The Bank’s forecasts for real GDP growth over the next two years. 2014: 2.8%, 2015: 2.3%. WHAT A BOOM. What an explosion of growth! In the Inflation Report press conference today, the press first asked lots of sensible questions about forward guidance and monetary policy – you know, the things the MPC are actually responsible for. But there was an elephant in the room, something was weighing on the minds of assembled hacks… see if you can spot it.
Richard Barley, Wall Street Journal: … Because I guess the concern is that so far we’ve seen perhaps some worrying signs of returning to the old normal and greater lending, reliance on house prices.
Guy Faulconbridge, Reuters: Just a follow on on the housing, I see you have a section on property. Do you see any signs of a bubble in any regions of the British housing market, because overall it’s fine to say that perhaps prices are still below the 2007 peak, but in London dinner parties the prices that you pay for prime real estate in London is kind of the main topic of discussion.
Tim Wallace, City AM: Governor, another one on housing.
Maybe hold the press conference up North somewhere next time?
Paul Tucker is leaving the MPC later in the year. That’s the good news. Here’s a quote from his speech today which I cannot resist ridiculing:
It is sometimes suggested that independent central bankers are more averse to inflation than to periods of low growth and increased unemployment.
Gee whiz, Paul, really? Why could that be?
I hope the past few years have demonstrated that, in fact, it is the credibility of the Bank of England’s commitment to price stability that enabled us to provide such exceptional monetary support to help the recovery.
Oh. So… during a period with the worst real GDP growth on record, and high unemployment, what you’re saying… as you and your colleagues have done in speech after speech… is that what really matters is the Bank’s “commitment to price stability”?
It is unimaginable that, prior to Bank independence in 1997, any government would have been able to hold the policy rate at effectively zero and make a further monetary injection of £375bn without inflationary expectations – and government financing costs – spiralling out of control.
Inflationary expectations… hmmm… wait. For some reason I am getting the impression that independent central bankers are more averse to inflation than to periods of low growth and increased unemployment. But it must be the voices in my head.
(Those three sentences really are placed together in that order in his speech, I’m not making this up. Tucker also has a delicious reference to his definition of the phrase ”escape velocity”, with a footnote referencing his remarks in 2011 to the TSC. It’s hard to know what he is getting at.)
There was an almighty showdown: Mr. King found himself confronted by a powerful coalition including Chancellor of the Exchequer Alistair Darling, top Treasury officials, the Financial Services Authority led by its then-chairmen Adair Turner, and senior members of the BOE’s Court. All demanded that he do something to stem the deepening credit crunch. Much to Mr. King’s fury, Bank of England Deputy Governor Paul Tucker had circulated a paper to top officials at the BOE suggesting the central bank set up a new long-term funding facility that would allow banks to use their illiquid mortgage portfolios as collateral. A concerted effort was made to force Mr. King to agree to the plan. In a night of high drama involving a series of late phone calls, Mr. King relented and the Special Liquidity Scheme was born.
The SLS was arguably the single most successful crisis response deployed in the U.K.
Stop right there Mr. Nixon, I can’t resist this one…
The UK’s major foray into creditism co-incided with the worst collapse in aggregate demand on record, before or since. If that’s success, I’d hate to see what failure looked like.
Mark Carney tried to explain Woodfordian monetary policy to some reasonably smart MPs today and he failed completely. ”Train wreck” would be a moderate description of how badly that Select Committee meeting went.
Is the 7% unemployment rate a target? Erm, well, you see…
What will happen if the 2.5% inflation knockout triggers? Erm, well, you see…
Are higher interest rates a sign of looser or tighter monetary policy? Erm, well, you see…
Is forward guidance a loosening or a tightening of monetary policy? Erm, well, you see…
That was an awful public performance and painful to watch. Carney has an impressive grasp of the UK data, but he was struggling to explain something as simple as the stance of monetary policy when forced to rely on the language of interest rates and “state-contingent guidance”, etc. I’m sure it would be much simpler if he could stick to money and nominal incomes!
