Winner of the New Statesman SPERI Prize in Political Economy 2016

Sunday 4 August 2013

Playing catch-up at the Bank of England

On Wednesday (7th August) the Bank of England will announce what it intends to do on forward guidance. Many seem to expect it to follow the Fed, and indicate a combination of (expected) unemployment and inflation that would not result in monetary tightening. Expectations may turn out to be wrong, however, because there is a quite wide divergence of views on the MPC about these things.

I think it is pretty clear that they should announce something like this, for two main reasons. First, it would help clarify what the overall objective of UK monetary policy is. As I argued here, a quite plausible interpretation of recent MPC’s behaviour is that they are simply targeting inflation two years or so ahead, and ignoring the expected output gap. Such a strategy is not consistent with how most academics think monetary policy should work, and it would not be compatible with Fed style forward guidance. So by adopting the latter, they could signal that they are in fact following a more orthodox, and appropriate, monetary policy. Second, forward guidance of this type gives us an indication of how they currently view the trade-off between the objective of achieving the inflation target and the objective of achieving a zero output gap. (My reading of the Treasury paper in March is that it makes clear, which it was not before, that having such a trade-off is compatible with the UK’s inflation targeting regime.) I cannot see how revealing that information can be a bad thing.

There are two other areas where the Bank could usefully receive forward guidance from the Fed. The first is to end the nonsense of not revealing what it expects future interest rates to be. I have always found the arguments for not publishing its own forecasts for interest rates particularly weak - they often amounted to the view that the public was too stupid to understand the difference between a forecast and an unconditional commitment. However, as long as only a few ‘minor’ central banks did publish this information (New Zealand, Sweden, Norway), the Bank of England could get away with this. Once the Fed starting publishing this information, the case for the Bank not to do so collapses. (See more here.)

The second is to be honest about fiscal policy and Quantitative Easing. This does not mean the Bank should say that the current government’s austerity programme is wrong (even though it is), but that it should say that it makes it much more difficult for monetary policy to achieve its objectives. As I have argued before, this statement is almost undeniably true, so why not go on the public record as Bernanke has done? It is in the Bank’s own interest to do this.

When the Bank was given independence in 1997, the regime the Labour government then established was arguably ‘state of the art’. Within the context of inflation targeting, it was very sensible to establish a symmetrical range where getting inflation too low was considered as bad as allowing inflation to be too high. Having an MPC that included some academics was a good idea, obviously (and debate within the MPC has clearly been much better as a result). However the Bank has largely stood still since then, in terms of practice and transparency, in part because the Bank itself is an inherently conservative institution that instinctively avoids public discussion. (A recent example, now rectified, is here.) So now it is behind best practice, and needs to catch up. Anyone who still thinks the Bank is transparent enough should read this recent post from Tony Yates.

Playing catch-up is all the more important because ‘best practice’ (what the Fed currently does) is still probably a long way behind what is optimal. This is not a criticism of central bankers so much as an acknowledgement that the game today is much more difficult than we thought it was just ten years ago. Miles Kimball has a very nice little piece on the major challenges that future monetary policy faces. Even if the recovery gathers pace and unemployment falls back to more normal levels and central banks can safely raise interest rates above the floor, the lessons of the Great Recession need to be learnt. To do better next time (because there will be a next time), is there a role for explicit policy commitment to mitigate the impact of the ZLB, and would level nominal GDP targets be a means of achieving that? Are there more inventive ways of removing the ZLB constraint, or if not, should we think about raising the inflation target? Is there a permanent role for unconventional monetary policy, and how does macroprudential regulation coordinate with conventional policy? Do we really have to keep discussion of using inflation to help reduce debt a taboo? All that, even before we start thinking about the financial sector and banks.

So there are huge challenges ahead, and it would be great if the Bank of England could be at the forefront in addressing these. The Bank should be given substantial credit for undertaking Quantitative Easing, and innovative programmes like Funding for Lending. However it would be even better if it could be at the innovative frontier across the whole range of monetary policy practice, as I think it was fifteen years ago.    


  1. There was and I think there will probably remain that tense ambiguity between having an independent central bank or one that is as open to political will/interference through its nationalisation.

    In the US Krugman seems to have spent a lot of his last five years attacking the print-money-get-hyperinflation Say's Law crowd, but in the UK those people pretty much don't exist. I asked myself why that is, and I guess it's because the UK has had a central bank since the 1680s and in rightist politics they know that debt helped the UK defeat Napoleon. There is nothing like that in US history and its 1919- Fed.

    In short, I keep hitting politics where economic argument should be. So anything the BoE can do for openness, it should do as quickly as possible, because if Japan works out, fiscal stimulus will be the talk of the town going into May 2015.

  2. "that it makes it much more difficult for monetary policy to achieve its objectives"

    It sure has been "difficult" getting that CPI rate down to 2%, eh?

  3. I'm not a fan of central bank interest rate predictions, since it suggests that CB's see their job as one of stabilizing interest rates over the long term. And like stabilizing exchange rates ("fear of floating"), it compromises more important goals.

  4. I agree with Britmouse - if the Bank is broadly achieving on inflation, then it's not its job to look after the economy. Rather, it is to look after the interests of the banking sector and austerity does not run contrary to those interests.


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