This is from the minutes of the February 2012 MPC meeting – the punchline is right at the end:
37. The Committee had announced a programme of £75 billion of asset purchases at its October meeting, and this had recently been completed. While the Committee continued to monitor the impact of its asset purchases, it saw no compelling reason to think that their impact on nominal demand would be materially different than had been anticipated in October. It would keep this under review in judging the policy actions needed to support the recovery and meet the inflation target. In terms of the immediate decision, the Committee considered the arguments for increasing the stock of asset purchases by £50 billion or £75 billion, either of which would be sufficient to put inflation broadly on track to meet the target in the medium term on its central projection. Committee members placed different weights on these arguments.
38. A number of reasons for the smaller increase were advanced. Recent data on the domestic and international economies had on balance been more positive than might have been anticipated towards the end of 2011, pointing to the possibility that growth might be stronger than expected in the near term. Moreover, the ECB’s LTRO had reduced some of the worst immediate downside risks to the outlook stemming from the euro area. Although inflation had fallen back broadly as expected, short-term inflationary pressures remained. The rate was still well above the 2% target and there was a risk that inflation might prove more persistent than in the Committee’s central projection, especially if downward pressure from labour market slack was less than expected. An increase of £50 billion in the stock of asset purchases would represent a material monetary stimulus, and it was not clear that a stimulus larger than that was warranted at the current juncture. In addition, given market expectations, a larger increase risked sending a signal that the Committee thought the economic situation was weaker than it was.
What clearer message could we get that the MPC see the UK economy as being exactly where they want it? There is no demand problem. These aren’t the unemployment figures you’re looking for. Everything is under control. Keep calm and carry on.
The Monetary Policy Committee minutes from the February 2012 meeting are out, and we have not one, but two doves in the house. Adam Posen has again broken ranks, and is joined for first time by David Miles in asking for larger asset purchases, against the MPC consensus for a £50bn extension:
Regarding the stock of asset purchases, seven members of the Committee (the Governor, Charles Bean, Paul Tucker, Ben Broadbent, Spencer Dale, Paul Fisher and Martin Weale) voted in favour of the proposition. Two members of the Committee (David Miles and Adam Posen) voted against, preferring to increase the size of the asset purchase programme by £75 billion to a total of £350 billion.
The updated CPI forecast data has been published as well, and here’s a graph showing how the forecasts have changed over the last four quarters:
On this metric, the policy easing (£75bn of QE) in Q4 can be deemed to have “worked” somewhat; the median forecast has shifted significantly upwards (from the light blue to the purple line). But the CPI rate remains below the 2% target from 2012 Q4 onwards, which motivates further easing.
David Blanchflower has fired both barrels at the Bank of England Monetary Policy Committee in a new column for the Independent. He finds Sir Mervyn King and his team to be poor value for money:
The Bank of England is packed full of economists paid out of the public purse, and the public is entitled to value for its money and it hasn’t had it. To this point, there has been no official inquiry into why their overly optimistic forecasts on growth and inflation have been worse than the proverbial monkey throwing darts at a wall. The MPC’s forecasts are aspiring to be hopeless; downward revision of the growth forecast has followed downward revision; upward revision of the inflation forecast has followed upward revision.
Above all, a review is needed because the Bank appears to be repeating the same mistakes that were made in the run-up to the recession, which is hardly surprising given that all the same people remain in charge. Why? The forecasts are ultimately the responsibility of two officials who have been in charge since July 2008: Charlie Bean, the Deputy Governor for Monetary Policy, who was previously the chief economist, and Spencer Dale, the current chief economist. It’s hard to lead a team whose morale I gather is at rock bottom, when you have been consistently wrong. Bean and Dale’s terms should not be renewed.
Go Danny! Blanchflower was the only real MPC dove when it mattered in 2008 – voting for rate cuts in every single month of the year, and for faster rate cuts in the first two months of 2009. The rest of the committee was strongly consensual, voting as a block, with the minor exception of Tim Besley who voted for rate rises in both July and August of 2008.
But the line of argument is slightly odd – perhaps because it has been simplified for a mainstream audience? Under inflation targeting, forecast-targeting, we must not simply judge the MPC’s forecasts against later outturns, which seems to be what Blanchflower expects. The MPC cannot be expected to correctly predict oil prices or changes to indirect taxes; the markets will not do that either.
Indeed, that expectation contradicts Blanchflower’s own voting record: why else vote for rate cuts when current inflation is above target? If the MPC’s task is to stabilise the inflation forecast, we can judge them on that front alone.
Simon Wren-Lewis argues that the UK monetary policy stance in 2011 would have “allowed” easier fiscal policy, and better real outcomes. If we presume that the Monetary Policy Committee are targeting the forecast, does that claim bear out?
