those marginal service benefits at finite values of real balances.

What if the reform that happens mid-way through responding to the natural rate shock did change the asymptote, however?  For example, what if the reform involved abolishing higher denomination notes, which increases the costs of managing cash?  I’m not absolutely sure here, without actually doing this properly, but I hazard this guess.  Nothing happens, much, if central banks hold interest rates where they are, except that they have to allow real balances to decline via a reduction in nominal money quantities.   The reform, however, will create an opportunity for the central bank to lower rates if it wants to, in case the old floor to rates [previously zero, now lowered] implied an amount of stimulus that was less than optimal.

The more interesting question – in fact the question that JP Koning actually posed – is what happens in the real world, of course.  But you’ll have to go elsewhere for answers to questions like that.

Is there really a credibility problem in the face of deflation?

Tim Young, in typically combative style, doubts in a comment on this blog that there really is a credibility problem in the face of deflation.  I accept that historically, and theoretically, we have focused on the difficulty of persuading the private sector that we will not generate too much inflation, thereby eroding the real value of nominal government debt, nor nominal wage contracts.

However, there are two genuine doubts that observers of a central bank might have.

First, there is the doubt that, whatever they say about how confident they are, central banks may not have potent or reliable tools to fight deflation in the face of the zero bound.  The Bank of England has reassured us that ‘we have the tools’.  But perhaps they haven’t.  We know that they have a vested interest in reassuring us because in so doing, they help anchor inflation expectations, and thus inflation itself, and thus make their lives easier.

Second, there lurks the suspicion in the popular mind that central banks are actually inflation nutters and would really like 0 inflation, rather than the 2 per cent actually mandated.  Sure, we had a history of governments in the UK and elsewhere generating too much inflation.  But monetary policy was then supposedly passed on to these central bank types to solve that problem.  Perhaps this was overdone?  If you think this is far-fetched, note that several official remarks about our sub-target inflation, and remarks by prominent commentators, have been approving of the benefits of 0 inflation.

So, for those reasons, I think Marvin Goodfriend was right to warn that there is a credibility issue in fighting deflation, or at least sub-target inflation, and, accordingly, a motive for monetary policy to lean towards the vigorously stimulative.