Post script on the campaign to reform the economics curriculum

I enjoyed Simon Wren Lewis’ excellent post on this on MainlyMacro.   A few points by way of a post-script.

1.  Simon comes close to giving the impression that the only conclusion you can reach from ‘mainstream’ textbook models is that ‘austerity’ was a public policy disaster.  I don’t agree.  At the time the Coalition took over, there was a genuine risk of us being dubbed ‘like Greece’.  Recapping briefly [more here].  Although we can print our own currency, and, if we chose to, use that printing to finance budget deficits instead of defaulting, I don’t consider that much of an alternative.  It would be hard to control, damage monetary and fiscal policy for at least a generation (perhaps, like in Germany leading to overly restrictive institutions and attitudes about these policies in the future), and would expropriate plenty.  As the crisis wore on, it became clearer that we were unlikely to be dubbed ‘like Greece’.  But at the same time, inflation was high and stable, which, using the same mainstream models that Simon uses, can be interpreted as telling you that there is no weakness in output that it is appropriate for monetary or conventional demand-boosting fiscal policy to stimulate.  On this view, chronically weak output has some other cause – likely the sclerosis in the financial system.  So, to recap, I think these same mainstream models do make a case for fiscal policy roughly along the lines of what we saw.  [Of course, that doesn’t make them worse models, simply because it happens they can be used to explain an unpopular policy].

2.  One of the complaints by the campaign for a new curriculum is for a shift in emphasis away from ‘neoliberal’ market economics.  It is fair enough to take the position that more intervention in markets would be the thing to stop a crisis of this sort repeating itself (though there are plenty who would disagree).  Perhaps even the subversion of the entire market system.  But it seems to me that such an analysis has to proceed first by studying the system as it was, an imperfectly functioning market system.  Those who go on to do graduate studies learn about the ‘social planner’s problem, and the circumstances under which the solution to this problem does or does not get reproduced by markets.  I don’t know if this features in any undergraduate programs.  It didn’t in mine, but that might be because that was too long ago.  This intertwining of the analysis of the social planner and the competitive market equilibrium expresses the unity in a formal way between the thing the curriculum critics want to subvert and what they want to replace it with.

3.  What is most galling about the whole debate is the deluge of ‘expert’ opinion from commentators and writers loosely connected with the economics and policy profession, but who are not practising economists.  Not either responsible for implementing policies, nor in any recent period, or perhaps ever, producing research at the frontier, or, seemingly, not even reading it.  (Actually, if you aren’t producing it, it’s hard to read it, as most is not very user-friendly).  I read a lot of popular physics books, and have a tendency to follow tweet or other internet links on physics (greatly detrimental to my own productivity).  But I wouldn’t dream to pronounce on how physics funding should be reformed, or how the physics curriculum should be changed.  But this is exactly what economics journalists and other commentators are doing.  Economics has a flavour of common sense about it.  It’s about buying and selling isn’t it?  Demand and supply?  I know that, because I want stuff, and people give it to me.  The price of fish?  I’m an expert because I buy it all the time. They feel like they already are economists and that their daily life tells them all there is to know about it.  And when they hear whiffs (for example from Paul Krugman) that it’s not like that sometimes, they conclude quickly that it should be.  One retort might be:  but why do I have to read all that stuff ? It’s exactly that ugly tricky mathsy stuff about markets that has gotten us into this mess in the first place isn’t it?  I don’t believe it is, actually, but, even if you are more sceptical, you can’t judge what has to be thrown away if you have never grasped what it has to contribute.