Here is a graph of the full range of the inflation forecasts published at each Inflation Report in 2011:
In the forecast-targeting game, the MPC were not obviously failing in the first or second quarters. Indeed, the median CPI forecast in Q2 (red line) being above target all the way out gives reasonable justification for the three MPC members wanting to raise rates at the time. In a counterfactual with fiscal policy planned to be looser, presumably pushing those forecasts up higher, it would be very hard to predict the MPC response in the first half of 2011.
Yet Wren-Lewis makes a stronger claim:
So, if the MPC had raised interest rates in 2011, they would have been wrong to do so. That is obviously true in hindsight
This does not seem at all obvious to me if you endorse inflation targeting, forecast-targeting. Wren-Lewis appeals only to the discretion of the MPC in judging the appropriate stance for monetary policy, advising some kind of cost/benefit analysis based on the size of the “output gap”.
This is the whole argument? UK macro policy is based on the hope that we can find benevolent MPC members who will exercise their discretion wisely?
How well has that turned out since 2008? How will we hold them accountable for exercising discretion? What is the benchmark? CPI? An abject failure; four years above target. The CPI forecast? Unstable since 2008. Deviation of nominal GDP from trend growth? Disastrous failure. Likewise for Real GDP? Failure. Unemployment? Failure, failure, failure. It is failure all the way down; so let’s hand out a knighthood.
Wren-Lewis has another answer. We need not hold the MPC accountable at all, because we can find always find an appropriate bogeyman for macro policy failure – politicians:
But the real source of the [2010/11 macro policy] error is to be found much earlier, when the Conservatives opposed the government’s fiscal stimulus measures in 2008/9
The disaster of 2008 shows exactly what can happen when monetary policy-makers exercise their discretion and decide to burst a commodity price bubble. Are we doomed to repeat this experience? No, no, no.
Yet it is hard to see how the debate in the UK will move beyond a discussion of fiscal policy when the economics profession is so blinkered. The BBC Today programme’s Evan Davis – an ex-IFS economist, no less – hosted a discussion of UK “austerity” recently. What mention of the failings of UK monetary policy? Zero, zilch, nada.
Lars E.O. Svensson‘s “best practice” for inflation targeting is to target the forecast – to set the stance of monetary policy such that the forecast of the inflation rate remains on target, even if the current inflation rate deviates. With the inclination towards market inflation forecasts (as opposed to some mathematical model), Scott Sumner dubbed Svensson a “Market Keynesian“.
The Bank of England’s legal mandate does not strictly endorse targeting the forecast, setting their objectives as follows:
- to maintain price stability, and
- subject to that, to support the economic policy of Her Majesty’s Government, including its objectives for growth and employment.
The specific interpretation of “price stability” and HM Government’s economic policy are confirmed yearly in a letter from the Chancellor:
I confirm that the operational target for monetary policy remains an inflation rate of 2 per cent (measured by the 12-month increase in the CPI). The inflation target is 2 per cent at all times: that is the rate which the MPC is required to achieve and for which it is accountable.
The framework is based on the recognition that the actual inflation rate will on occasions depart from its target as a result of shocks and disturbances. Attempts to keep inflation at the inflation target in these circumstances may cause undesirable volatility in output.
(A note to those who call for a higher inflation target: HM Treasury, not the Bank, has the legal power to change the specific interpretation of “price stability” at any time; there would be no need even for Parliamentary approval. It is easier to change the inflation target than to change the fiscal budget!)
The Monetary Policy Committee seem to find enough leeway in their remit to adopt the language of forecast-targeting. For example, in October 2011, with annual CPI inflation at 4.5%, well above the target, the MPC was willing to ease policy, giving the following justification:
The deterioration in the outlook has made it more likely that inflation will undershoot the 2% target in the medium term. In the light of that shift in the balance of risks, and in order to keep inflation on track to meet the target over the medium term, the Committee judged that it was necessary to inject further monetary stimulus into the economy.
This begs the question how the “medium term” is defined. Fortunately, the Bank publish detailed forecast data. Here is a graph of the CPI forecasts produced at each quarterly Inflation Report, the forecast based on market interest rate expectations is used looking both two and three years out:
Had the MPC been targeting something close to the two-year forecast (red line) they should have eased in 2010. But they did not ease (or otherwise change) policy throughout the whole of 2010, nor through the first three quarters of 2011. Policy was loosened only once the forecasts across the curve dropped precipitously in the final quarter of 2011.
This presents a conundrum, because in 2008 the opposite was true: the justification for tightening in the first quarter can surely only come from an emphasis on the nearer-term forecasts which did spike upwards. Likewise in the third quarter of 2008, the three year forecast drops significantly below the 2% target, which would have indicated easing, whereas the three year forecast remains above – and the MPC fatally held rates at 5% through that entire quarter.
