Haldane on how to get firms to do what we want them to do

Andrew Haldane, BoE chief economist, was interviewed by Newsnight’s Duncan Weldon, and he makes many interesting remarks.  Including comments that firms are too short-termist, are not spending enough on investment, are returning far too much money to  shareholders [this is presumably bad], and that we should consider alternative forms of corporate governance to make sure that the wider social good is served.

Such an occasion cannot pass without the customary reflex reaction pointing out that Mr Haldane is again talking on topics a long way from an already wide-ranging BoE remit.  Unless he can draw a connection between the BoE’s ability to hit its monetary policy and financial stability goals, and corporate governance, I don’t think he should be making these comments, however intriguing an antidote they are to run of the mill argument that businesses are best left to run themselves.

AGH does attempt to draw a connection, when Duncan reminds him of the Bank’s remit.  But it doesn’t work.  Paraphrasing the response, it’s that short-termism and speculation was the cause of the financial crisis.  That’s fine as a part-diagnosis of the problems with banks, which the BoE is charged with regulating but not as a description of the role of non-banks in the crisis. It also implies that the current toolkit to deal with bank shareholder mischief are not adequate, somewhat at odds with the official line coming from the Bank.  To the extent we can take this argument at face value it’s also self contradicting.  The crisis was caused in part by the private sector over-extending itself, failing to price risk properly and therefore undertaking projects that should not be undertaken.  Yet at the same time, collectively, according to Mr H, it under-invested.

Many might complain that restricting a free-thinking mind such as his to the pedestrian matters for which he was appointed means missing out, and wasting talent.  But, to those I would say the following.

First, off-remit freelancing carries with it risks.  In particular, risks that the next round of appointments will be vetted to make sure that the candidate’s off-remit opinions, [read, essentially, ‘politics’], are acceptable.  Personally, I don’t want senior BoE staff selected on the basis of whether they share the government’s current inclinations regarding interventionism.

But if the Treasury come to expect that new appointments will assume the role of informal economic commissar, with a brief to reflect on pretty much anything, they are going to have an interest in making sure that those reflections don’t complicate the general business of economic policy-making.

Second, the remit the BoE has is already extremely large, and the tools it has to pursue them are powerful and invasive.  Especially in the early phase of sitting atop such a powerful remit, the BoE has to be sensitive to the risk of becoming suspected of regulatory overreach or empire and influence-seeking.

All this is without getting much into the substance of this issue, which is, to say the least, controversial.

To paraphrase Nigel Lawson, the governance of business IS the business of government, and not the central bank.

Advertisements

Short post on fiscal short-termism

Paul Krugman complains at the harmful focus on the long-term in US fiscal policy, fighting to solve problems that are too distant to matter, while the need for short-term stimulus is neglected.

Just a conjecture, but I wonder if the longer term issues had been transparently sorted out, and in a way that was likely to hold, politically, perhaps the amount of stimulus that could have been squeezed out of Congress would have been greater.

At least part of the reason for the fiscal hesitancy in the UK in the early phases of the crisis was the burden of a history that the authorities felt bequeathed them with low credibility.   Even if you don’t subscribe to this, you might sign up to the idea that this was an argument that provided political cover for inadequate stimulus, while the state was surreptitiously shrunk.  Cover that if removed would have forced better policy.

Likewise, harping about structural reform – Krugman’s second complaint about long-termism – is not a distraction.  If the fiscal stimulus is being done by one polity in favour of another, it’s what persuades them to unzip the wallet, since they are thereby convinced that the money is going to a better cause, and not to pay for benefits that the electorate in the polity with the deeper pocket don’t get at home.  These issues may not be  something a benign social planner might prioritise, if such an entity were likely to face policy implementation bottlenecks.  But so what?

Given the way the world is, perhaps we should see addressing long-term problems as a way to generate economic and political flexibility to more vigorously respond to short-term needs.

 

The global surplus bogeyman recycling mechanism

It’s becoming almost a standard narrative that actually the crisis was not caused by the Greek’s overborrowing, but instead by inadequate demand in Germany, needing involuntary demand for Germany’s exports to stabilise Germany, a demand that later wreaks havoc.

Before this takes hold too tightly, I think it’s worth remembering basic open economy models of trade, in which current account surpluses arise naturally, and improve everyone’s lot, if they are related to the relative demands and supplies for future consumption, and relative returns.