4.  Simon comes close to making the comment that most economists did not make the mistake of failing to forecast the crisis.  From where I stood, it seemed that most people did make this mistake.  And many of those that did not were forecasting the same crisis for most of their lives, over and over, for reasons that often were internally inconsistent, garbled, and seemed to reveal that they hadn’t absorbed any recent economic thinking.  [Some of those populating the senior ranks of the BIS I would put in this category].  So I think most have undergone a re-evaluation of their position on what questions are really solved and what are open.  Caballero has a paper in which he refers to a ‘pretence of knowledge syndrome‘, which captures the problem.  There were long strands of thought on proper monetary and financial economics in macro, but these were minority activities.  Not any more.  Everyone is at it now.  And citations of those who got in early (Gertler, Bernanke, Kiyotaki, Moore, Williamson, Wright, Lagos, Gilchrist, Carlstrom, Fuerst) have gone through the roof.

5.  To re-iterate Simon’s point about forecasting not being a good way to judge economics.  Read Nate Silver’s book.   Some things may be inherently unforecastable.  At risk of irking the anti-economics reader, we know that in theory there are inherently unforecastable things, so it shouldn’t surprise us to find them in the real world!

Goldman Sachs’ HQ and UK exit from the EU

Last night, watching Goldmans’ explain carefully that a UK exit from the EU would be one of the things they would consider in locating their HQ, it struck me that we have seen many such interviews, and all of them seem to miss the obvious point.  That being:  the biggest factor weighing on where to locate such an HQ (or on related decisions) is where other similar firms are going to locate theirs.  Being near others has many advantages.  You can steal their staff more easily because they don’t have to worry about relocating.  You can bank on a parrallel network of suppliers coordinating on being in the same place.  If you are a top executive you can more credibly threaten to leave yourself if you happen to be located close to a competitor, etc.  Once you see this, then the biggest factor in how to respond to an exit from the EU is how you think others will respond.  And once you recognise that, then it’s clear that that means that the key factor is how you think others will think you will think they will respond.  And so on.  Ad infinitum.  In situations like this, it could be quite possible for everyone to up and leave even if there were a whiff of an exit, even if the ‘fundamentals’ of location [business rates, schooling, regulation, etc] were not much different from one place to another.  For a similar reason depositors can run on a healthy bank, financial firms could pull out of London, simply because they think others will too.

Debt-ceiling fights destroy many kinds of money, and money in many countries.

I wrote before about how worries about a possible default or interruption in payments on US debt, resulting from Congress failing to agree a rise in the debt-ceiling, destroy money and liquidity.  Just to tease two things out of the analysis that need emphasising, even if they were already there….

First, fights over the debt-ceiling don’t just destroy the money-ness of US Treasuries.  Though they certainly threaten to do that.  They destroy other kinds of money.  In modern financial systems, many other institutions’ liabilities become money.  The most familiar being deposits in a retail bank, of course.  [This is partly why we don’t want them to fail, because their failing would amount to a devastating monetary contraction].  But short-term paper issued by retail and other banks into wholesale financing markets also serve similar kinds of functions.  When these markets are working well, those liabilities are convenient and predictable places to park your wealth and redeem it for something else you want by trading later, in the knowledge that the price at which you can trade will be fair and predictable, because there will always be plenty of people to make the trade with.

Those institutions who have parked their money in Treasuries, and are threatened with a shock to their cashflow by a default (or more realistically an interruption or deferral in payment) by the Congressional fights, may also have issued liabilities into the market that other people use as money.  Because people may worry about whether they can really pay up on those liabilities, or worry that others will worry (and so on, ad infinitum), those liabilities can quickly become much less money-like.  I wonder if there are any Wall St CEOs funding Tea Party Republicans?  I will wager that there aren’t.  Because those institutions earn a lot from the fact that their liabilities function as money.  [Just like the US Treasury].  If you happen to mix in those circles and read this blog [very small joint probability] and you know a Wall St CEO who is funding a Tea Party Republican, set them straight.

The second thing to tease out of this is that those institutions may be domiciled abroad.  The Tea Party Republican threats destroy money created by and that provides services in other countries.  Those people in the other countries affected by those Republicans’ threats don’t have any say in what is going on.  They can’t currently turn up to the primaries in which those extreme candidates are elected and register their protest.  Though I guess the TPR’s could not care less about that.

