Corbynistas need reminding what central bank independence is and why it’s good

These points will be old hat to economics cognoscenti, but they need repeating because of how the debate about ‘Corbynomics’ has been conducted.

I’ll single out Richard Murphy, Corbybn’s economics advisor, as an example, citing points he made in his discussion of the proposed ‘People’s Quantitative Easing’ [PQE] with myself and others.

But the views addressed here have surfaced many times in recent months, so RM is not the only rhetorical offender.

One is that ‘central bank independence is an illusion’.   Being so, PQE or any other policy that seems to intrude on central bank independence is not a problem, because there is nothing lost by dispelling an illusion. In fact, the ‘illusion’ analogy suggests, PQE or similar may allow us to see things how they really are.

It’s certainly true to say that, in functioning democracies what central banks do follows from choices made by electorates, or at least by politicians on electorates’ behalf. In the UK, for example, the electorate chose a Labour Government in 1997, and on its behalf it delegated to the Bank of England the task of wielding monetary policy instruments, but in pursuit of a goal it would determine. [Lately finessed to express this as stabilising a combination of inflation and real activity].

So what the BoE actually does with interest rates and asset purchases from month to month traces back to decisions voters made in May 1997.

That being the case, Mr Murphy’s arguments imply, there’s no problem voters choosing Jez’ manifesto, and, along with it, instructions for the Bank of England to buy bonds issued by a new Government infrastructure investment vehicle.

However, there IS a problem, deriving from the fact that, despite this ultimate democratic control over the monetary authorities, there IS a form of central bank independence, which we might more revealingly call ‘curtailment of government control over monetary policy’ and put there not by accident, but purposefully, to solve a pre-existing problem.

The curtailments of government control are twofold. First, the BoE has control over the instruments on a month to month basis.   This gives confidence that the government won’t say one thing [‘price stability!’] and do the other [‘cheap mortgages!’] with the instrument. This is known in the trade as the BoE having ‘instrument independence’].   Second, by passing the BoE Acts, in which the broad terms of the BoE’s goals are set out, the government restricted its day to day freedom to change the goals of monetary policy.   For sure, new Acts could be passed, and the goals re-written. But this would cost the government, in reputation, Parliamentary time and even political favour.

The Acts themselves contain clauses allowing for the government to take back control over monetary policy instruments in times of national crisis. But if these were used lightly, the benefits flowing from passing the Acts in the first place would evaporate.   So, despite the existence of those clauses, the Government’s month to month control over monetary policy goals and instruments is curtailed.

This begs the question what those benefits are. Having established that central bank independence [read curtailment of government control over monetary policy on a month to month basis] is not ‘an illusion’, we still have to remind ourselves why such curtailment is a good thing.  A second line of attack adopted by Richard Murphy in some of his media encounters, inconsistent with the first ‘central bank independence doesn’t exist’ strategy, is the line of attack that central banks should simply do what governments want them to (sounds reasonable, put like that, doesn’t it) and if they don’t like it they can go and take a running jump.

The reason curtailment of government month to month control is a good thing is that politicians themselves proved that they could not be trusted to set good monetary policy themselves.

Governments have horizons limited by the electoral cycle, and, in a tight race for re-election, will be unable to resist pressing the economic accelerator to create a boom that they can then take credit for. Only later, after the election, putting on the brakes again.   Subjecting the economy to damaging ‘political business cycles’. A related problem with government control is the issue of time-consistency. When it starts out, the government promises low inflation, hoping to be rewarded with muted wage settlements and low bond yields. However, once the advantages of that promises are pocketed, the temptation to renege and generate higher inflation is irresistible, because it will boost employment [by eroding real wages] and lower the real value of government debt.

The way out of this was for the government to make it more costly for itself to change the inflation rate from period to period. Which is just what the complicated legislative infrastructure of monetary policy does.

In a Twitter exchange, responding to my ranting about how PQE erodes central bank independence [why it does this I explained in previous posts], Richard Murphy said ‘you hate democracy, don’t you’. Hopefully if you read this far you can see what my answer to this is: Of course not. But governments acting on behalf of electorates in democracies face time-consistency problems. And have to devise solutions to them to make their electorates better off [in this case by generating low and stable inflation]. The particular solution discussed here [central bank independence] was itself chosen by the electorate, pretty much. Or at least, plenty of time has elapsed for the electorate to have a pop at overturning it.

So defending central bank independence is not anti-democracy. On the contrary, it’s campaigning for a democratically chosen institution. And one that makes the economy in a democracy function better. Perhaps, ultimately, allowing the institution of voting to endure. If you think that sounds overblown, think of the examples of Weimar and Zimbabwe, and wonder if better designed and more resilient institutions might have made the outcomes there more favourable.