So even if the MPC are vaguely Svenssonian in its communication, it seems that they do exercise discretion over policy; or at least whatever policy rules they follow are kept well obscured.
If only our press corps could hold them accountable for these decisions, rather than imploring Sir Mervyn King to pontificate at length about Moody’s, the Eurozone, and SME financing; the pertinent issues for UK monetary policy makers?
Bank of England Inflation Report, November 2006:
Actual and expected changes in Bank Rate affect the level of nominal demand in the economy.
Bank of England Inflation Report, August 2007:
Monetary policy affects inflation via its influence on nominal demand.
Bank of England Inflation Report, August 2008:
Monetary policy affects inflation via its influence on nominal demand.
Bank of England Inflation Report, February 2009, about to hit the zero bound:
The MPC’s ability to influence the value of nominal spending and inflation in the economy, and hence achieve the inflation target, ultimately derives from the fact that the Bank of England is the sole supplier of sterling central bank money: banknotes and reserves held by the banking system at the Bank.
Regardless of how monetary policy is implemented, the objective for policy remains the inflation target. That means that, whatever the uncertainties about the strength of the transmission mechanism, the private sector should be assured that the MPC will take the steps necessary to bring inflation back to target. If the MPC were to adopt unconventional measures in the future, that commitment would be a crucial element in ensuring the efficacy of policy, helping (as now) to anchor inflation expectations and boost nominal spending.
Bank of England Inflation Report, August 2009:
In the United Kingdom, nominal GDP fell by 3% in Q1, the sharpest decline since the quarterly series began in 1955 (Chart 2.1). It was absolutely nothing to do with us, though. Nope. Not our problem, mate. Blame the bankers.
Bank of England Inflation Report, May 2011:
But the evolution of nominal spending over the remainder of 2011 is uncertain. The path of nominal spending since mid-2009 may provide a positive signal about households’ and businesses’ willingness to spend. In that case, steady nominal spending growth could continue. We don’t really know what will happen, to be honest. Economics is a complete mystery to us. La la la la. Nice weather, though.
Bank of England Inflation Report, February 2012:
Four-quarter nominal spending growth has fallen back somewhat since the latter part of 2010 (Chart 2.1). I didn’t do it. The dog ate my homework. Look! There’s a Eurozone crisis! Here, look at some pretty fan charts.
Minor embellishments my own.
After the UK left the ERM in 1992, HM Treasury had to adopt a new nominal anchor for monetary policy fairly quickly. Before entering the ERM the Government had ostensibly used money supply growth rate targets as the framework for monetary policy, though they were not good at hitting the targets.
One anonymous civil servant discusses alternative frameworks in internal Treasury correspondence from 1992; an inflation target was ultimately picked. Included are sections of something called “the December 1989 Chevening paper”, covering the relative merits of inflation targeting, a “price/output” framework, and an NGDP framework.
Below is a transcription of the section on using an NGDP target (growth rate presumably):
45. In recent versions of the MTFS the aim has been to use money GDP to provide this [nominal] anchor. This is the best measure we have of the total activity in the economy in the prices of the day – and it has become the centre piece of our nominal framework.
46. The implicit view of how the world works is the same as in the price-output approach. The essential principle is that over the medium term, output growth is determined by the supply potential of the economy and any persistent growth of money GDP above this rate will be reflected in faster inflation. In the short term it is likely to be reflected in a faster growth of real output but subsequently inflation will rise and output revert to trend.
47. Bringing down inflation means bringing down the growth of money GDP closer to the underlying rate of output growth. In the short-run this is likely to mean a period when real output growth falls below its underlying rate but in time we would expect output growth to return to trend and inflation to stabilise at a lower rate.
48. Of course these are only tendencies; in practice there are no hard and fast rules because changes in money GDP can be brought about by a number of factors, both internal and external, which directly affect prices.
49. Again we can interpret recent events in this framework (see Chart 10). Money GDP growth accelerated to almost 10 per cent in 1997 and 11 per cent in 1988 before appearing to decline slightly this year (1989). Not suprisingly, in both 1987 and 1988 real GDP growth was significantly in access [sic] of supply potential (say 3 per cent). Inflation picked up in 1988 and rose further in 1989.
50. If the underlying rate of growth is 3 per cent, reducing inflation from its current rate of 6 per cent plus requires bringing the growth of money GDP below 9 per cent on a sustained basis. The extent of the reduction of inflation will depend on how far money GDP growth is reduced.
51. There are also problems with this approach:
- the initial data is poor and money GDP growth can only be controlled in a rough and ready way taking one year with another; if it departs significantly from its desired path it takes time to bring it back into line;
- we have a record in recent years of underestimating the growth of money GDP which has affected the credibility of this approach;
- presentationally it has unattractive features. A frequent criticism is that it is a curious magnitude to target, being the addition of inflation, which is bad, and output, which is good.
