Adam Posen is wrong to suggest the BoE has been cosying up to the Banks

In a recent interview with Reuters, Adam Posen hit out at the Bank for having cosied up to the Banks, implicating the post-crisis Mervyn King leadership in that, and therefore urging on Carney’s efforts to bring about cultural transformation.

I thought his comments gave quite a misleading view of what has been going on at the Bank, and missed the big picture.  Readers of this blog will know that I am always up for some BoE kicking with my tired, long-serving boots, but only when it’s deserved.  But on this occasion I feel obliged to push back on Posen’s comments.

In a twitter exchange with him Adam said [sic] that King’s rhetoric was sincere, it had not translated into concrete policy action.

Well, here are some examples, most of which I tweeted already, but written up here for completeness.

First, I’d cite Mervyn King’s moral hazard lecture in the Summer of 2007.  This wagged a disapproving finger at banks who had adopted aggressive funding and lending strategies, arguing that it would be a betrayal of those that hadn’t for the BoE to extend its hand of support.  In fact Mervyn was widely criticised for this lecture, for it seemed not to foresee the systemic nature of the problem, and even aggravate it.  That’s contestable.  But it certainly was not cosy, and it translated into a concrete policy of not offering help that wasn’t deserved (in Mervyn’s opinion).

Second, you could cite the surge in interbank rates in September 2007, which the Bank allowed to happen, when it could, had it chosen, relaxed its Sterling Monetary Framework.  That had the effect of being decidedly uncosy.  Although it’s arguable that that happened because of neglect and lack of foresight than any conscious policy to be harsh to banks who were short.

Third, what about the operation of the Bank’s Special Resolution Unit?  How uncosy can you get?

Fourth, I’d cite the extremely conservative nature of Quantitative Easing.  Mervyn King and the other Executive Team members were dead set against large scale private asset purchases, which could have involved relieving Banks of troubled assets, or purchases of Bank bonds, or bonds of firms that banks were exposed to.  Instead, while operating a piddlingly small corporate paper purchasing scheme, the Bank bought only gilts.  That’s not cosying up to banks.

Fifth, one must presume that the analysis and rhetoric of Mervyn King and Andrew Haldane, enumerating the vast implied public subsidy in historic funding rates for the banks on account of too big to fail, and arguing for very conservative capital regulations, and making the case for narrowing the allowable scope of bank investments, had some influence on the Banking Commission report led by John Vickers.

Sixth, would you describe Mervyn King’s involvement in the deposing of Bob Diamond as cosy?

Seventh, I would list the determination of Mervyn and Andrew Bailey to instigate a new supervision model that involved less box-ticking by junior staff, and more big picture judgements on the overall health and competence of a bank, by more senior staff.  That’s not cosiness either.  That was an analysis of how the FSA failed to turn the screw on the banks, and how they were going to put it right.  You can argue about whether it was the right diagnosis, but there was one, and the objective was very clear.

Eighth, Adam forgets the war that broke out between Vince Cable and the PRA/FPC over the latter’s demands that banks improve their capital positions quickly.  Vince was more concerned that the Banks should be allowed to extend themselves and lend regardless.  Leave aside who was right, but those under the auspices of the BoE were not cosying up to the Banks.

Ninth, one could think about the very long lag between the onset of the crisis and the beginning of Funding for Lending as being indicative of a reluctance to be cosy to the Banks.  Emphasised too by the careful design of the scheme to stop banks gaming it.

Tenth, note the determination of the BoE to wind up the Special Liquidity Scheme, despite warnings that Banks would face a possible ‘funding cliff’.  That was seen through.  No cosiness.

Eleventh, I’d cite the clean bill of health given in the external report by Ian Plenderleith on the Bank’s Emergency Loan Assistance during the crisis.  You might scoff that Ian was a former BoE employee.  But his legacy would have been in tatters if he had let the Bank off the hook, so his incentives were very clear.

Adam’s remarks aren’t without provocation, most recently the yet to be determined nature of BoE involvement in foreign exchange fixing, if that’s what it was.  But we have to put this unresolved issue in perspective.  The Executive Team’s messaging was frequently hostile to Banks, articulating the tragedy they had inflicted on the economy, and what had to be done to rein them in, and that culture transmitted itself around the institution.

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One big hubristic consultancy jargon firework display

That was my reaction to the Mais lecture.    As well as seeming to me to be what the title of this post suggests, the relaunch was at the same time surprisingly, and almost unreadably dull, plodding through several management cliches about Oneness and synergies.  And it was quite an anti-climax, after the extraordinary step of the high-profile employment of McKinsey.

Despite the grandiose theme of Bank Oneness, the changes seemed, plausibly, to have quite different imperatives.

For example.

Spencer Dale and Andy Haldane swap jobs.  Imperative (1)  eliminating conflict between Carney and Haldane over how to deliver financial stability.  Imperative (2) stemming the momentum Haldane had built as the pre-eminent BoE thinker on financial stability.  An achievement that can’t be allowed to overshadow or complicate Carney’s role as Chair of the Financial Stability Board.  Imperative (3):  these are the only jobs either of them would accept without leaving having lost out to Ben Broadbent/John Cunliffe respectively.  Imperative (4):  it solves the problem of both  not having to work for (one presumes) their fellow competitors for those DG jobs.