Won’t the Tea Party have to call everyone’s bluff to retain credibility?

Thinking ahead to the next round of the debt-ceiling talks in February.  Republican negotiators may be worrying that they are losing credibility.  The first time they extracted real concessions from Democrats.  This time they got nothing of note and appeared to come off worse in polling and in the chat-osphere.

I worry that going in to the next round of negotiations they may calculate that they have to actually trigger a default to be taken seriously in the future.  Otherwise, the whole thing looks like posturing.  What’s worse: being ridiculed for being prepared to trigger a default by refusing to agree a rise in the debt-ceiling, or for pretending to be prepared to do it?

The Republican idea that somehow a default would be purifying and beneficial is pretty crazy.  But at least it sounds like a principle, part of the wider view of the benefits of a small state. And risking all for your principles can look like an admirable thing to do.  But risking all by faking crazy principles sounds to me like a thing that would be seen to be dispreputable.  If you turn out not to be telling the truth about being prepared to risk a default, what else are you not telling the truth about?  How are you going to be treated in any other negotiation you participate in, either with the Democrats, or with other Republicans, carving up the spoils of Congressional Office?

Actually, for bad things to happen, you don’t have to worry that Tea-Party Republicans will try this.  You just have to worry that financial market participants will worry that Republicans will try something.  Or that markets will worry that others in the markets will worry that Republicans will try it.  [Or… And so on ad infinitum.]

5 triumphs at the Bank of England

I have, occasionally, pointed out things that the Bank has done well in this blog.  However, it’s fair to say that most of what I have done is to detail things I think could be done differently.  But in case you worry that I am not objective on this subject, I thought it was worth stepping back and recapping.  It’s far more entertaining to criticise and pick holes.  And as a reader, I think I usually find that more fun too.  But it’s worth setting out what I think has gone well, so that a proper perspective is not lost, and the criticisms can be seen for what they really are:  important points of details.

So, onto 5 triumphs at the Bank of England.

1.  Most recently, resisting the UK Treasury’s incursion into operational independence by asking it to review a policy explicitly designed to inject more monetary stimulus (forward guidance), by declaring that it wasn’t injecting more stimulus.  However confusingly put, that was the intended outcome.  If the cliché ‘what doesn’t beat you makes you stronger’ has any truth in it, then this was a triumph.

2.  Absorbing the PRA.  This isn’t over yet.  But institutional change of this magnitude constitutes a mountain of projects big enough to sink other government departments.  But this didn’t happen.  Neither has there been any obvious fall-out or chaos within the Bank.  Surely this counts as a triumph too. [Their conference room also has very nice seats].

3.  Setting up the Financial Policy Committee.  Mervyn King once gave a speech under the banner ‘practice ahead of theory’.  It was a play on an old real business cycle paper entitled ‘measurement ahead of theory’.  He was talking about monetary policy, but you could say exactly the same about the new FPC.  From where I sit/sat, it seemed like the reason there was an FPC at all was because of the Bank of England.  This new institution got staffed with central banking and financial dignitaries of the appropriate calibre because of the Bank’s long-won reputation for competence and seriousness.  The FPC had to be set up amidst the ebb and flow of post-crisis and recurrent crisis management;  that it was done relatively smoothly has to go down as a triumph for the senior management in the Financial Stability function of the Bank, and the Treasury.  It also had to be done in a sea of ignorance about exactly what the right thing to do was.  Setting up the MPC was much easier by comparison.  There were role models.  And a long history about the single instrument (at that time) it was thought necessary for them to vote on.  And there was little difficulty in figuring out what the goals ought to be.  Life for the FPC builders was much different.  No real role models.  Except a deluge of anecdotes from largely emerging market countries who had been intervening in their banks’ lending for decades.  And an academic profession studying business cycles that, though rubbing its hands in glee at the interesting new questions opening up, had few practical answers to offer.  As an outside observer, I was impressed by two things:  the deluge of requests and notes about the ‘big questions’ to do with FPC design, showing a preparedness to think things through from scratch.  Combined with the relentless [for me hard to empathise with] grind through the nitty-gritty of the project management side to this.  Another potential hazard was the stark philosophical differences between Mervyn King, Paul Tucker and Andy Haldane.  This no doubt caused practical headaches for those serving the FPC and made the process feel uncomfortable at times. But, in the same way as the recurrent fights between the doves and hawks on the MPC has, in my view, left it stronger, so the FPC has survived this difficult early phase, and there are now precedents for future FPC members to have these fights without fearing that doing so will wreck the institution.  A final obstacle was the fact that the FPC was being grafted into an institution designed to do other things.  I’ll bet that when McKinsey take a look at the reporting lines and the organogram, which of course date back to before the FPC’s inception, they will think of plenty ways to wield their practiced bureaucratic chopper. But they should not forget that behind the strange structures and customs is a seething mass of clever and adaptable people throwing themselves at the shifting demands of new and old customers.

