Surfacing how much Underground there is in the new BoE blog

Simon Wren Lewis joins in the celebration of the Bank of England’s new blog for staff.  But I think he can be read as going a bit too far in divining a message – and discernible dissent – in one of the first posts, by Haberis, Masolo and Reinold.

The Bank Underground compares two simulations of the distribution of inflation, one where the effective lower bound of 0.5 per cent constrains policy, and one where there is no constraint on monetary policy, and highlights the increased probability of deflation in the former relative to the latter.  Simon says ‘The blog does not discuss the policy implications, but they are pretty obvious.’  And goes on to explain that these implications are that, faced with such a risk when you are constrained, you should be overshooting the inflation target in the most likely scenario.

Simon clarified on Twitter that he didn’t intend this reading of his words, but, I think some might read him as saying ‘see how subversive the new blog is: they are allowing staff to communicate that they think the MPC should be overshooting the target’.

But there is nothing in the post to tell what the staff think is the most likely simulation.  The MPC have said on a few occasions that they ‘have the tools’ necessary to deal with the current conjuncture, which implies that they think they are unconstrained.  [Assertions that I think are hard to substantiate btw].  And the staff are careful not to contradict this message.  I suppose that the very fact that the constrained simulation is there at all might be interpreted as some sort of oblique hint.

The weighty issue of what one can and cannot read into a Wren-Lewis text aside, I’d give the Bank a ‘could do better’ mark for transparency on this post.

You can see that the senior management have gone with it because they think that by leading with a potentially sensitive topic they are signalling that this is going to be a forum for dissent and free thinking.

However, the very boldness of this signal of intent is contradicted somewhat by the editorial decision to ensure that the authors are silent about the main point.  That being, of course:  are the MPC to be thought of as constrained, contrary to how they describe themselves?  And is their distribution of future inflation given what they have in mind for their instruments too deflation-heavy or not?

[If it isn’t already obvious from the above, I don’t blame the authors for these things at all].

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BoE cultural revolution: staff blog and uncensored working papers

Today is a big day for the Bank of England.

A staff blog, ‘BankUnderground‘, with connotations of radicalism that will be tough to live up to.   And a relaunch of their working paper series, now emphasised to be a Staff Working Paper Series to mark the fact that these will not be censored for conformity with BoE policy lines.

Both of these seemed impossible even a few years ago, it being enough to suggest these things for one to be branded as naively failing to grasp the business risks, or the importance of cherishing continuity.

For those of us who scrambled over the wall to the outside world to escape the constraints the Bank imposed, it feels slightly disorientating to watch the BoE getting on with a revolution, and with scarcely more fuss than it organised the universal ‘One Bank’ screensaver.

I managed researchers who struggled with the task of self-censorship at the idea-formation stage.  I managed others who were more oblivious, and ended up careering with their mildly critical texts into the implacable opposition of the Press/Governor’s office.  And still others who had oblique technical papers about macro prudential policy blocked from appearing at an obscure conference by the current Chief Economist.  And, in a short stint in the Governor’s Office myself – lest you think my hands are entirely clean – I was responsible for pulping one working paper whose subversive vector autoregressive econometrics had somehow eluded the eyes thus far cast over it.

All changed.  Most of the old gamekeepers have left, and those that haven’t are now turned into poachers by Mark Carney’s different perspective on transparency and openness.

It’s early days, of course.  We will have to see whether, when there is something really at stake for the institution, these outlets reveal anything of substance about staff-policy-committee discord.   Or how the BoE manage work that appears to contradict not just its own views, but those of its HMT principals.  And Mr Carney has only 3/5 of his time left, so there is also a risk that he will be seen as the Gorbachev of Bank of England Sovietism.  A brief period of happy glasnost before the next regime closes in.

However, I am more optimistic.  Rather unscientifically, I conjecture that openness and transparency in Western institutions has a way of being hard to reverse.  And that this is also a reflection of a generational phenomenon.  It would be inconceivable today that the Bank’s internal performance criteria for young analysts include, as they did in the 1980s, ‘manner and bearing’.  Likewise, future generations will not believe that once upon a time the BoE working papers were so closely vetted that the disclaimer ‘these are not the views of the BoE nor the MPC…’ was a routine contradiction.

Hyun Shin on US monetary policy and emerging market deleveraging

Hyun Shin’s presentation, at this week’s BoE/IMF/Hong Kong Monetary Authority conference on monetary policy and macro pru, went something like this.