Re-create the old International Division which existed pre-1994.  [No mention of that historical echo in the fanfare].  Imperative:  giving the new Deputy Governor Shafiq another directorate to make the job bigger.

Paul Fisher dropped from the MPC.  Imperative:  ease possible tensions with the incoming Nemat Shafiq, so she doesn’t have to experience his disappointment at not getting that job, and he doesn’t have to experience her thinking he is disappointed.  And it’s pre-emptive action in case Forexgate implicates him, though it has not yet.

Orchestrate ‘single research agenda’.  Imperative (1):  makes the job of the Executive Director for the old Monetary Analysis directorate feel a bit bigger again to make up for having the international economics division chopped out.  Imperative (2):  it adds to the oneness of it all, doesn’t it?

Shafiq to be charged with executing exit from QE.  Imperative:  make her job look even bigger.  Reality:  it’s just a restatement of what would have been the task of the markets directorate anyway.  MPC will decide when to unwind QE.  [Barring another heist by the BoE executive, mirroring the one at the launch of QE excluding them from an input into what to buy].  When they do unwind, that directorate would have always had the hair-raising task of flogging all those gilts.   Thinking about it, why weren’t the other DGs also charged with similarly sounding grand challenges?  Those challenges are certainly there.  Ben Broadbent presumably has to chart a course back to neutral interest rates.  And Spencer Dale will have to help Jon Cunliffe figure out which lever to pull to choke off the housing boom.

All of the above:  ensure no-one who was an ancien regime appointee benefits.  Imperative:  Mark Carney was appointed because the old regime was judged to be bad, (otherwise they would have got Paul Tucker in), so, to follow that through, anyone associated with the old regime is bad or has to be sidelined to underscore the overall purpose and reality of regime change.

Perhaps that is too much conspiracy-theorising.  But, at least one could interpret the changes as following definite purposes, rather than in pursuit of an MBA-style case-study set to students in a hurry.  And, remember, Mark Carney is in a hurry.  Soon a year of his shortened 5 year term will be gone.  A couple of years more, and he will be in campaign mode, charting his course back to a senior Government role in Canada, needing a shake-up of the BoE on his cv to justify the overseas venture.

The continued emphasis on oneness was perplexing.

The Bank embraces two separate policy committees, the Monetary Policy Committee and the Financial Policy Committee, charged with separate tasks, but where discharge of the one affects the performance of the other.  The objective of the MPC is in principle clear, though MPC choose not to make it so, or, if they have (since I left) they keep that to themselves.  The objective of the FPC is not even clear in principle.  (That’s no-one’s fault).  Despite the fact that the Committees themselves probably don’t know precisely what they are doing, nor have tried to figure out how they might systematise and share their reaction functions, we are to suppose that emphasising the Oneness of the Bank by, say, pulling together divisions with an international focus, and swapping two Executive Directors, is going to sort it all out!

Those Committees have different timetables, different agendas (one still has to work out what it’s doing and how it’s going to do it), different personalities with different expertises.  They are going to want very different things from their suppliers in the Bank and there’s no amount of declared oneness that will get around that.  If the Bank wants supervisory excellence in the PRA, what would this oneness mean to someone who cultivates that through a lifetime of study in financial law and balance sheets, but sees others spending their lifetime cranking DSGE models? They might slurp the same custard on their BoE canteen spotted-dick pudding, but they will not be as One.

The BoE is becoming more like its old self, before the reorganisation into two ‘wings’ after a senior management meeting to decide it all at a hotel in Ashridge in 1994.  ‘International Divisions’ then was carved up between those studying the international economies through trade-linkages, and those looking at international financial exposures of UK financial institutions.  I was oblivious to what was really going on there,  too young to know anything or even care if I had, but the received wisdom was that this was an area that had assumed its own amorphous purposes that didn’t even overlap with the Bank’s, often much work done for the Foreign and Commonwealth Office, and uncosted.  Today’s bank is very different, with two identifiable clients.  So I doubt that the new directorate will sink into the (alleged) ways of the pre-1994 version.  But it might still cause problems.  For example, a decision about how to model the world economy in the MPC’s forecasting model could be made by the Chief Economist [executive director for monetary analysis].  Now that can’t happen.  The international division can say ‘sorry, got too much global linkages and synergy stuff to focus on’.  The higher up the joining of reporting lines between directorates that need to share and collaborate, the less likely they are to do it, and the more likely they are to cultivate independent capacities to substitute for their failing collaborator.

Interestingly, there’s the item of giving the Chief Economist the task of realising a ‘single research agenda’.  In the old days, ‘Chief Economist’ was a misnomer, because Spencer Dale was, for example, not ‘chief’ of the economists in Financial Stability, who numbered roughly as many as those directly under his charge.  Now, the title is to be given some meaning.  But what a meaning!  How could there be a single research agenda?  There are many, distinct policy problems begging questions of research.  What does it really mean that there would be a single agenda?  That all the questions would be written down on a single piece of paper, owned by Andy Haldane?  Would this be a single agenda with as many sub-agendas reflecting the different research going on currently?  Research is in a state of crisis in the Bank, as I blogged about previously, because terms and conditions are so difficult relative to the alternatives, and despite the best efforts and new initiatives of senior management.  I wonder how the motivation of researchers is going to be sustained while this ‘singleness’ is enforced.  Singleness sounds like more top-down management and determination of what will and will not be researched.  That would subtract from the meaningfulness of the researchers’ roles themselves, making them even more likely to leave.    What is going to be offered to compensate for future ‘singleness’?