Thus, as a mature economy, with scope for future income growth limited, and an aging one, with demand for saving higher to provide for old age, it would be natural for capital to flow to countries engaged in a process of catching up levels of average factor productivity in Germany, where marginal returns are higher.  Like Greece for instance.

In such a world, policy could shut off this intertemporal trade, but at great cost to both parties.

Part of the standard narrative is that this pernicious German saving was aggravated and helped along by the creation of the Euro, which, because of the weakness of the other countries, meant that German exports were overvalued.

The counterpoint to this is that nominal exchange rate regimes should not matter for anything much, intertemporal trade included, beyond horizons of 5 years or so.  Certainly not at the frequency of 2 decades, which is what some of the versions of the evil savings hypothesis deploy.

All is not quite so simple, of course, in the real world.  For the welfare improvements long- term current account surpluses and deficits to be there for the having requires that parties on either side of the trade understood the relative income profiles correctly, and also correctly understood the risks around them.

In the case of Greece and the other catch-up countries, it’s plausible to think that there ought to have been great uncertainty about just how far, given existing institutions, or plausible assumptions about how they would evolve, Greece’s income per head would catch up.  And that it was easy, in the early phases of that catch up, to guess the end point wrongly.  And we know now that there is much evidence, not least hindsight, that risks were not correctly priced in, or, if they were understood, were understood to be the business of someone else [in the case of mysteriously narrow spreads on EZ peripheral sovereign bonds].

Seen this way, the appropriate response is not radical and far-reaching intervention to prevent countries that want to save from saving, but mechanisms to tackle market failure in risk bearing and risk pricing.  Which is what, slowly and clumsily, is going on.

All that said, there are lots of problems with and puzzles for the basic toolkit on which those insights [they aren’t mine] are built.  But it should take more to displace it than simply the assertion and global recycling of the story of an evil capitalist saving bogeyman.

Charles Wyplosz urges Syriza to get ready for Grexit

Amusing:  just after blogging about why I think making a plan ready for Grexit would have been self-fulfilling, and sabotaging of plan A, Charles Wyplosz writes on VoxEU that they should indeed be doing that now.

His argument is – echoing Krugman, who is mystified this plan wasn’t executed earlier – that by planning for it carefully, the risk of hardship and chaos associated with a currency interregnum can be reduced, and this makes Grexit a more attractive option.

However, as I stated last time, I’d guess that by planning, openly, Syriza would make any other option extremely unlikely.

It would accentuate the current bank run.  While Greece’s future finances were dependent on Eurozone generosity it would also preclude there being any return of the vast sums of money that escaped Greece before capital controls were imposed from returning.

It would also surely harden the creditors’ stance.  For a start, it would strain to the limit the ECB’s preparedness to extend ELA to Greek banks.  It would act as a counter-signal about the government’s preparedness to implement the conditionality associated with a bail-out.   It would make it more likely that the creditors would judge Grexit as the eventual outcome, and thus make them less likely to fund Greece in what would, in that eventuality, be a futile attempt to keep them in the Euro.  Full readiness might cost several hundred million euros.  Are the Eurozone going to want to see their funding used for that?

From the creditors’ point of view, if such a plan were allowed to be pursued, what kind of precedent would that set for other troubled sovereigns?  Imagine how it would change the characteristics of the euro for its holders to know there were vast locked warehouses of many other currencies dotted around the territory.  A typical euro holder would be much more reluctant to leave wealth in the form of deposits domiciled close to one of those warehouses.  Knowing that the local polity could simply unlock the doors at the slightest whiff of a public financing problem would make a local deposit holder fear re-denomination.  Taking into account all this, the creditors will strain to make sure that such warehouses of alternative money are not built, nor the equally important operational ‘warehouses’ of battleplans for currency law change.

 

Greek plan B would have been self-fulfilling and sabotaged plan A.

Some are debating why Syriza appeared to have no plan B when it became clear that their strategy of trying to gain significantly easier terms for a new bailout was going to fail.  Paul Krugman puts it down to incompetence.  Aristos Doxiadis argues instead that having a plan B would have turned the Greek electorate against Syriza, since they were determined to stay within the Euro;  and that the act of spelling the plan B out would have revealed how bad it was, causing them to back down.