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Reading list from Twitter

An excuse for a blog post, but one of the things I like most about Twitter is how it’s showered me with great reading recommendations I would never have come across otherwise.  In case any of you have not read these, they are all great, and thanks to those Tweeps who passed them on.  I can’t remember who they were.

The deluge [Adam Tooze], Modern Greece [Stathis Kalyvas], Nixonland [Rick Perlstein], Poor Economics [Banerjee/Duflo], The True Believer[Eric Hoffer], Command and control [Eric Schlosser], 1491, [Charles Mann].

I’ll take the risk that this looks like book-dropping [literary equivalent of name-dropping] in the hope that it prompts people to reply with more.

Helicopters and slippery slopes

One of the reasons I am against using helicopter money as a counter-cyclical monetary policy tool is that, once society gets a taste for it used in these circumstances, there will be pressure to use it for acyclical purposes, financing whatever might win an election.

Well, if you think this is concern-trolling [an internet term I only recently realised applied to me], you need look no further than the debate about helicopter money in the UK.  The early interventions, in the darker days of the crisis, urged it as a tool to boost aggregate demand and close the output gap, while conventional fiscal policy was constrained.

Now, with the helicopter idea out there again, comes the next step:  Corbyn’s ‘People’s QE’, being touted as a means of general deficit financing, pretty much orthogonal to whether it’s actually needed for monetary policy purposes [since no reference is made to the fact that those charged with monetary policy are not voting for more stimulus of any kind].

You can see why.  Corbyn is making some expensive promises about ending austerity and renationalising industries.  After all the fuss caused by proposals to sell slightly more bonds than the Tories, printing money seems like a corridor of least resistance.

Going further back, you could argue that the first slippage was QE itself.

As the public grappled with the ‘print money, buy assets’ meme, it’s only natural to wonder why if the Bank can buy those sterile old bonds, it can’t buy something more useful for us all.  Such worries were alive and well when I was in the Bank of England.  And they were not helped by the UK Treasury using the ‘profits’ from these purchases [which one would expect to be reversed later, as assets are sold by the BoE] to reduce its routine borrowing.

This is a small argument in favour of the idea pushed recently by Miles Kimball and Willem Buiter, that institutional reform should be undertaken to remove the zero bound to central bank interest rates, to preserve maximum continuity in monetary policy operations when a large stimulus is needed.  Or, in due course, of raising the inflation target.  This would not achieve the same flexibility in permitting large stimuli, but it could be got with less institutional innovation, and a smaller risk of a kind of ‘WTF’ moment when the populous grapples with the idea it has to pay someone to borrow their money from them.

Stepping back, the resurgence of helicopter money talk of one sort or another has been one episode amongst many that show the forces arrayed against monetary policy regime stability.

When interest rates were pushed to their natural floors, and inflation was allowed to rise into the 5 per cents, the conservatives thought this an example of outrageous overreach, and/or forecast spiralling inflation.   Now, on the other side, we have calls for the authorities to solve our problems by harvesting magic money trees.

So far, the monetary policy regime, held together in the UK at least by slender legislative threads, has stayed intact.  That it has is pretty impressive.

One of the things I grasped in my time writing speeches for my betters at the BoE was the idea that monetary stability wasn’t simply a technical matter of the monetary authority figuring out the right interest rate setting, or even the Treasury figuring out the right mandate to hand off to the central bank.  It was the endurance of a political consensus about what the means and goals of monetary policy should be.

It often seems like there are a great many who don’t share the same basic understanding of the mechanics and benefits of monetary policy as the economics profession [who knows they may yet be proven right].  So it’s something of a marvel that what I see as basically the right monetary framework has survived despite this lack of understanding.

Super Thursday=Mansion House redux

That was the summing up of Moyeen Islam on Twitter, and I thought he captured the event neatly.

To explain what he meant:  The Governor’s Lincoln speech, in which he said that the decision about whether to raise rates would be ‘thrown into sharper relief’ at the beginning of next year, was, as he surely knew, going to be taken as a signal that, relative to before, markets should bring forward their estimate of when the first rate rise would come, and increase the probability of such a rise early in the year.  The totality of his remarks, the MPC minutes and votes, and the Inflation Report, by contrast, were taken, as the Governor and his fellow MPC members surely anticipated, as sending the opposite signal.

So, the Governor succeeded in talking up the yield curve at Lincoln, and then talking it back down again in the Inflation Report Press conference.  This echoes what happened at Mansion House in 2014.

The Governor was clearly irritated, yesterday, as in 2014, that his remarks appeared to have been misinterpreted.  [Witness his bad-tempered put down of the Guardian’s Heather Stewart, claiming she had not ‘read the speech’, unreasonable given that he will have known what he was going to do to the yield curve at Lincoln.]  One might have read him as saying:  you BoE watchers, you need to do your job better.