4.  The Bank’s nimble response to the financial crisis.  The resolutions of Bank failures, done on the hoof, at great political and legal risk, without a proper machinery [that we hopefully now have].  The administering of emergency lending assistance [ELA].  The reform of the Bank’s Sterling Monetary Framework, both to accommodate financial distress of Banks, and to adapt to QE.  The instigation and winding up of the Special Liquidity Scheme.  The devising of the Funding for Lending Scheme [a testament in particular to a small group of phenomenally clever youngsters at the Bank who I am probably not allowed to name].  I have been very critical of the decision to focus monetary policy efforts on quantitative easing. But, given that that was the decision, the effort in the Markets Directorate to set up the ‘reverse auctions’ used to buy the gilts under the QE program must also count as a triumph.

5.  Monetary policy through the financial crisis.  Hang on, I hear you say, haven’t you spent months getting off your chest all that you hate about monetary policy?  Well, yes, but these are details.  At least relative to the big picture.  Which is that, however described by the Bank, the MPC decided to take a risk and tolerate what was in the history of inflation targeting an unprecedentedly large overshoot in the inflation target, judging that a price worth paying to ensure that the contraction was less painful, and shorter than otherwise.  This was not an easy decision, I am sure.  And it was not always characterised as this, or as self-consciously acknowledged.  But that was its effect.  The MPC still had the chattels of a relatively recent bad inflation history.  [The equivalent on the side of fiscal policy was part of the reason why the Coalition felt they had to tie themselves up in an austerian straitjacket].  But the crisis prompted them to embrace ‘flexible inflation targeting’ long before their political masters used the term in the recent inflation target review in March.  Several years of quite high inflation is, therefore, in my view, a triumph.  That it has been pulled off without triggering inflation scares in financial markets or survey data, I think will confer a great benefit on future MPC incumbents.  It’s surely much harder and riskier for the first inflation targeters to try out ‘flexibility’.  Later flexers can simply point to their forerunners’ wise words and successes.

We should have all copied the Swedish debt management office

I heard an interesting tale during my Riksbank visit, from Karolina Ekholm, Deputy Governor.  She explained to me that in the immediate aftermath of the crisis, the Swedish debt management office were OVER-issuing government debt [ie selling more than they needed to finance the deficit] and using the proceeds to finance the acquisition of riskier, private sector assets.  So they were doing negative QE.  If you accept the line of argument pushed by Vissing-Jorgensen and Krishnamurthy, and also Caballero and Farhi, that there is a special demand for safe assets with duration, then this is just what the authorities  should be doing at times of heightened financial stress and low risk tolerance.  Central banks commonly use the event study analyses showing that QE lowered yields (raised prices) on government bonds as evidence that what they were doing was a success.  But, on the contrary, this impact on yields could measure not the benefit, but the cost imposed by starving the economy of safe assets and of foregoing the benefits of the better, Swedish variety.’