I think there was another reason.  Setting in motion operational plans for creating its own currency would have made that plan B self-fulfilling, by accelerating the bank jog into a full-scale bank run, as people feared their deposits being re-denominated into a new currency they rightly presume would be less valuable.

Such plans require contracts with large-scale printing firms;  they require brainstorming, drafting, agreement, sequencing.   A process that would need to involve at least dozens of senior officials across government, the central bank and the banks themselves.  Careful thinking has to go into which button to press when.  Much legislation would have to be drafted and passed.  Action plans would need to involve the police and armed forces, and someone who owns a lot of trucks.

It would be impossible to carry out these tasks in secret without leaks in any government.  And certainly in trauma-torn Syriza.  [Witness the pulling-his-hair-out cry for help document written by central bank governor Kournaras a few weeks ago].  Leaks would sew panic and chaos, and probably jeopardise negotiations over the terms of plan A, the  bailout.  [‘Why should we fund them if they are about to cut and run?’]

The lack of a ready to go plan B is therefore not an accident.  Look around the other countries in the Euro, and my guess would be that there is also no ready to go plan B.  Because having one would undermine the degree to which being in the Euro constitutes an act of hand-tying;  and therefore erode one of the key supposed benefits of being a member.

A Plan B that was already worked out and ready to execute at speed would be like a marriage in which both parties have their kitchen walls adorned with post-its for divorce-lawyers and ready to go applications for internet dating websites.

 

Should the UK Treasury appoint another ‘dove’ to the Monetary Policy Committee?

Recently, ex-MPC member Danny Blanchflower, known for his ‘dove-ish’ views on interest rates, wondered who would get the ‘dove-ish’ seat on the Monetary Policy Committee that David Miles was vacating [leave aside that DM would reject that label], and Danny and others before him had filled.

This begs old questions like what is a dove or a hawk anyway, and are there places for these people on the Committee.  The answer, in my opinion, is:  yes and no!

The inflation targeting mandate is decided by the Treasury, so there is no question that those who are not prepared to accept that objective – and put aside their own personal views about the optimal inflation rate – should not be given the job.  Otherwise, the delicate but beneficial separation of powers [between the power that the BoE has to control the instrument as it sees fit, and the power of HMT to set the goal that the BoE aims for] would be lost.

The MPC are, however, asked to determine the ideal trade-off between fluctuations in inflation and real activity.  Partly because there is no hard and fast answer to this important question, it is delegated to the experts.  And for the same reason, there is scope for disagreement amongst MPC members about that trade-off.  Reasonable people can differ on unsettled questions in economics.

A ‘dove’ might then be someone who is relatively tolerant of inflation fluctuations, and prefers instead to keep unemployment/real activity stable.  Given a long enough run of business cycle experience, however, that should not translate into this dove voting for a level of interest rates that differs from average from someone who was hawkish defined this way.

Since that’s true only for a ‘long enough run’ of experience, though, it might well be possible for an MPC member to differ on average for 1, 2 or even 3 year terms, and still be behaving in a way that is acceptable according to this technical definition of a dove.  Such a person would be hard to distinguish from an MPC member that simply preferred a different inflation rate from the target set by HMT.

On this definition of a dove, there probably is a role for seeking out a range of views for the MPC and ensuring balance.  Ideally, the only qualification would be a preparedness to look at the question of the trade-off afresh and assess on the basis of the evidence at the time.  But, since it’s hard to verify whether this is being done faithfully, and people inevitably have prior exposure to this grandest of policy questions, that ideal is not likely to be feasible.  So it would be natural to seek a distribution of views that reflects professional uncertainty about the trade-off.

So, if there is a role for these kind of doves and hawks, how would you find them?  If life were as simple as a New Keynesian model, you could simply ask them about a few of its primitive parameters and be done with it.  But it’s not.  Could you just ask them whether they were comfortable with the current policy stance to get a feel for their trade-off-dove-ishness relative to those currently voting?

Sometimes.  But the read-across from trade-off dove-ishness to views about the current policy stance would not always be straightforward.  As the MPC were experiencing a large trade-off inducing shock in the early phase of the crisis, allowing inflation to rise to >5% as output and employment were driven down, the job was easier.  A trade-off dove was one that was relaxed about the choice to allow inflation to go so high.

