No need to show the wrong sort of spine over raising rates

I was alerted by Matt O Brien on Twitter that some [see, for example this NY Times op-ed] are arguing that the Fed and other central banks, who had prefigured an imminent first hike in rates in their speeches, should follow through regardless and raise rates, ‘to show some spine’, else run the risk of losing inflation-fighting credibility.

This argument ought to have no foundation.  But unfortunately it has.

In an ideal world, the central bank would be sufficiently transparent about its objectives, and its interest rate plans, and how the latter are contingent on the evolution of data, that there would be no need, if bad economic news interferes, to follow through on an interest rate rise that was consistent with the old data, for the sake of ‘showing spine’.  Indeed, in that world, raising rates would constitute an unwelcome policy surprise, a departure from the agreed contingent plan.  Those who had grasped the old plan would set about working out what the new plan was, and for a while, the economy would suffer as a result of the increased monetary policy uncertainty.

The element of truth in the argument is that there is not this sufficient degree of transparency.  We don’t know precisely how the FOMC or the MPC, for example, trade-off their goals of stabilising inflation and real activity.  And we don’t know how those objectives translate into operational policy rules, nor how those rules, given a view about how the economy plays out over the future, translate into a properly state-contingent plan for interest rates.  This opacity allows the view to take hold that the Fed needed to and was going to raise rates come what may.  And that any sign that they don’t, following a stock-market correction, is a sign that they have been taken over by the low interest rate lobby.

Despite this kernel of truth, I’m confident that policymakers won’t put much weight on this concern, behaving instead as they do in a properly contingent fashion, and will put back rate rises if necessary.  But they would be advised to try harder to communicate what they do, their plans for achieving it, and how that translates into interest rate trajectories from quarter to quarter.  This won’t and shouldn’t insulate the Fed and other central banks entirely from criticism.  But it would raise the level of debate from ‘you should be raising rates, cowards!’ to:  ‘oh, those are your objectives, are they, well I don’t like that!’ or ‘if that’s what you are trying to achieve, you have a funny way of going about it!’.

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Lower terminal central bank rates doesn’t mean it will be time for PQE.

That’s the conclusion of Richard Murphy’s latest blog.  He has latched onto the latest of dozens of speeches by central bankers pointing out that for one reason or another, they don’t expect the resting point of central bank rates to be as high as in the pre-crisis period.  And concluded that this means we should be adopting People’s QE – the periodic funding of public investment through the creation of new central bank money.

Actually, aside from the problems with that policy that I have explained in previous posts, there’s no reason to conclude that.

For one thing, we can contemplate raising the inflation target.  I’ve proposed 4%, falling into line with a suggestion by Blanchard in 2010, to be reviewed every 5-10 years as evidence about long run equilibrium real rates shifts.  Raising the inflation target will raise the terminal point for central bank rates one for one, and make more room for nominal rate cuts.

Second, we can contemplate more active use of conventionally financed fiscal stimulus policy.  Simon Wren Lewis, Jonathan Portes and others have proposed just that, under the auspices of an independent fiscal council.

Third, we should remember the battery of new unconventional tools that the BoE has already availed itself of;  vanilla quantitative easing;  funding for lending;  macro-prudential tools;  and purchases of private sector assets [‘credit easing’].

Fourth, recall the solution proposed by Miles Kimball, Willem Buiter and others – to reform the institutions of money so that negative nominal rates are possible.

Fifth, we have the possibility of more concerted and coherent forward guidance, articulated as both lower interest rates for longer (than historical policy rules would suggest), and as a corresponding, conscious overshoot of the inflation target.

Sixth, there is the possibility of adopting, temporarily, in a crisis, levels-based targets, either a price level target, or a nominal GDP target, as a device to make the lower interest rates for longer, and inflation overshoot in the above solution more credible.

Seventh, in extremis, we have the possibility of helicopter drops of money direct to consumers, an old idea urged on us recently by Wren Lewis, Eric Lonergan, Mark Blyth, and others.

So there are plenty of other – to my mind far more attractive – options to consider.  So far Mr Murphy has said nothing about these other options, which is curious.

If the motive is to solve a monetary policy problem, we need to know why these other seven options are less appealing to the Corbyn team.

More likely, the omission stems from the fact that they are reasoning from a financing problem [‘how can we get more stuff without borrowing to make us look crazy?’].  That there are better ways to solve a monetary policy problem is not relevant if those options don’t solve a financing problem.

[Needless to say, I don’t think there really is a serious financing problem].

Paul Levine on the 41 claiming Corbynomics is ‘mainstream’

I’ve been organising an anti-the-41 letter, which has been going slowly, the score currently 41-29.  In the course of that I corresponded with Paul Levine, a Professor specialising in macro at the University of Surrey.