One of the silliest aspects of the day was Carney’s suggestion that we might not have had such an acute crisis or subsequent contraction [we might have had more ‘Canadian’ ‘outcomes’] if this model of the Bank had been in place in the 2000s.  This comment was made in the Q and A, so if it was a slip, it is one that can quickly be put right, but hasn’t yet.  If it wasn’t a slip, well, how absurd.

Everyone surely recognises that Canadian outcomes for banks and the Canadian economy were achieved (i) because there was a fortuitous ‘backwardness’ in Canadian banking.  That word in quotes because of course the conservative funding and lending practices turned out to be better than ours.  Fortuitous because those practices derived at least as much from lack of competition as from financial or regulatory wisdom.  And (ii) outcomes were ‘Canadian’ because of the massive commodities windfall experienced as the emerging market economies bid up the price of their raw material exports.  It’s not surprising that they did ok.  Their private sector was getting rapidly richer, and the banks lending to them had no fear for their loan books.  Did this have anything to do with how the Bank of Canada was structured, or Mark Carney’s contribution in his short stay as Governor?  It seems to invite ridicule to suggest this, but that is what Carney’s words did suggest.  His staff will surely see this hubristic claim for what it is.  And that will inevitably weaken the credibility of the senior management team in the Bank in realising the structural change and the ‘oneness’ in the new culture that is sought after, making it less likely to happen.

Most major changes in the Bank in the past seemed to have been driven by clear and grand ideas.  1992:  (inflation targeting) target the thing you care about, and people will believe you care about it.  1994 (Ashridge)  people who work for the Bank should be working for the Bank!  1997:  (independence) take monetary policy out of politicians hands;  (FSA) supervision is too much for one institution to do, and mistakes in the one make others needlessly culpable.  2012 (PRA);  true enough, but separation loses too much expertise and nimbleness in a crisis;  (FPC)  we need macro pru, and more accountability in financial policy.  The sad thing about this latest set of changes is that it is not driven by any clear economic or institutional ideas.  Except the false one that shuffling a few chairs around would have enabled the BoE to see what almost all the rest of the economics and finance profession failed to.

Reflecting on this with an old contact, it was put to me:  “in true BoE style everyone will now either ignore it or interpret it in a way that suits them best.”

In fact, there’s not a lot to what’s been done so far, and if no more is done, then it will be easy to ignore.  To dig out another cliche to add to those in the Mais lecture, the devil will be in the detail.

BoE Strategic Review. The Bank’s regional agencies and the Centre for Central Banking Studies

Looking a little closer at the institution, and what might be ripe for ‘Review’.

The first thing that comes to mind is the Bank’s Centre for Central Banking Studies [CCBS].  This is a Division of 5-10 economists, including management, and some support staff, contracting in help from elsewhere in the institution, that delivers training courses in economics and finance to other central bank staff, predominantly those from developing or transition economies.  The CCBS attracts great people, partly because it offers a quasi-academic life for those working there, removed from the hurly-burly of the policy work, instead teaching, traveling, and offering time for research that is less directed.  Many of the Bank’s most talented and disgruntled researchers have found a home here, and been managed sympathetically, often in the interim few years before these individuals exit into a university.

What’s wrong?  Well, CCBS I would guess, historically derives from the UK’s ex colonial role.  Why is the Bank taking upon itself to spend money delivering courses to foreign central bankers?  Especially when – if you accept my jaundiced view that technical skills of the Bank’s own employees are neglected – there is a training problem at home?  Many CCBS courses are open to BoE staffers, but the vast majority of the effort is directed at this foreign aid function.  As such, this does not strike me as a core part of the central bank business.  Foreign aid decisions should be taken elsewhere, consciously, not opaquely inside the central bank.  At a time when the core policy functions are short of technical resources, it makes no sense to me to fritter them away on teaching others.

A second function that deserves scrutiny is the Bank’s network of regional agencies.  In days gone by, these were fully functioning offices immersed in note distribution and many of the core businesses of a paper-based central bank.  Now, they are slimmed down operations with Agents and deputies visiting scores of contacts in business, and coordinating the regular visits of MPC and Executive Team members.  Sounds good, no?  These visits serve two purposes.  The first is regular PR.  The Bank is shown to have a listening ear to business’ concerns.  The second is intelligence gathering.  The interviews and conversations are ‘scored’ and aggregated and stories taken back to the regular monthly briefing meetings for MPC.