Debt-ceiling fights destroy money, but strengthen monetary policy

In this post I explained why I thought that the fight over the debt ceiling acted like a monetary contraction (as well as, ironically for the Tea Party, acting like a wealth tax).  The argument, made by others too, is just that it reduces the usefulness of Treasuries as a means to park your wealth where it can be quickly turned into something else, as and when you want, and at a price you can predict.  It occurs to me that at the same time as this was going on, the fight also enhances the strength of unconventional monetary policy.  QE is argued by some to be a weak instrument because it involves swapping one zero interest, default risk free, money-like asset (reserves) for another (Treasuries).  So it leaves private sector balance sheets little different from before.  However, the debt-ceiling fight clearly made reserves and Treasuries less close substitutes. Treasuries became less default-risk free and less money-like.  At the same time as more monetary easing is needed, to make up for the money destruction, the liquidity-injecting properties of future monetary policy are enhanced.  Of course, the Tea Party wouldn’t like that either, because they are against the Fed interfering with monetary policy too.

In defence of panning Forward Guidance

Simon Wren Lewis writes ‘in defence of forward guidance‘.  He scolds Chris Giles, myself and others for ‘panning’ the Bank of England, for fear that it might retreat away from this bold experiment back into its natural, conservative, and insular mode of being.

Well, first, to recap on why I think they need panning.

1.  The MPC deserve a panning for not attempting Forward Guidance proper when it would have had most effect, shortly after Lehman’s.

2.  Mark Carney deserves a panning for appearing to take a position on the necessity for extra stimulus before he had assumed his role as chair of the MPC.

3.  He deserves another for refusing simply to back down, when he realised he could not carry others on the MPC with him.  The only way to explain the ‘no stimulus’ forward guidance policy is as a way for him to save face.  Central bankers with meteoric careers should be above needing to save face.

4.  The MPC as a whole deserve a panning for not realising that the garb of forward guidance should have been saved for when it was needed.  As I wrote in my mock Carney speech, they risk being misunderstood or not believed when they engage in Forward Guidance proper.

5.  Lastly, the Treasury deserve a panning for causing the mess in the first place.  The expectation is that central bank independence allows them to decide on operational matters, whether more stimulus is needed or not, and how, if it is, it should be injected.  The Treasury’s insistence on a review was designed to raise the costs of not undertaking Forward Guidance proper, and of not stimulating further.  If it was not designed with that intention, it was extremely ill-judged not to realise that it would have that effect.  Or, if that was realised, it was poor judgement to think that the other benefits of requesting a review outweighed the effect of raising the costs of not injecting more stimulus.  Although, come to think of it, perhaps it wasn’t poor judgement.  It was the short-termist political calculation that it was better to try to cave in central bank independence by kicking the MPC than to risk backtracking on monetary policy.  The former would only damage future monetary policy forever.  The latter would lose the Coalition this election for sure.

What is there to say in defence of the MPCs version of forward guidance?

1.  The eventual outcome reflects well on the MPC, and on the institutions of monetary policy.   Despite all the strain put on those institutions by Carney’s pre-Gubernatorial utterings, and the Treasury’s intrusion into operational matters, the MPC stood firm.  For a while most of the media seemed to think that the economy had been given a kick-start.  (I worry rather unscientifically that most of the country still do think this).  But, in fact, the MPC did not buckle.   Monetary policy is somewhat wounded, but will live on to fight another day.  A positive way to look at it is that the Treasury tried to bully the Bank of England into making up for its own fiscal policy incompetence by loosening monetary policy further.  But the Old Lady was not for turning.  If the MPC can stand up to this blatant trespassing on operational independence, it looks all the stronger for it.  Maybe people will conclude that the Treasury won’t try to play dirty again.

2.  The legacy of the whole affair will probably be that the MPC will find it harder to avoid communicating about future interest rates in the future.  This extra transparency will have many benefits, extolled elsewhere at length.  People will come to understand monetary policymaking and what the Bank does better.  The Bank will acquire extra legitimacy through exposing itself to more effective accountability, leaving the institutions governing not just monetary policy, but its other spheres, more robust.