One dimension along which the dollar has become the global currency is in denominating debt, especially in emerging market economies, presumably because of a history of institutional and other local risks there.  This happens, increasingly, between parties neither of which are domiciled in the US.  At the point where the Fed begins to tighten, any resulting increase in the dollar may set off a debt-deleveraging event.  Higher value dollar debt relative to the home currency of the borrower leaves that borrower with a higher debt-service burden, whose per period home currency revenues or income are now worth less.

This makes the borrower more likely to go under, which increases the riskiness of the portfolio of the lender, who may respond by switching assets away into something else;  the effect of which may be to aggravate the problem even further, as it starves those same foreign currency borrowers looking to roll over funding, reducing their net worth and increasing their riskiness still further, and so on.

Hyun put this forward as one reason why the Fed ought to have thought carefully about loosening so much in response to the financial crisis.  The effect of which, by depressing the dollar relative to the counterfactual, was to encourage dollar-denominated borrowing.  Presumably, since we start from here, not 2009, the implication also is that the Fed, having erred by over-doing it, should tighten cautiously [pointed out at the conference by Steve Cecchetti].  Note that these concerns are urged on the Fed even if they are focused solely on their US mandate, because of the effect of a blow-back on the US from these important markets.

In his discussion of Shin, Charlie Bean questioned whether the mechanism he had  identified was quantitatively important enough to worry about.

In the same spirit, imagine this concern put before the FOMC as they contemplated the grand loosening strategy in the aftermath of Lehman’s demise.  One might charactarise Shin as having articulated a risk, relative to the New Keynesian, finance-free model that the Fed staff use for forecasting, of over-doing the stimulus.

However, recall that at that time central banks were probably estimating that the zero bound was going to deprive them of something like 6-8 percentage points of interest rate stimulus.  And they did not have the evidence they comfort themselves with now of the encouraging impact effect on long yields of quantitative easing.  Moreover, they would have doubted the willingness of Congress to pass a sufficiently large fiscal stimulus package, and wondered too about its efficacy.

So by far the predominant concern was that there would be far too little stimulus, and the economy would get trapped as the zero bound, as Japan appeared to be, and as the same models with our without finance explained could happen.  Indeed, as things have panned out, with a protracted period of below target inflation, and time spent at the zero bound far longer than most predicted, these concerns were arguably proven well founded.

Shin’s risk of stoking a foreign currency-borrowing related spree in emerging markets would, I suggest, have been dwarfed by this concern on the other side.  In the absence of any constraints on policy, one might have expected the Fed to fine tune it somewhat to insure themselves against the risks Shin identifies.  However, forced to chart a path a long way from the ideal by the many constraints placed upon them, such things would have made no difference at all.

How not to intervene in a crisis: Bank of Greece version

This was my reaction to reading this document, circulated on Twitter today by Ambrose Evans-Pritchard.

It makes some controversial forecasts, for a start, including predicting that Greece would be booted out of the European Union, not just the Euro, if there is no agreement leading to another bail-out.  Without substantiating this.  And really?  I can see scenarios where that happens, but many where it doesn’t.  Predictions like this are set against other statements – far more believable – that it’s actually very hard to forecast what would happen to Greece.

It makes many statements that are intensely political in the current climate.  Including, for example, asserting its  belief in further liberalising structural reforms, a matter on which central banks are not paid to be experts, even if, by dint of general knowledge, they might think they have their own views.  The likely response from many will be ‘oh, you central bank neoliberals with your connections to the networks of the Greek right, of course you would say that’, weakening the BoG’s ability to do its regular job.

An even more central example is the urging of continued Euro membership come what may.  Whether or not Greece stays in the Euro or sets up its own currency arrangements again is a decision not for the central bank of Greece, but for the Greek polity.  BoG might mount a defence pleading that its recommendations are the best for achieving its mandate of financial stability for Greece.  But agreement on harsh terms might not necessarily be better for that mandate.

If Greece were to leave the Euro, [when the executive could do whatever it likes with the Bank of Greece], and perhaps even if it does not, these political interventions bode ill.  They are highly likely to lead to pressure to make sure that the next round of appointments over which there is political discretion to be made on the basis of fealty and not economic and financial expertise.  Or at least that this will be expected.  And many bad things flow from that.  Central bank independence works best, and is most likely to be enduring, if it is, as far as possible, ‘instrument only’ independence, and questions of what central banks do and are for are left, at least in public, to the electorate and its representatives.

The report also a strange tactic, because has the effect of weakening the bargaining position of the BoG’s political masters.  If Grexit could be executed smoothly for Greeks, the Eurozone would feel under more pressure to offer more favourable terms.  And it’s a tactic that makes the bad things it fears would happen more likely to happen.  If you run around screaming ‘FIRE’ in a peacefully operating blast furnace, there’s more chance of a fire in the ensuing panic.