However, the lesson for me was that the MPC needs to do its job better, and simply release its best guess at what the trajectory of interest rates will be, given how it sees the economy developing.  Or rather its best guess at the distribution of future rates.

Ben Broadbent tried to head off such demands, which were encoded in the questions put at the Press Conference, by suggesting that it ‘would be foolish to pre-announce’ the future path of rates.  Carney himself adopted a similar tactic by saying that ‘the precise timing’ of the first rate rise could not be known in advance and would be ‘data-dependent’.  But these comments rebut a request that was not being made.  What was really being requested was that the MPC reveal the forecast trajectory for future rates in which the current vote was just one part.

To re-emphasise, I urge them not to compute something that isn’t already computed.  But to reveal what must already have been computed and, for reasons undeclared, is being withheld from the BoE’s audience.  This forecast distribution has to have been already computed because, when policy works with lags that are long and variable, and other shocks have effects over many periods too, a coherent monetary policy choice is a choice over a trajectory, and not a choice over a single rate.

Some readers might remember Mervyn King’s famous adage that they faced ‘one ball at a time’, which was to be understood as meaning the MPC does not worry about future rates.  But that could not have been true then and is not now.  The remarks of Broadbent and Carney veer towards encouraging the same view, that monetary policy can be done in a static fashion.  I can sympathise with wanting to take questions in this way, because the BoE don’t want to be put on the spot for simply concealing from us something they know.

But I hope people do put them on the spot, because it seems to me there is little merit in the deception.

The situation we find ourselves in, where the conversation happens with verbal hints, is like a mix between Groundhog Day and Tom Stoppard’s Dog’s Hamlet.

In the latter, characters talk in a barely decipherable code:  the language is not English, even though all the words are English.  Thus, we have continuous MPC communications in code, incorrectly parsed by the audience, with further communications about what was or was not said.  And the whole episode gets repeated over and over.

I played one of the characters in Dogs Hamlet, and had to commit to memory the line ‘cycle racks hardly butter fag ends’.  This being about 30 years later, I have no idea what the line was supposed to mean now.  Likewise, even a few days on, I’m not sure I know what ‘thrown into sharper relief’ means in this game.

[Thanks to Mark Butler for spotting a slip in the first edition of this post:  I misinterpreted Carney’s remarks about the state of the yield curve pre-Inflation Report].

The people’s public institution bonfire

A quick post to tease out more clearly the issue of whether or not Corbyn’s proposed ‘People’s QE’ would be inflationary or not.

The reason it would be is because it sets a precedent for using money creation to finance public expenditure, a precedent that those thinking of buying government bonds, or negotiating wage contracts, would expect would be repeated.  That expectation of inflation would be to some extent self-fulfilling.  And if the precedent were followed, more money would surely mean more prices.

Yet the policy has been proposed at a time when interest rates are at their practical floor of zero, alluded to in a comment by Richard Murphy – Corbyn’s cheerleading advisor on this matter – who asserts that there is ‘a shortage of money’.

This doesn’t provide room for PQE.  For starters, the current Bank of England Monetary Policy Committee don’t think there should be any further asset purchases, or any further monetary loosening, for that matter.  They judge that the current stance of policy is sufficient to bring inflation back to target.  From their perspective, there is no ‘shortage’.  Reasonable people can disagree about this, of course, but it would require subversion of the MPC’s judgement on shortages to implement any PQE right now.

Failing that immediate subversion, what is being proposed is really a hypothetical monetary financing, one that may never happen.  Or even if it were to happen, one that might be expected to be curtailed once monetary policy goals were achieved again.  Such cyclically mandated monetary expansions can’t provide for sustained public infrastructure investment.  And, indeed, the very fact that such things imply sustained flows of finance would inevitably engender the expectation that what is supposed to be cyclical monetary policy in fact won’t be.

Chris Dillow alludes to the point that there is no reason to stick to the current inflation target.  In fact, I have argued before that we should, at an opportune moment, raise the target to 4 per cent as a preventative measure so that future business cycles lead us to spend less time at the floor to interest rates.

Could a Corbyn’s PQE not be part of a means of achieving that?

A couple of points.  First, the higher inflation target, once met, would not itself produce much extra government revenue from the faster rate of money creation.  Seigniorage is not a great earner.

Second, the risks entailed in monkeying around with the inflation target, which brought hard-won price stability after a terrible few decades, mean that this ought to be undertaken in as regular and conservative way as possible.  For me that means waiting until a period has elapsed where we are at the current target, interest rates have climbed back to their resting point, and then a new interest rate stimulus can be applied, probably after the BoE has unwound the portion of its asset purchases that it judges it should.

Would not print money for a Corbyn cabinet.