OK, first comment.  The intelligence gathering is done by mid to late-career staff most of whom have never worked as an economist or statistician, and none of whom are professional survey researchers.  If this intelligence is important, then the lack of science applied to the process – compared to other bodies who do the same job, and compared to the care taken in other bits of the Bank’s economics analysis – is inexplicable.  Sampling is haphazard and unscientific.  Those compiling the Labour Force Survey or working in YouGov would wonder that the staple of stratified random sampling is ignored.  Even with such science applied, as, with, say the LFS unemployment numbers, the result is a noisy signal on true unemployment, but where we understand the noise.  The Bank’s Agency material is nowhere near even that, and there is no hope to understand the noise.  Moreover, the quality of the data is impoverished further by the fact that the design of the questions posed themselves is done by amateurs, neglecting another few decades of expertise accumulated by professional survey researchers.

It used to amuse me to hear MPC members regularly asked what they thought the most important information they encountered in the course of their briefing, and to a person they would always point to the information from the Agents.  This was pure politically correct PR, to present themselves as listening kind of people, not vicious rate-hikers indifferent to the plight of business.  And it was incongruous with the way they used to behave with the Bank’s Agents themselves, who, charged with delivering the murky results of their ‘surveys’, and often uncomfortable with formal statistical analysis, would regularly be torn apart by MPC members looking for sport.  I recall one butting in:  ‘Excuse me : do you mean the rate of change, or the rate of change of the rate of change, or the rate of change of the rate of change of the rate of change?’  [with scarcely concealed irony].

The Bank has managed to professionalise this activity somewhat over the years, and the Agencies themselves are in a continual mode of cost cutting, cramming themselves into ever leaner premises.  But.  The basic philosophy of intelligence gathering is still amateur.  My suggestion:  open this function up for Review and consider intelligence gathering by outside, contracted survey professionals.  Mixing intelligence gathering with PR makes for bad intelligence.

What about the PR?  Well, here, personally, it makes me queasy that money is handed out on such a large-scale for an essentially PR function.  Can’t public bodies just do their job at minimum cost, and avoid spending cash on persuading us what a great lot they are?  The modern era seems to suggest not, and most public services have improved at the same time as their providers have got in our faces about their loveliness.  So there is clearly correlation.  Perhaps PR does help.  If we have to have it, though, why skew so much of it to these invisible one-on-one meetings with businesses?  Or private dinners?  What proportion of these visits involve a meeting with the workers?  If PR is the purpose, why not spend time visiting other public bodies?  The impression got is of the Old Bank, cozying up to men in suits who make the money, in private, so that they can quietly reassure them that the Bank is working in their interests.  And if we have to have PR, the Bank should call it that, and then add it to all the other money it spends [on its education program, the website, other media activities] so we can take a look and ask whether that’s a sensible proportion of the seigniorage to spend, or whether more of the money could be remitted back to the Treasury.

The Bank of England Strategic Review and the BoEs vision for delivering economic analysis for policy

The Bank is shortly to publish its Strategic Review, in which it enlisted the help of Mckinsey consultants.  As an ex-BoE staffer with 20 years of pent-up ignored (no doubt ignorable and probably tainted) advice I can’t possibly resist the temptation to set out what I would be looking for.

First off, it’s odd isn’t it to do it before you put in place your Deputy Governor for monetary policy?  The Review has presumably been going on while they are doing the interview process.  How has that conversation gone?  Has the Treasury said:  ‘look Ms X/Mr Y, Mark has done his review, and we think this is the job you should be doing, and this is how you should be doing it.  Are you ok with that? It would be nice to have involved you in shaping the future of your directorates, but we’d rather just get you in to crank the handle and implement McKinsey’s vision for us.’  Or maybe it was more like ‘Look, Mark is doing this review, and we don’t know what he will come up with, but we will back him all the way and want the kind of person who will do whatever he says we should.’

Why not wait, Mark?  Perhaps the Review will be a Review of what further Reviews will be done when the senior team is in place.

Second, I would take a look at the human capital situation in the policy/analytical areas.  I tweeted rather glibly last week about this during the Treasury Committee hearings, but would like to clarify in case the wrong people get offended by it.  In my view, the very top of the Bank on the Executive Team set the wrong vision for how to do monetary policy, and, though I speak more as an ex spectator than a participant on this, I don’t see much difference in the vision of how to do Financial Stability Policy either.  The team as a whole is full of unmatchable energy and talent.  But they lived a certain life and do things a certain way.  You can look at the skill profiles of the directorates they have created, and in my view, they miss a big trick, and look very different to some of their major competitor central banks.

Most of those individuals have spent most of their careers away from the frontiers of macroeconomics and finance themselves.  There may be many reasons for that, but one of them might be that they therefore feel that the activities going on at those frontiers are not productive or relevant.  The vision they therefore set is to generate an extremely large volume of data analysis.   To realise that vision, the Executive Team hire a few dozen extremely clever Heads of Division tasked with delivering and managing that informal data analysis, and hiring the armies of equally clever doers and potential successors.  Almost all of those Heads of Division have likewise spent most of their careers (perhaps wisely!) away from that frontier.  And so they naturally share the vision that in order to deliver good policy analysis, you should devote just about all your resources to basic data analysis.  And they enthusiastically set about recruiting the armies of equally impressive intellects out of Masters programs to produce the goods, and, hopefully, to guarantee succession.  This isn’t the only mode of analysis.   But the other mode, stemming from frontier empirical or applied theoretical work, is crowded out.  Those managing the budgets aren’t familiar with it, are often suspicious of it, and aren’t enthusiastic advocates of it as something worth offering up to their policy clients.