Conspiracy theories flourish in crises, and this report is likely to encourage the view that its implicit criticism and weakening of Syriza is a calculated political tactic.  Maybe it  isn’t, but the risk that it would be seen this way is surely plain, and makes the text all the more regrettable.

You can see that these concerns constrain the author.  For example, it’s not clear who they are urging to do what.  Are they saying Syriza should budge?  Or the Eurogroup?  Or are they urging a split the difference?  And on what criterion?  But this holding back only serves to make the document seem all the stranger and more desparate.

 

Cost benefit analysis of default for your typical Greek public sector ‘dependent’

Duncan Weldon reiterated, on Twitter,  a point I read Huw Pill of Goldman Sachs make a while ago.

The holdup in negotiations between the Troika and Syriza is described as being over the latter’s inability to support a cut in pensions, an extension of VAT, and, formerly, to reverse measures to rehire civil servants.  Measures that are ‘red lines’ for the Greeks.

However, those Syriza are bargaining on behalf of face a calculus that isn’t often teased out properly.

In the aftermath of default, there may be an interregnum when no public sector salaries or pensions are paid in anything at all.  Or anything that has any widespread, stable, accepted value.  The Greek government would at some point set up its own currency again, and, with luck, may be able to devise an arrangement that brings stability to it, insulated from the continuing pressure on Greek finances.  May.  And in the meantime?

Rehiring civil servants appeals to those wanting the government to reassert sovereignty, and bolster a statist vision for the Greek economy.  But if it triggers something that threatens the government’s ability to service payments to all the other state employees and dependents, would it be such a popular measure?

Likewise, refusing to extend VAT to electricity seems, on the face of it, a stand against a regressive tax.  However, what would post-tax-post-Grexit disposable income for public sector and even private sector employees be in the short-term, post default?  Perhaps very little indeed.  Even after a couple of years of well-executed domestic stabilisation, this number might be lower for those Syriza worry about than under the Troika’s current offer.

This is not to suggest anything about the morality or even economic efficiency of the Troika’s and Syriza’s bargaining stance.  Those are separate questions entirely.   Except that if you buy the arguments above, then Syriza themselves are not characterising the nature of the options as accurately as they might for their own constituents.  But that is not an uncommon crime in modern politics.

 

Surplus of fiscal legislation?

The Chancellor has announced that he wants to legislate to force future governments to run surpluses in ‘normal times’.  Two reasons make it hard to comment definitively on this proposal.  First, the devil will be in the detail of what constitutes ‘normal’.  Second, there are many unanswered questions in the theory and empirics of fiscal policy.  Nonetheless, a few points as a footnote to what others, particularly Simon Wren Lewis, have written in reaction.

First, it’s interesting to note that Robert Chote, head of the Office for Budget Responsibility, has suggested that they don’t want to be responsible for defining ‘normal’.  Monitoring whether given circumstances meet a government definition is fine, but coming up with a definition is not.

There is a logic to this that parrallels how our central bank is treated.  The Government designs the inflation target – the number, the price index, and so on – and the BoE decides whether policy is appropriate to meet it.  Chote is urging the same division of responsibility.  Goals are set by government, and delegated agencies operate the instruments to achieve them.  In the case of fiscal policy, governments retain also the instruments, but the OBR would have independence over its advice, which plays the role of an instrument here.

Whatever they do, if it’s true, as I’m told by someone who has seen, that they only have 4 full time economists at working level, they are going to need more resources to do it.  4!  The Bank of England probably employ about 250 economists.  For sure, the OBR no doubt do much of their work through the capable hands of cooperative civil servants in the relevant departments.  But still.  4?

On the concept of ‘normality’.  The notion that the Chancellor – and Chote in his comments – are heading towards is whether or not there is an ‘output gap’.  This is a term in quite wide usage, referring to the gap between what the economy is producing, and ‘potential’, if all resources were put to use.

But it is actually an extremely fuzzy idea, one that only really becomes concrete in a particular theoretical or empirical model.  We could think of the gap between actual output and a trend line.  And there are many concepts of trend lines.  Straight line trends.  Trends that assume that the level of otuput is mean-reverting, and trend lines that assme that the growth rate of output is mean-reverting.  Moving averages, and other filters.

We could think of ‘normal’ as being, in the New Keynesian macro model, the level of output that would obtain if, counterfactually, all prices and wages were flexible.  Or further, as the level of output we would get if some of the other frictions that slow the adjustment of capital for example, were not operating.  Some business cycle theorists would see ALL movements in output as ‘normal’.  ‘Normal’ is highly controversial in macro.