Paul is a founder member of the European community of economists that started to do macro properly, following the lead of the US.  And with Pearlman, wrote foundational papers in time-consistency and control theory that I remember Nobel laureate Tom Sargent marveling at in his macro lectures.

Anyway, cutting to the chase, Paul wrote his own letter, which the Observer seem to have decided to ignore, responding to the 41.  I hope their neglect was accidental, because it does not look like it, spoiling as it does a Guardian letter that became a one-sided Guardian story about how Corby is proposing respectable macroeconomics.  Here’s the text:

“The 41 signatories (Observer, Sunday 23rd  August) writing on  Corbyn’s economic policy fail to distinguish between the quite different forms of “anti-austerity” policies proposed by opponents of the Government. These vary from deficit denial (high debt doesn’t matter); to proposing much slower consolidation involving some combination of spending cuts and tax rate increases dependent on the growth of tax revenues;  to a simple painless solution based solely on  taxing the rich, raising corporation tax and incredible estimates of  preventable tax avoidance/evasion levels.  Corbynomics is firmly rooted in the latter, whilst being vague about debt targets. IMF, current Labour Party policy and, in effect, that of the SNP (as shown by the Institute of Fiscal Studies) belong to the middle category, often denounced as “austerity-lyte”.  The mainstream position is this one, not Corbynomics.”

 

Tsipras being decisive, not irresponsible?

Put as a question as I can’t claim to know enough to be sure.  But some are castigating Tsipras for being irresponsible and subjecting Greece to unwanted and unnecessary uncertainty so soon after concluding the 3rd bail-out agreement, and receiving the first tranche of money [paid straight to the ECB].

An alternative narrative is that once the agreement was signed, it was a foregone conclusion that the Left Platform group and supporters would ultimately withdraw all support.  That would force him to rely on the cooperation of too many opposition MPs, who would extract a political price that might undermine him, and perhaps the agreement itself.  [Really, what else is he now, except the agreement?]  Indeed, they would be looking for the first chance to sink him and his Syriza rump.

Given that foregone conclusion, better to call the election soon, to give LP as short a time as possible to organise their own Party.  Obviously he calculates that he will swap LP MPs for almost as many names that he has hand-picked for his new party list, and who will owe their new career to him, and thus be bound into his personal project of implementing the agreement successfully.  If an election has to happen to secure Tsipras’ hand, and thus ultimately the fate of the agreement [which lies in demonstrating cooperation over implementation] what benefit is there to waiting?

It might look odd, since ultimately Tsipras decide that the Referendum’s ‘No’ meant ‘Yes’.  But he has presumably been looking at the same polls as everyone else, and sees that no-one else can capitalise on that abrupt change in strategy, or facing up to reality, however one sees it.

The next research economist advising traders to get onto the MPC should serve gardening leave beforehand

This suggestion was put to me by an old friend, and it seemed right.  To explain:

Jan Vlieghe – who I think is a great hire for the MPC – is shortly to start voting on the MPC, following his appointment to the slot vacated by David Miles.  I’d like to propose that the next similar appointment enforces a protracted period of gardening leave, a period between departing the former private sector employer, and casting the first vote, lasting a few months at least.

Why?  We are used to the idea that those moving from the public to the private sector should serve time like this, so that their knowledge of the Bank of England’s policy deliberations has time to become sufficiently outdated that the future private sector employer is not getting any unfair advantage.

But why the need for a leave period to mark moves in the other direction?

A classic job type – including Jan’s – is for a private company to employ economists to scrutinise central banks, and the data they are watching, to figure out as accurately as possible what they are going to do next.  And then to figure out based on that what a fair price would be for assets whose value is closely related to current and future central bank interest rates.  Like that country’s government bonds.

Over time, such an economist will build up a world view, sharing it with those actually taking risk in the company, getting feedback, probing it, modifying it when it is shown to be in error, and so on.  Those actually taking risk might not share that view [one such Tweeeted at me today something like ‘if I listened to our economists I would be bankrupted’].  But they certainly know it, from hours of grilling.

Part of the process of worldview building is likely to be of the following form ‘if I was in their shoes, this is what I would be doing and thinking’.  In figuring out what the MPC will do, it may help to figure out what the MPC should do.

As Jan, or any future similar MPC hire, casts their early votes, they will be doing so tackling the same challenges that were explained to their former employers, including helping unravel what they thought were misperceptions by the Bank, or emphasising good insights that the other, ongoing, incumbent members had.   This puts the former employer, (in this particular case Brevan Howard), at an advantage, for the period while this information is useful.

If procedures inducting members like the Treasury Committee hearings, or other procedures like the Inflation Report and the Minutes, were immediate and entirely transparent in communicating the new hire’s worldview, then the advantage got by one of your economists being hired as an MPC member will be very short-lived and immaterial.  But such procedures fall sufficiently far short of this to leave room for money to be made.