3.  An even more profound legacy, harder to appreciate from outside, is that it will help reinforce to future incumbents of MPC office that you can’t do monetary policy without forming forward plans for your instrument.  This was not understood by many previous holders of that office.  Many staff members who tried to explain this were dismissed as hopelessly impractical nerds.  Fortunately, in the business of oil-tanker piloting, or rocket science, grasping that forward plans is seen as a necessity, not something that disqualifies you from the job.

4.  If Forward Guidance proper, of the lower for longer variety, is ever needed in the future, MPC will presumably find it easier to resort to it.  That’s a good thing.

What about Simon Wren-Lewis’ worry that the BoE needs gentle treatment?  Is there any truth in this?  Should we go easy on them, sparing them criticism that is due, in case it discourages further, more beneficial changes?

1.  If this were true, I’d suggest that it was grounds for serious outside action, not a case for scribblers like me to keep schtum.  It would surely be a sign of gross incompetence if an important organisation eschewed taking substantively justified steps to reform itself because it was worried about how outsiders would react.  As an aside, I don’t think the Bank is inherently conservative.  It has undergone radical convulsions in the last two decades.  It has suffered from the fact that people don’t like to admit they are wrong.  So once a policy decision is made, it’s hard to change it without a change of guard.  But the institution that governs term-lengths takes due care of that, in my view, balancing that problem with the need for each new leadership team to have enough time to decide to do something and persuade the staff to do it.

2.  I think there are good examples in the past to point to.   Chris Giles’ pointed remarks about the Bank’s fan charts are a good example.  These set analysts in the Bank scratching their heads and consulting statistics textbooks to come up with new fans, and prompted interesting new developments that might even constitute an improvement.

3.  The MPC did a good job of cheerfully ignoring everything I wrote when I was inside the building.  I doubt they will pay me any more heed now I am outside of it.

Either Forward Guidance IS a change in the reaction function, OR it’s misleading and empty

MPC have stressed that their version of Forward Guidance, unlike the original Woodfordian policy to which the term normally refers, is quite different.  Unlike the Woodfordian policy, the Bank of England are not communicating that rates would be lower for longer than one would predict based on a normal, historical reading of what the MPC cares about and how it sets about achieving it.   There’s no change to the MPC reaction function, we are meant to understand.  All that FG does is clarify what they were doing anyway.

Really?  How does that work?

Since when have MPC followed a scheme for responding to events as they unfold which amounts to not even considering responding to news, at all, unless unemployment moves through some threshold?  For example, since inflation targeting started in 1992, we know that you can fit a Taylor Rule (augmented with, say, a lag in the central bank rate) to the policy rate, and it will capture the main features of what the Bank of England tried to do.  That rule will have rates responding to real and nominal things.  You won’t get a better fit through those observed interest rates by trying to add indicator variables turning off the response to inflation unless an inflation forecast breaches 2.5 [a reference to the inflation ‘knockout’].  So unless the communication around forward guidance is completely empty, it DOES constitute a change in the reaction function.  [Thanks to Richard Barwell of RBS for articulating these points so clearly to me over coffee.]

And are we meant also to consider that the MPC foregoing the normal convention of reconsidering their policy stance afresh each period amounts to not changing anything relative to before?  If so, what is the point of ditching the ‘face each ball as it comes’ language?  Unless that commitment is empty, this also constitutes a change in the MPC’s reaction function.  Either they have laid out a data-contingent plan and intend to stick to it, as they say, in which case this is different from what went before, when there were no such pre-agreed plans, or they haven’t, in which case the words are hollow.

So, in short, either forward guidane does constitute a change in the reaction function, contrary to some of what has been claimed by MPC themselves.  Or it does not, in which case the commitment made is empty.  Which is it?  Can someone explain?