Exactly the same issue, of course, is grappled with by the Bank of England’s Monetary Policy Committee.  In order to produce a forecast for inflation, and inform a judgement about the trajectory of their instrument settings, they need to take a punt on ‘normal’.

There is something to be said for the idea that, for the sake of credibility, this fuzziness should be resolved by making a choice – even if not warranted by the diffuse evidence – in favour of some definition.  But we should not pretend that any Chancellor defined concept is more than this.

I’m in favour of the principle that we should aim at paying down the debt slowly, so that we can run it back up again with vigorous fiscal stimulus when needed in a crisis.  But the unknown is wether fixing on an overall surplus is too conservative or not.  Simon Wren Lewis worries that this would mean the same generation paying for the crisis it had experienced.  That worry is founded if crises happen less than once in a generation.  My take so far from the crisis is i) they are more likely than we previously thought, notwithstanding the financial reforms enacted subsequently;  ii) in the absence of good knowledge about the distribution of future crises, it’s better to err a little on the side of caution.

Some have scoffed at the suggestion this be built into legislation.  They point out correctly that a government cannot bind future parliaments.  I’m not so sceptical.  The Bank of England Act could be repealed easily enough, undoing central bank independence, which binds governments under ‘normal’ circumstances not to interfere in monetary policy.  But it so far has not been.  And I conjecture that’s because legislating has raised the political costs of changing tack.  So I think legislation might be a positive step.  And since it confers a certain amount of technocratic independence over fiscal policy [on the OBR] that’s a good thing too.

A particular concern I have – oft stated here and by others – is that this long-term fiscal musing is being done in the context of a determination to make aggressive cuts to spending while interest rates are trapped at the zero bound, there being now limited scope for the BoE to counter any ensuing contraction that might prevent them from returning inflation to target.  Part of the reason for doing this, I suspect, is the perceived need to earn credibility for sound public finance management, so that the ‘job’ can be seen to have been ‘finished’.  If we are in the business of mandating the OBR, or some other third-party, to comment on fiscal policy, a priority for me – more pressing, and less controversial than the Chancellor’s mooted surplus rule – is for such a body to be able give the government cover for vigorous deficit-stimulus in today’s circumstances.

 

Sen on austerity and structural reform

Amartya Sen writes on austerity, comparing the futility of the Troika extracting primary surpluses from Greece and its other debtors to the self-defeating strategy of the Entente powers extracting reparations from Germany, the subject of a blistering critique in Keynes’ ‘Economic Consequences of the Peace’.

But he chooses not to explain the real nature of the bargain.  He asks why ‘structural reform’ should be paired with austerity.  Especially, as many contend, the latter makes it harder to carry out the former.

What is actually happening is that debtors are offered a range of possibilities.  At one end is the option of getting no more funding at all, in return for which the debtor country can run itself as it wishes, but under its own steam, and in this case coping with default, capital controls, and perhaps exit from the Euro.  Then beyond that there is a sliding scale of increasing amounts of further funding, in return for which the creditors want something in return.  That something being ‘structural reform’.  Either to satisfy a desire for a sense of fairness (however well or badly founded) amongst the funding voters, or to try to prevent another bout of financial mismanagement (as they see it).

So, the deal is not ‘austerity plus reform’.  Instead the deal is:  ‘if you want to avoid super-strong-austerity by taking more money from us, carry out reform.’  Another way to express Sen’s discontent is:  ‘the creditors should offer more funding than they are currently for the reforms demanded.’  It’s pretty obvious why they don’t.  The creditors’ taxpayers would rather keep the money for themselves and don’t value much the diffuse benefits of solidarity that may one day accrue a long time down the road.  Can you blame them?

The other aspect of Sen’s article that needs a coda is his point that the austerity demanded makes the structural reform required harder to implement.  There’s undoubtedly truth in that.  But – and this is presumably how the creditors see it – there is also truth in precisely the opposite.  The Greek polity, like many both in crisis and outside of it, has swung behind self-destructive microeconomic policies, and costly macroeconomic ones [early retirement, paying public sector employees to produce not much, high minimum wages, uncompetitive public procurement, high costs of hiring and firing, onerous regulations on business formation].  Without the carrot of extra funding [which Sen correctly but misleadingly calls ‘austerity’] these policies will not be undone while they are seen as desirable by voters.

So, while ‘austerity’ [translate:  too little extra funding compared to cutting a defaulter loose] makes some structural reforms harder to implement (through mechanisms yet unspecified) it also makes it more likely to happen.