It goes without saying that Jan is just an example here and the problem is not specific to his hire at all.  It would have applied with the same force to Ben Broadbent, the late David Walton, and probably others.  It was pointed out to me that even those economists who work for large industrial corporates fall foul of this, since those companies have large Treasury operations who would make money by knowing a little better what would happen to interest rates.  So a hypothetical return of Spencer Dale, who went to be Chief Economist at BP, would present the same problem.

So the solution is to enforce a few months of gardening leave, enough time for the new MPC hire’s world view as it was when they left their private sector employer to be sufficiently outdated that their first few votes become no easier for them to predict than for other market participants.

 

Infinitely short and not variable

Here’s a recent restatement by James Alexander, at Marcus Nunes’ blog, of one of the tenets of market monetarism.  That monetary policy – via financial markets – has its effects instantaneously, always, and that the ‘long and variable lags’ commented on by Milton Friedman, which this blog is named after, are a figment of mainstream monetary economists’ imaginations.

“Many conventional macroeconomists still cling to the notion of “long and variable lags” before the impact of changes in monetary policy have an impact…. They could not be more wrong. Markets do the heavy lifting, the signalling, the changed expectations, instantaneously. The rest is history, or rather the inevitable playing out of those expectations in terms of high or low inflation, or rather high or low nominal growth. Of course, expectations can change as central bankers shift their views but often they get stubborn, with disastrous consequences.”

This is an intriguing, utopian view, stated before by Scot Sumner, the chief of the market monetarist tribe.  Unfortunately, there’s just no evidence in favour of it.

Dozens of applied macro economists, perhaps even hundreds, have been working on how to identify the effects of monetary policy changes.   The research came in several waves, as the profession thought more and more deeply about the difficulties of separating out the effects of monetary policy changes from the effects of monetary policy simply responding to other things going on in the economy.

But without exception – at least in the modern and best incarnation of this research – the lags are measured to be ‘long’.  That is to say, there may be some small effect that comes through quickly, but most doesn’t, and the peak effect of monetary policy is measured to come between 1 and 2 years after the change.  A classic survey from 1999 is this paper by Christiano, Eichenbaum and Evans.  But there has been a torrent of work since, reconfirming this basic message.

And those studies that look into their variability – me included – find that they are, though the jury is probably still out on whether that variability is fact, indicative of a shifting economic structure, or artefact.

That’s not to say that the effect of expectations is not important.  On the contrary.  And those that have actually tried to disentangle the effect of expectations changes on the economy find such effects, and, lo and behold, those lags are long too.  [I’m not aware if anyone has looked into whether they are variable, but knowing how such things are done, my guess is that we would also find that they are, with the same qualifications as to what one infers from that].

There are plenty of controversies in this literature.  But that there are substantial lags in monetary policy is not to my knowledge one of them.

Should Mark Carney be weighing in over Corbynomics?

In the past, I’ve written that Carney and other senior BoE officials have been speaking out of turn, on subjects like ‘inclusive capitalism’, the economics of volunteering, and whether we have the right model of corporate governance.  The complaints were that these are outside the BoE’s already large mandate, and encroach on territory reserved for directly elected politicians.

Were Carney’s comments also out of order when he said, as quoted by Peter Spence in the Telegraph, “The reason why one doesn’t even start on this conversation is the removal of any discipline on fiscal policy that comes from that”?  Fiscal policy is, after all, a matter for government.

Actually, I think Carney was right on this occasion.

Commenting on fiscal policy in general should be considered out of bounds.  But if fiscal policy is conducted in a manner that threatens the BoE’s ability to do the job entrusted to it, central bank officials are within their rights to point this out.  Financing public expenditure through money-printing would likely lead to higher expected inflation, as observers consider the probability that, whatever Richard Murphy says by way of later qualification, a Rubicon once crossed will be much more easily crossed again.  And that higher expected inflation will raise the costs – in terms of unemployment and real activity – of delivering inflation on target, if not become entirely self-fulfilling.

In circumstances like this, Carney’s dismissive tone was just right.  Taken to the limit, the interference in the conduct of monetary policy that would be entailed by occasional monetary financing amounts to making central bank independence a sham.  Better to point that out, and thereby clarify why current arrangements are not a sham.

I might point out, thought, that in the same spirit, it would also have been fine to explain how contractionary fiscal policy while interest rates were at or close to their effective lower bound also made it harder for the BoE to deliver inflation on target.  Carney and others took the [in my opinion Panglossian] view that ‘they have the tools’ to compensate, so the issue for them was an academic one.  But one could envisage a different MPC intervening in the debate about austerity in this fashion.