One way out for the MPC is by reference to the ‘unwarranted’ rise in interest rates at that the MPC described as priced in to the yield curve at the August MPC meeting.  Perhaps all the terminological tomfoolery is about trying to get the yield curve to behave as it always used to, for the two decades prior to August?  Perhaps that is why the MPC needed to borrow a policy label used for something else, conjor up ‘wayposts’ and ‘knockouts’, to tether the yield curve so that it sways in the economic wind just as it always used to.  No, that doesn’t seem to ring true either, does it?  Are we to believe that the yield curve always did pretty much what MPC wanted it to, until now, when a new policy framework was needed?  This is not very believable.  The summer giration was hardly that unusual.  What happened is that a new Governor arrived, one prepared to talk about future interest rates and compare them to the yield curve when previous Governors were not.  Unfortunately, that same new Governor had also boxed himself into needing a new policy framework, or begin his Governership with a defeat.

The speech Mark Carney should have given but didn’t

Folks.  I found myself in a tricky position when I arrived.  The bosses in Whitehall were really taken with this thing about keeping interest rates lower for longer, and, frankly, since there was no way they could loosen fiscal policy, they were in the mood to try anything.  They had backed themselves into a corner by saying that there was going to be no more fiscal loosening.  And though the economics of this sucked, the politics was clear.  And maybe, at a stretch, you could understand it, since it was a legacy of the pretty scary times they started out in back in 2010.  So HMT were really hoping to get more stimulus through Forward Guidance.  They knew I was into it and we hit it off.

They made a good show of being cautious about appearing to change the monetary framework, commissioning a review.  But they knew what I thought already – I’d gone on record about it -and we both knew what the answer was going to be.  Except, when I got here I found that there was a majority against any more monetary stimulus.  I was hoping to persuade them but I couldn’t.  It’s a little tough to accept, since I started out thinking that this was what was going to ‘secure the recovery’, but the reality is that the other MPC members think the recovery is in safe hands.  So our review is an in principle review.  I think that many of my colleagues accept that if we needed more monetary stimulus, it would be worth having this tool in your kit.  However, most think that we don’t need to try to engage in ‘lower for longer’ right now.  But we are not going to leave things there.  I have managed to persuade my colleagues that we should be more open about future interest rates in general, and about what we are trying to do with our policy instruments.  The former Governor had strong views about this, but we think it’s time for a change.  The Reserve Bank of New Zealand have been publishing interest rate forecasts for two decades without any difficulty.  The Scandinavian central banks are facing challenging times, as market forecasts of what they will do have differed from official ones for some time.  But on balance we feel that this has proved educative.  Why shouldn’t those forecasts differ?  And the debate there has focused on the economics of how the conjucture will play out, not the competence or credibility of the institution.  So, this is what we will do from now on.  Moreover, we are going to explain more about how we arrive at our policy plans.  For instance, although everyone has got the idea that the central bank should stabilise the real economy, as well as inflation, we have been totally silent, and, frankly, evasive, up until now about just how much weight we should put on each concern.  There’s no great clarity in the literature about this, but previous regimes have tended to hide behind this observation to avoid taking a punt.  But without taking a punt, frankly, it’s impossible to know what should be happening to your policy instruments.  [How were all those votes cast before, you might very well ask yourselves, and how did our Treasury bosses tolerate handing over all that power without even specifying what we should do with it, or asking us to be clear about that?].  So, taking that punt, we are going to go for two to one weights in favour of inflation.  The consensus in the modern macro literature is for weights much higher than that.  They have to do with the models’ assumed very high costs of invalidating the forecasts of firms whose prices can’t adjust period by period.  We think those very high costs probably over-egg it.  After all, no-one seriously believes firms will not change prices no matter what.  Those comments need a proper dive into the technicalities to explain them properly, and we’ll do that, but for now take it on faith.  Two to one might change, as we learn more about what that means for our policy plans.  Having set out (actually for the first time!) what our objectives are, we next need to present you with some tools we use to decide on our plans, and to help you reflect on how we do it too.  To begin with, we present a range of simple policy rules, the coefficients of which have been honed to achieve the best on the two to one weights objective, given how we see the economy.   And, just to probe things further, we’ve repeated the exercise for slight changes of the two to one weights assumption around our base case, and interestingly, also for a two to one assumption replacing price inflation with nominal wage inflation.  (One of the predictions from these models is that central banks should care as much about nominal wage inflation as price inflation).  Obviously, these rules can’t capture all the complexity of what we think we face, particularly now.  And you can see our central forecast for interest rates differs from what all of the rules suggest.  But we go into reasons for that in our Inflation Report.  To reinforce these openness steps, we are providing all the code and judgements applied to the Bank’s suite of forecasting models that are used to produce each forecast.  That way you’ll be able to check that we are being honest, and see how we use and abuse these models.  Amongst other things, you’ll be able to see important things like what the assumed effect of the Funding for Lending Scheme is; what the assumed effect of changes in capital requirements made by FPC is;  the assumed effect and transmission of quantitative easing.  So you can get an idea how all the different instruments interrelate.