The old joke that I tweeted last week, that some used to make [‘there goes the human capital of the Bank of England’, referring to when the Bank’s foremost macro-model designer used to walk past with his lunch tray] didn’t mean at all that the Bank’s other staff knew nothing.  On the contrary.  The armies of other staff knew lots of things, and were darned able at finding out more and getting it across elegantly.  My point in digging out that old joke here is that the Bank invested very little in this other sort of analysis.  Frontier formal model building and analysis has not exactly had a great press since the crisis, so in putting forward this view I can guess that it would be controversial in many quarters, and there would be many arguable defences.  [Great!  The squeezed those loony macro modellers out!  Thank goodness for that!  What good did any of that do the economy anyway!].

Despite this dominant view about what to spend money on in delivering policy, rightly or wrongly, the Bank maintains a core macro model for forecasting, which it uses to articulate its forecast.  But there are actually alarmingly few people in the Bank who would be either able or willing to take charge of this beast.  The combination of project and man management skills, modern macro, empirical macro, and a willingness to forego any hope of cultivating a stream of publications to secure a set of plausible exit options, is a rare combination indeed.  I would guess that the Bank has always been within a couple of resignations of a catastrophe in this respect.

There is a larger number of those familiar with RBC/DSGE and econometrics.  But, to me, also a distressingly small number.  And if you were to ask : how many international economics experts does this small open economy central bank have?  You would get a very small number indeed.  Or if you were to ask:  how many recognised experts in the progress made to incorporating financial frictions into macro does this central bank have, you would get the reply that there are alarmingly few.

The Bank hires regularly from the PhD job market, and tries hard at offering them meaningful roles and career progression.  There have been a multitude of initiatives to improve the lives of those doing research and cultivating an interest in the latest macro and econometric tools for policymaking.  But there are iron facts working against them.  The first I have already mentioned.  What is for me a mistaken vision that policy analysis consists in a vast informal Kalman Filtering exercise, involving a few thousand charts.  Part of that is not even the fault of the informal Kalman Filtering [jargon for mass chart inspection in search of signal] Executive Team, because it’s the Treasury who appoint the external MPC members, and many of those in the past have been untrained or unsympathetic to this kind of analysis, so naturally you would not make much room in your budget for this kind of product.  [Recall Adam Posen, ex-MPC member, who tweeted sternly ‘microfoundations are without merit’].  But the result of this is that those who do want to devote their lives to this feel in the minority.  They are troubled eccentrics, with a management tree stretching above them peopled by those who steered clear of what they are doing, begging the question to all but the least observent ‘why don’t you stop coding up those silly models and follow my example?’

Other iron facts.  The Board of Governors at the Fed has greatly expanded its demand for PhDs.  [Three of my ex staff got jobs there].   Many other central banks have too.  The EZ member central banks have often decided to focus on research to reinvent themselves post euro.  [For example, the Banque de France].  At the same time, there has been a long-lasting pay freeze.  And at a time when the university labour market in the UK has been deregulating fast, as the wave of fees coming in from Asia and other places for economics and finance course starts to make its presence felt in salaries, busting official lecturer/reader/professor pay scales.  When I was first recruiting for the Bank back in the mid 1990s, we used to be able to say that we offered much better pay, at the cost of some independence (you had to work on things the Bank was interested in, of course).  However, the Bank now regularly gets outbid by all of the top-ranked and many second-tier departments in the UK.  I won’t name names.  But I can’t count on my two hands the number of institutions that pay more for entry-level PhD jobs.  In short, others are scooping up more of the talent and paying them more.

Another iron fact.  Censorship.  Researchers like to feel that what they are doing is noble and objective.  But the Bank, though it has moved some way in recent years, is extremely risk-averse towards allowing its junior researchers to publish research, even highly technical pieces, that might cast what they are doing in an unfavourable light.  Recapping on previous tweets on this, red-line topics in the past have been papers that progress the task of assessing the euro as an optimal currency area;  papers that suggest that the Great Moderation was good luck and not good policy [ironic, eh!].  I once had a QB article of mine on the zero lower bound doctored to suggest that such a situation was ‘highly unlikely to occur in the UK’. Two of my staff were prevented for about 12 months from even presenting at conferences a paper on monetary and macroprudential policy.    And there are dozens of other examples, often biting earlier in the process, as the naive new PhD recruit finds out that they have to bin this or that idea that won’t make it.   I didn’t ever fall foul of this myself, because as an old hand I was an expert self-censor, knowing what would and would not make it through the thicket of those who understood the  ‘optics’ and the ‘political economy’ and the ‘big picture’ of these matters.