The chatosphere seemed ablaze today about UK Labour Party leadership contender Jeremy Corbyn’s plans for a ‘People’s QE’.  Richard Murphy was reported as being on World At One defending it, based on its resemblance, I presume, to a ‘green QE’ plan he wrote about some time before.  [For a comprehensive demolition of that, see Frances Coppola’s blog].

There is lots wrong with Corbyn’s plan, and I don’t think shadow Chancellor Chris Leslie’s attempt to counter it really works either.

First, I dislike the populism behind the label ‘People’s QE’.  It implies there was something elitist about the QE the BoE conducted.  For sure, QE had distributional impacts.  But the counterfactual, if it had any effect at all, would have been life much worse for those that would experience the deeper recession, which, historically, has always been the poor, since it’s they who disporportionately suffer unemployment.  If we can wave a QE wand for ‘the people’, why not proclaim a ‘People’s Interest Rate Policy’ too?

Second, and more importantly, Corbyn’s plans are not being presented on monetary policy grounds only.  Any attempt to hijack the printing presses for general deficit financing, when loose money is not necessary to achieve the BoE’s mandate, will wreck monetary policy for a long time to come.  Simon Wren Lewis, who actually favours helicopter money transfers for monetary policy purposes, made this same point on Twitter [at least I read him that way].

The reason for the wreckage will be that the next time the Government fancies winning an an election by promising grand public works schemes, it will be expected that the BoE will print money to finance that too, and this will lead to more inflation, and, because this will be expected, will make it ever harder to finance expenditure this way.

Corbyn’s QE is the first step along the road to undermining the social usefulness of money, and would ultimately impoverish us.

If we were in a state of monetary policy crisis, then QE-financed something is at least worth considering, and Wren-Lewis, Lonergan and I think Portes have all supported the idea.  But that something should be as politically neutral as possible, and not a matter for the BoE.

At any rate, even in such a state, I would consider this an almost last resort.  [The very last resort being altering the institutions of money to permit substantially negative nominal interest rates].

The first resort, which Corbyn and others should be considering, is simply a slightly looser and conventionally bond-financed fiscal stance.  Together with, as I and others have urged, some institutional device to make assistance of monetary policy semi-automatic at the zero bound to interest rates.

The fact that Corbyn has not simply gone for what I describe as the first resort, even in a more accentuated and therefore left-appealing fashion, is striking, and betrays a lack of basic understanding, or a Magpie-like attraction for the radical-sounding, or both.

To amplify a point made earlier, all this is not to say that there is not a perfectly arguable case for looser fiscal policy, directed now in pursuit of public infrastructure projects.  The linchpin of that case is the fact that current real financing rates for such projects might be argued to be fortuitously low now, and future generations would lament that we did not take advantage of them.  At the same time, current public infrastructure is argued to be ailing in many respects [power generation and rail being the most obvious cases], and so social returns are high.

However, that said, this is not something that should be done in a way that involves the Bank of England directly, and nor need it be done this way.

Whether the ‘People’s QE’ will prove an electoral liability, who knows.  In my experience, QE is hard to fathom, even for senior central bankers, so it might prove catchy in the wider public debate.  But, if Mr Corbyn could be made to see that it’s unnecessary and silly, the electoral downside risk for his party, of coming to seem like financially inexpert cranks, would be avoided.

Insufficiently conservative central bankers

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Simon Wren Lewis writes thoughtfully about my post arguing that Andrew Haldane should keep his views on matters outside the BoE’s remit to himself.  It’s socially wasteful to clip the wings of visionary thinkers, he points out.

However, a few points.

First, a hypothetical, ruthlessly-remit-focused Haldane isn’t all waste.  It frees him [and the groups of the best analysts picked to support him] up to focus on… stuff that is within the BoE remit.  And for which he’s paid circa £250k a year in total compensation.

Second, visionary thinkers command many outside options, and they are free to take up posts whose remit isn’t so narrow, in academia, think tanks, or some other policy institution.   There’s no reason all those thoughts should go to waste even if the Bank chose not to fund them.

Third, remember that the reason for wind-clipping has its roots in the principal-agent problem in monetary policy.  That was the issue that governments could not be trusted to keep interest rate decisions untainted from considerations about what would win the next General Election.  Delegating to the central bank, a bunch of people with no stake in politics, and hired only to crank the tedious handle of monetary policy, was the solution.  For everyone to be convinced that this separation is being stuck to requires that it is stuck to.  So the central bankers have to be evidently without any stake in politics.  And the government has to be seen to have no reason to select on the basis of political favour.

The central banker not having any stake in politics is not consistent with them speaking out on matters that are political.   And neither is a politically-intrusive central banker consistent with the government having no interest in that central banker’s politics.  It’s possible that there was no problem in the first place, so wing-clipping is just bad.  However, there’s a fair amount of historical and theoretical experience that suggests that politics does make for worse monetary policy.  And even if this is not conclusive, I would prefer to err on the side of caution.