However, supposing that right now we are in the middle not of a trade-off inducing shock, but a straightforward case of too-weak demand, [driving both inflation and activity below ideal levels] then you can’t infer trade-off dove-ishness from how relaxed people are about the current large undershoot of the inflation target.

For all these reasons, it would not be right to try to populate the MPC with doves or hawks more conventionally defined – just preferring lower or higher interest rates right now, simply for the sake of it.

Of course there’s more to it than the above lets on.  If there were not, there would be no scope for disagreement about the current level of interest rates.  Assuming that I diagnosed the current shock correctly.  But of course I may not have; and in fact there may be reasonable disagreement about the extent to which the current constellation of shocks is trade-off-inducing.  And there may be disagreement about the costs of pulling the policy levers to stabilise the economy.  Or disagreement about the persistence of the shocks hitting the economy.  Or, in fact, about any number of things.

None of these things mitigate against seeking a range of views about the current level of interest rates.  Far from it, but they do mean that it could be hard to know what kind of person you are getting for your current interest rate vote, so that conventionally defined ‘doveishness’ is not to be prized for its own sake.  [Or hawkishness for that matter, of course].

Mark Carney and the yield curve

Mark Carney hints that interest rates may rise at the end of the year, and many of the more compressed media pieces on his intervention turn a hint about the obvious into something that sounds like a racing certainty.  For the purposes of balance, therefore, it’s worth mentioning the following:

1.  De jure, Carney speaks for how he will cast his own vote only, though, de facto, the voting record shows that the internal members of the Monetary Policy Committee cast votes that are disproportionately correlated with each other.

2.  We can recall from Carney’s two interventions around his 2014 Mansion House speech that he is capable of back-tracking quickly.  After that, a rational Carney watcher puts a higher weight on any given signal containing more noise.  This is to put to one side the debacle of Carney’s unemployment-trigger-forward guidance;  the non-stimulative policy that was nevertheless meant to ‘secure the recovery’, and which scuppered the chances of a future MPC using genuine forward guidance as a preventative tool against the next crisis.

3.  Weighing against the policy guidance are several factors:  the hard to quantify, depressing effects of the ongoing Eurozone crisis and the risk of a disorderly workout;  the continued headwinds from fiscal policy, which, despite the inappropriateness of this when close to the zero bound, will be tight for the foreseeable future.  And not to mention the fact that inflation has failed to begin its return to target as predicted.  On Radio 4 this morning Andrew Sentance claimed that rates needed to rise before inflation began rising back to target.  Waiting until afterwards would be waiting until it was too late, he implied.  Well, that’s not consistent with the Bank’s own model, I wager, nor with any that I know.

4.  Despite the confident assertions that the MPC ‘have the tools’ to loosen should it be necessary, the reality, in my view, is less heartening.  Even QE believers worry that the marginal returns from this policy have fallen.  Despite needing to ‘secure’ that recovery, Carney urged the MPC to set aside this tool, probably for the reason that they felt those marginal returns had fallen too far.  Interest rates can be lowered a bit, but to what effect we don’t know.  The Government has boxed itself in again so that a significant loosening would be an embarrassing back-track.  (Although against that there is no real opposition to capitalise).  On the other side of the risk-management balance sheet:  should it prove necessary, fiscal, interest rate, asset purchase and macroprudential tools can all be tightened, with at least 3 of those policies highly likely to work in the way intended.

5.  These factors mean that the risks of a premature tightening outweigh the risks of one that is too late, considerably, a judgement that is coloured by recent anecdote in the form of the Swedish and Eurozone experiences.  In David Miles’ last speech he concluded that there were not great risks of a deflationary spiral as the economy approached the zero bound.  But I don’t agree.  The crisis has given us one observation only on that issue.  And one that can be read a number of ways [eg:  it takes extraordinary, extreme monetary and fiscal stimulus to avert a deflationary spiral].  And the models we have to make sense of most macro policy issues tell us that there are tangible risks of such spirals.  David leaves the Committee with central bank rates having been trapped at the zero bound for the duration of his stay.  Not necessarily an experience that endorses the view that we know how to provide adequate monetary stimulus to combat a large recession.

So, don’t be too sure that it would be optimal to raise rates quite that soon, nor that the MPC will conclude that it is.