I risk becoming one-sided here.  There are big reputational risks in being freer with your publication policies.  Central banks are nothing without their integrity and their competence.  The value of the currency and the ability to perform lender of last resort functions depend crucially on confidence.  But other central banks manage fine.  The Fed and the ECB for years published papers about inflation targeting, flouting the stated regimes of their policymaking clients.  One senior Fed system staffer said ‘OK you can’t call Bernanke a nutcase, but pretty much anything else goes’.  Both the Fed system and ECB working paper series are stuffed with analysis that is implicitly or explicitly critical of what they are doing.  Those institutions found their way to an equilibrium where staff wrote about their own views, and outside observers understood that, and so the disclaimer was taken at face value.  BoE working papers also carry a disclaimer.  But the disclaimer is mostly a sham, because pretty much all views that are in any way at variance with what the policymakers want to say are stripped out.  It says that ‘these are not the views of the Bank of England…..’  and in so doing conceals the energetic and skilful censorship and selection behind the work.

So, that’s a very long way of saying that the Bank could realise a different vision for supporting its policy and analysis functions, and staffing them.  This isn’t going to happen without very senior appointments of people who would share that vision.  (In that respect it is going to be very interesting to see who gets the DG for monetary policy job [such as it is likely to become] with the two recognised thought leaders in monetary economics, Charlie Bean and Mervyn King, soon to be both gone.)  I doubt it will be easy to achieve without creating a recognised research department, such as exists at other central banks.  This idea is almost unexpressable in the Bank of England, and will mark you out as a nutter who wants to fritter hard-won seigniorage.  It’s true that there are risks in creating such bodies, principally that they end up doing what they want to do, and not what’s useful.  But at least they guarantee that you will have some, a guarantee that the Bank’s current staffing model does not provide, and often, when I was there, looked perilously like imploding before our eyes.  Those who scoff at the mess this body of skills and knowledge pitched the world into might laugh at the suggestion we need to secure more of it.  For my part, I see a bewildering array of impressive work in macro and finance, and econometrics, trying to make sense of the mess, and if the Bank of England can’t organise itself to tap into enough of it, it won’t give itself the best chance of setting good policy, or of shaping the debates over supranational policies.

The Strategic Review is a great opportunity to change this vision.  I’ve watched the talent in the Bank jump at all kinds of impressive and daunting feats in the last several years.  Despite the lack of formal training at the frontier of macro/finance/empirics, knowing their average IQ and work rate, I forecast they would overcome this without any difficulty whatsoever, if only the right incentives were put in place and given the right direction.

OMTs are fiscal risks, and they could be outside the ECBs mandate

This post responds to recent interventions by Paul de Grauwe, which I think put up interesting counter-hypotheses to the position of the German constitutional court, essentially supporting the ECB, but don’t undermine their case.

To recap on my previous posts on this.  I do think OMTs were, on balance, the right thing to try.  If there was a chance that they would be believed, and the promise could be sustained for long enough without some judicial intervention undermining it, it was worth it.  However, I also think they were an almighty bluff, implying uncapped losses that would have meant either breaking the promise to bring about price stability, or bankrupting itself and its stakeholders, or even both.  There are definitely risks associated with getting a reputation for bluffing.  But desperate times demand taking them.

But, this post isn’t about whether OMTs were right or wrong, it’s about the debate over whether they justly fall within the ECB’s remit or not, and the arguments made by the ECB and the Court claiming that they do or don’t.

Paul contests that the policies were ‘economic’, in the sense of being directed at resolving solvency problems in troubled sovereigns in the EZ, on the grounds that, contrary to the assumption of the court, it’s possible that yields on those troubled sovereign bonds can diverge from yields based on rational assessments of the sovereign’s long-term solvency.  He suggest that the German court’s ruling is false because it relies on the defunct and false assumption of perfect markets (in the sense of agents in those markets having perfect, correct information about the fundamentals of the sovereigns).

Well, I agree it’s possible that this is why sovereign yields blew up in those troubled countries.  I don’t agree that real-time indicators of sovereign fundamentals mentioned in his post are such a good guide.  After all, the point is to project out into the future what might happen to the tax base, and to yields.  So, for example, debt to GDP ratios are not that helpful.  My debt to GDP doesn’t look that bad.  But if tomorrow I lose my mind, I won’t have much chance of paying off my mortgage.  Still, it’s distinctly possible that market prices are based on false information about ‘fundamentals’.

However, it’s also possible that markets had a point.  That markets were guessing that there might be trouble in those sovereigns’ banking systems;  that EZ-wide monetary policy was incompatible with those sovereigns’ state of the business cycle;  that they could not withstand the fiscal pressure of the politically-essential automatic-stabilisers.  Personally, I think there’s quite a lot in this conjecture.  But it only has to be a conjecture.  And we don’t have to conjecture that these views were exactly right.  We can just conjecture that they were approximately right.  In reality, there is a probability distribution over future outcomes for troubled sovereign finances.  We don’t know what it is, but we can conjecture that markets’ distributions over this had roughly the right shape.  You don’t need to assume ‘perfection’ on the part of market participants’ expectations.

Since either hypothesis is plausible, a reasonable assessment is that it’s at least possible that those sovereigns did have a genuine long-term solvency problem, and that they had an ‘economic’ problem whose day of reckoning was at least postponed by the promise of OMTs.  Provided it’s at least possible, one can’t judge those policies as purely equilibrium selection policies.  To do that involves taking an extreme view of the possible causes, not substantiated by the meagre evidence of contemporaneous fiscal and economic indicators.  After all, Paul and the ECB are putting on the table multiple rational expectations equilibria as part of their story.  Fair and educative to do so, but these stories require many leaps of faith to believe too, so they cannot be the only possible explanation.