Even so in my view it is a useful framework. It enables Government to concentrate on the financial framework and take a ‘hands-off’ approach to the division between real output and inflation. In principle it is easier to relate to the behaviour of monetary aggregates; it is consistent with the approach followed throughout the 1980s; and avoids getting tangled up in the web of fine tuning output and inflation. In theory it is entirely consistent with the price-output approach. Being from the same stable they are complementary – different ways of looking at the same problem; one is easier to understand intuitively, and throws light on short-term movements; the other is probably a better control procedure from a medium term perspective. It also possesses presentational advantages.
The “MTFS” is the “Medium Term Financial Strategy” published by the Treasury in the 1980s.
Other hints at the use of NGDP as a not-quite-explicit target in the 1980s can be found in Hansard:
The Government are pursuing a responsible path for the growth of money demand. During the past few years it has grown by 8 per cent. a year. That is more than adequate for any reasonable increase in demand in the economy. It provides ample scope for both inflation and unemployment to fall. There might be an inadequate real demand, but the notion that the solution is an increase in money demand is a profound fallacy. Money demand is the only instrument on the demand side that the Government can manipulate.
That was Nigel Lawson, then Chancellor of the Exchequer, speaking in the House of Commons after the 1985 Budget.
The Office for National Statistics’ current data on quarterly UK nominal GDP growth in 2008 is as follows, at Seasonally Adjusted Annual Rates:
- Quarter 1: 4.3%
- Quarter 2: -1.7%
- Quarter 3: -5.2%
- Quarter 4: -3.4%
That collapse in nominal spending has no precedent in the data, and is certainly worse than anything since the 1930s. Who cares about nominal GDP (nominal demand)? This is what the Bank of England said in the Inflation Report from August 2008:
Monetary policy affects inflation via its influence on nominal demand. Four-quarter nominal GDP growth was relatively robust in 2006–07, but slowed to 5.3% in 2008 Q1 (Chart 2.1), close to its average over the past decade. With inflation rising sharply (Section 4), a stable path for nominal demand growth implies slowing real spending growth.
(Note the figure for Q1 has been revised since the contemporary data available to the Bank in 2008.)
UK monetary policy is tasked to control inflation, and it does that by influencing nominal spending. If nominal spending collapsed in 2008, we should hence surely blame a failure of monetary policy?
Jonathan Portes considers the state of demand management, and is not so sure:
But just as this approach [primacy of monetary policy for AD management] was motivated by pragmatism more than theory – monetary policy was better suited to this task – my change of mind is similarly motivated. If monetary policy alone was indeed enough in practice, we wouldn’t be where we are now, with unemployment a million higher than the OBR’s estimate of the natural rate, and no prospect of it coming down in the immediate future. Any demand management policy that delivers that outcome is not one that policymakers should regard as remotely adequate.
- January: Bank Rate left at 5.5%
- February: Bank Rate lowered to 5.25%
- March: Bank Rate left at 5.25%
- April: Bank Rate lowered to 5%
- May: Bank Rate left at 5%
- June: Bank Rate left at 5%
- July: Bank Rate left at 5%
- August: Bank Rate left at 5%
- September: Bank Rate left at 5%
The problem is now obvious: Mr Portes can only mean the dreaded 5% Lower Bound on interest rates, described throughout the macroeconomics literature.
After the fact, that looks like a catastrophic policy error. But surely everybody spotted what was happening at the time? Martin Weale was doing Mr Portes’ forecasting job at the NIESR in 2008; here is his comment on the September 2008 rate decision:
The Bank of England’s decision to keep the interest rate at 5% p.a. is to be welcomed. It will be very difficult for the Bank to cut the rate before inflation turns clearly down. At the same time it needs to be recognised that a cut now would have no real impact on the growth rate for the rest of this year and it therefore is not in a position to alter the risk of an imminent recession.
It certainly looked “difficult” to cut rates below 5%!
During September 2008, Lehman Brothers failed. In October, already well behind the curve, the Bank of England dramatically cut the base rate to… 4.5%.
By March 2009, Bank Rate was finally lowered to 0.5% and the Bank began a program of gilt purchases, with the explicit aim of boosting nominal spending:
Accordingly, the Committee also resolved to undertake further monetary actions, with the aim of boosting the supply of money and credit and thus raising the rate of growth of nominal spending to a level consistent with meeting the inflation target in the medium term.
The nominal GDP outturns for the subsequent quarters of 2009 were as follows, annualised growth rates again:
- Quarter 2: -0.4%
- Quarter 3: 5.0%
- Quarter 4: 3.7%
A tepid recovery rate, but a recovery nonetheless. So which should we worry about more, the 0% lower bound in 2009 onwards, or the 5% lower bound in 2008?
(Here’s a happy ending: Martin Weale was appointed to the Bank of England Monetary Policy Committee in July 2010.)