So, the upshot is, we are not engaging in Forward Guidance as other central banks have chosen to use the term, ie we are not trying to keep rates lower for longer than you would guess we would based on normal modes of setting interest rates.  That’s because there is a majority against injecting more monetary stimulus.  We have all of us agreed that there may come a time in the future when this kind of policy would be effective.  Probably, the best time to do this would have been when it became clear that interes rates were going to fall a lot after the Lehman’s Crisis.  That was when the yield curve was still projecting steep rises from their trough, fairly soon after the crisis hit.  So there was a lot to be gained by flattening that curve.  Some of my colleagues pointed out that embarking on this policy now, so long after interest rates have already been pinned at the zero bound, would be to do so at exactly the time when this policy would have least effect.  So, we are not doing Forward Guidance.  But we are entering a new era of transparency about what we do.  This will make monetary policy ‘more effective’, in the following specific sense.  It will make it easier for you to judge whether we are keeping our promises and acquitting the important duties assigned to us.  It will bring the technology of holding central banks accountable up to the standards now expected of modern democracies.  It will hopefully guard against people worrying that we have gone soft on inflation, because you’ll have a better idea what we are doing, and why allowing inflation to be consistently higher than target for so long is still the right thing to do, despite our remit.    It’s extremely important for us that our new policy is not confused with the Woodford lower-for-longer policy, and that for that reason we will completely eschew the ‘Forward Guidance’ language.  This is semantics.  But important semantics.  Because we don’t want to mistakenly inject monetary stimulus we collectively judge not to be needed.  And, more importantly than that, if we are to keep lower-for-longer Forward Guidance as an effective tool for the future, we don’t want to blow it by somehow riding on the coattails of other central banks and pretending what we are doing is like what they are doing.   If we did that, and we were found out by close questioning that there were no more monetary stimulus, we might get a reputation for trying to spin our policies for things that they were not, which would be an extremely hazardous thing to carry forward into the near future.  Although my colleagues are against more monetary stimulus now, they recognise that we might have to rethink in the future.  For example, there are great risks of things working out in the Eurozone badly over the next couple of years.  If that happens, we will need every monetary stimulus tool at our disposal, and our reputation for plain speaking intact.  That would be the time to present a tool that we label ‘Forward Guidance’.  And when we do, we want people to take us at our word that more stimulus was intended.  If we presented a ‘no-stimulus’ Forward Guidance policy now,  there would have been a risk that people thought this was Mr Carney rising to rescue the recovery and then finding out that I wasn’t doing anything at all. Down the road, when the recovery really needed rescuing, and we launched the ‘kick start Forward Guidance’, they might then think we were trying to pull a fast one again, and wrongly conclude that we were in fact sitting on our hands again.  This would be a hoax on the scale of trying to pretend that buying gilts with electronic money was some great new stimulus policy, when all that was going on were some fancy open market operations!