The ECB itself made a lot of the distinction between what it called ‘liquidity’ problems of such sovereigns, caused by multiple equilibria, and genuine ‘solvency’ problems.  It saw itself – and Paul sees them – as able to separate out the two nicely, and to use its balance sheet in the service of providing liquidity, confident in the knowledge that solvency of the troubled sovereign is not in question, and, therefore, that the ECB balance sheet is safe.  It made a lot of this distinction because it was hoping to pre-empt legal challenges that would prevent it from using its balance sheet to address solvency problems.  Liquidity is ok.  Solvency is out-of-bounds.  However, I don’t think it’s possible to make such a distinction in practice with any confidence.  For the same reasons that you can’t have complete confidence in the reason for a sovereign not being able to sell its bonds.

And anyway, is the distinction meaningful?  Imagine the hypothetical situation that the ECB is the only one who thinks a member sovereign long-term solvent, buys its bonds when no-one else will.  It buys them because it calculates correctly that if everyone else believed that those sovereigns were solvent, and/or that everyone else believed that everyone else believed that they were solvent, the sovereign would, in fact, be able to sell its bonds.  However, why does this nonexistent hypothetical world where beliefs line up with the ECBs conjecture make the policy not fiscal?  What if beliefs never change about the long-term viability of the sovereign in the absence of ECB action, and yields are only low because everyone believes (surprisingly as I’ve argued), that the ECB will foot the bill?  Does the ECB’s view of the matter make it not fiscal just because it has a different view?  What would it even mean to be ‘right’ in this case?  Simply to maintain that there was a counterfactual world in which everyone shared its view and prices reflected that?  So what if there was such a counterfactual world?  How would one ever hold such an institution to account if the monetariness of a policy was decided simply by maintaining that there was such a world in which everyone shared its view?  It would surely be in the interests of the ECB to say exactly what it did say, and express unjustified confidence in one amongst many explanations for why yields were high in the periphery.  It’s hardly going to say ‘you know what, we don’t really know why those yields are high;  it might be that those governments are basket cases and just can’t get along in the EZ, but it’s worth a go with our balance sheet to see if we can’t buy a bit of time for another bail-out.’

Paul’s other point is that the fiscal risks taken by OMTs aren’t a problem.  It doesn’t matter anyway if the ECB’s capital is wiped out, the ECB doesn’t need capital.  Here, I get lost.  I think it boils down to saying that the ECB can simply print money to recapitalise itself.  Sure, like any central bank, it can.  However, it can’t guarantee that the ECBs inflation target can be achieved at the same time.  We can’t say for sure that it wouldn’t be delivered.  There might be scenarios where the requisite money printing actually helped.  But there are lots of scenarios where it would not.  If you like, we could put back on the table multiple rational expectations equilibria and argue that just the knowledge that the ECB was prepared to set aside risks to its capital would lead to a speculative attack on the value (in terms of goods) of the euro, bringing about extremely rapid inflation.  Only a possibility, mind.   Even leaving aside such attacks.  How much inflation would generate the seigniorage to recoup a few tens of billions of euros, or even a couple of hundred, lost through worthless OMTs?  Quite a lot, especially if it was expected.  Think of the calculation that someone forecasting future inflation might make if they conjectured that the market called the ECBs bluff and put its’ promise to make uncapped purchases, of potentially worthless bonds to the test.

Paul asserts correctly that central banks don’t need inviolate reserves of capital to function.  But surely they are vital safeguards to prevent them from functioning in a way that defrauds the citizens who use its liabilities as a unit of account and medium of exchange.  If an ECB loss of this kind were just ‘bookkeeping’ then why not get the ECB to buy all outstanding Greek, Portuguese and Irish debt and bookkeep the problem away for good?  Why bother with simply promising to do it in the event that yields rise above what it thinks is warranted?  Just buy the whole damned lot!  The Greek economy has suffered catastrophe on account of its fight to generate primary surpluses and stay in the EZ.  What is the point if a bit of bookkeeping and interest flow adjustments would make things better?

The point is that once the ECB balance sheet was seen to be fair game for making good fiscal trouble, EZ price stability, and perhaps even the usefulness of the euro money at all, would be presumed over.

The BoE is not the right body to consider whether to release transcripts or not

Yesterday [11 March 2014] Andrew Tyrie, Chair of the Treasury Committee, the cross-party Parliamentary Committee charged with overseeing the Bank of England’s activities, asked the BoE to reconsider its policy of destroying transcripts of MPC meetings once MPC had signed off the version of minutes to be published.   He said:  ‘There seem to me to be a good number of arguments for keeping such records, among them, to bolster public confidence that the minutes published after MPC hearings are an accurate reflection of what was said.’  Well put.

Of course the Treasury Committee can’t instruct the Bank to do or reconsider anything, let alone preserve and release transcripts of MPC.  So this is no guarantee that anything will change.  But it does make it harder for the BoE not to preserve these transcripts, especially, since on the day, neither Mark Carney nor Paul Fisher could muster a convincing account for why the transcripts were destroyed, and looked distinctly uncomfortable.  The tactic of raising this on the day when the main business was to quiz Carney about foreign exchange markets – if it was a tactic – was clever.  We might guess that the Bank would be glad to show willing on this smaller matter in the face of the more serious threat to its integrity.

However, Tyrie’s request is peculiar in one respect.  The Bank is not the right body to consider whether to change a long cherished policy of destroying tapes of MPC meetings.  It clearly has a conflict of interest, or, even if it doesn’t, might look as though it does.  One the one hand, it wants the monetary policy framework, and all the infrastructure surrounding it, to be above reproach, and to function smoothly.  But we might reasonably suspect that it would also suffer from the disease that most central banks, in fact most large organisations, have, which disposes them to keep things secret as a default, minimising scrutiny of their actions, and maximising discretion to present their affairs in a favourable light.

The Bank might wish to insist that the release of transcripts could have a deleterious effect on the operation of monetary policy, which is its own sphere.  At some point, it has to have discretion to manage some things itself without interference.  But the publication of transcripts has broader ramifications.  For the credibility of public sector records policy and freedom of information as a whole.  And for the ability of those outside the Bank to gain insight into the effectiveness of the MPC and the personalities that might seek reappointment or promotion from it.  These things don’t concern only the Bank, so we can’t expect it to weigh these factors up appropriately.

Still, in the absence of the Treasury itself doing anything about it, Tyrie’s request to the Bank was welcome.

More MPC minutes minutiae

Following on from my last post on transcripts.  Mike Bird at City AM featured that post and noted that transcripts are recorded, but destroyed after the MPC minutes are signed off and agreed by MPC members.  So, once MPC have agreed what they want us to think they said and discussed, they destroy the record of what they did actually discuss.

Danny Blanchflower, ex-MPC, tweeted that he thought that this was dubious in a democratic society, since MPC members are unelected, and, ultimately, appointed to act on the electorates’ behalf by the Bank’s Treasury clients.  Adam Posen, also ex-MPC, is against, worrying that transcripts would mitigate against a free-flowing discussion, and discourage members from moving from their original position.  [That’s not an unintended pun on the Rawlesian original position of total ignorance].  Whatever the merits, as Danny pointed out in his tweets, it certainly ‘looks bad’.  And often in matters of institutional competence and probity, it’s best to err on the side of making sure the right thing is seen to be done.  Which in this case is not destroying the tapes, since the reason it looks bad is that destruction is about concealment.  Of some embarrassing difference between the sanitised version signed off by MPC as a whole, and the original.

Further points from me.  First, are these transcripts being treated consistently with other public sector documents?  It seems quite odd that we can now read, 30 years on, the inner most thoughts of senior public servants and politicians about matters of war, yet we can’t see what was actually said at MPC meetings.

Second, Treasury observers attend these MPC meetings.  Do those observers take notes or recordings?  If they are notes, are they verbatim?  Are write ups made of them and will they be released at some point so they can be compared with the MPC account of what they want us to think they said?

Third, this is just as important an issue for the Financial Policy Committee as for the MPC.  If not more so, given the youth of this institution.  The FPC is part regulator.  And transcripts would be enormously helpful in giving detailed colour on whether that regulator was captured, or operated effectively against the financial sector lobby.

Fourth.  Adam’s worry about the stifling of free-flowing discussion was countered by Danny’s suggestion of a compromise.  No preserved recordings of Day 1 discussions.    Followed by more formal discussions on Day 2 with preserved recordings.  I have two things to add to this.  Effective chairing could force discussion.  Witness Bernanke’s challenging of the inflation-nutters on the FOMC, commented on by the Twitterati following the recent transcript releases.  It would be the job of the Governor as chair to make these challenges and orchestrate discussion.  Further, if it was clear that participating in debate and mutual discovery were part of the MPC members’ job, (it should already be), those members should want to avoid being seen as impervious to logic or counter-evidence and unprepared to shift their views.  For sure, changing your mind can look weak.  But not changing it can make you look stupid.

Fifth, and relatedly, transcripts would be a good device to allow us to discover whether the Chair was effective.  Chairs of meetings have the power to set the agenda:  was the agenda set for the good of the MPC, or in pursuit of the Chair’s own views or objectives?  Transcripts can help us discover that.

Sixth, in the UK there are periodically questions about the independence of mind of the internal members.  Are those junior to the Governor operating as individuals, and free to disagree – as is intended – or is the Governor blackmailing them into following his views, with the threat of giving them a bad reference in any possible Treasury-sponsored promotion up the ranks?  Transcripts would help us figure this out.

Seventh, the Treasury Committee has assumed the customary right to hold hearings into the appointments of new members onto the MPC.  They have no formal statutory right to oppose.  Occasionally, members are re-appointed.  It’s a shame that at least these Treasury Committee members can’t have private access to preserved transcripts to inform their assessments of the performance of the Committee as a whole, and whether particular individuals should be re-appointed.

[Update:  Andrew Sentance and Kate Barker, both ex-MPC, tweeted that they are also against preserving and releasing transcripts].