I’m back from the beach… and I want you to recall the quotes from Mervyn King’s infamous “Black Clouds” speech of June 2012:
… a large black cloud of uncertainty hanging over not only the euro area but our economy too …
… Complete uncertainty means that the risks to prospective investments … are simply impossible to quantify …
… the black cloud of uncertainty and higher bank funding costs …
… The paralysing effect of uncertainty, with consumers and businesses holding back from commitments to spending …
… the black cloud of uncertainty has created extreme private sector risk aversion …
… private sector spending is depressed by extreme uncertainty …
… during the present period of heightened uncertainty …
Contrast with the quotes I can cherry-pick from Mark Carney’s first speech as Governor:
We aim to get there in part by reducing the uncertainty that has held back growth.
… First, we are giving confidence that interest rates won’t go up until jobs, incomes and spending are recovering at a sustainable pace.
… Our forward guidance provides you with the certainty …
… should give greater confidence …
Our forward guidance acts as a stabiliser, …
However much I dislike the specifics of BoE policy, it would be churlish of me not to say it: this is much, much better. This is how a central bank Governor should talk; certainty, confidence, stability. Mark Carney is doing his job, and that is a good thing.
The simplest way to tell that there was no massive change in the BoE’s policy stance yesterday is to look at the forecasts. The forecasts for inflation are basically unchanged since the May inflation report.
The Bank is still expecting to hit its 2% target at around the two year horizon, and then slightly undershoot from mid-2015 onwards.
Simon Wren-Lewis is right to claim that the Bank isn’t targeting 2% inflation on the two year horizon. At two decimal places, the Bank’s median forecast for the CPI rate is 1.96% on the two year horizon. That’s what you meant, Simon, right?
Please, everybody, apply more Svensson. The Bank’s forecasts are what the Bank is targeting. There is no difference between the two. The forecasts tell us exactly what the Bank expects to happen to the UK economy.
Carney made it 100% clear that the MPC will adjust the “tools” of policy if they do not think the economy is on an acceptable course. He made it 100% clear that the MPC do think the economy is currently on an acceptable course; that is why they did not adjust QE/talk down rates/extend FLS/or whatever at the August MPC meeting.
It is 100% clear that the course the MPC currently expects the economy to follow is most likely to involve unemployment staying above 7% for the next three years. We now have the fan charts to prove it.
Ergo, the Bank of England is now targeting high unemployment.
It cannot get any clearer, or more transparent than that. It is a welcome improvement in transparency! The Bank have made it 100% clear that “price stability” remains dominant over all other concerns. No wonder the hawks signed up.
IR & press conference roundup:
1. Carney gave an impressively scary “steely eyed hawk” look to the WSJ’s Simon Nixon (who is a hawk, duh, like all WSJ employees) when pressed on whether the Bank cared if house prices rose 15% next year. ”No, Mr. Bond, we expect you to die.” – uh sorry, no, he said they were going to target 2% inflation (HT Marcus).
2. There was no addition to the BoE’s current levels of creditism. Celebration!
3. Scott rightly points out that UK monetary policy is still significantly looser than it was this time last year (market inflation expectations and equities up), even though the MPC undershot expectations. True. It is worth noting that the MPC has now undershot expectations with three consecutive announcements: the July MPC minutes, the August MPC decision, and now the IR.
4. Bill Keegan (Observer) asks the obligatory “but what about the tight, tight fiscal policy?” question. Carney, paraphrased: “Good one Bill, very funny. We don’t give a damn about fiscal policy, we only care about the CPI. Have you seen the CPI figures, Bill? They’re shocking.”
5. David Smith (Sunday Times) tries to trip up the new kid in town, quoting the RPI-based market inflation expectations. Carney is not at all amused. Don’t expect any exclusive interviews with the Guv’nor any time soon, Mr. Smith.
Any fiscalist who thinks this is a worthwhile improvement in UK monetary policy can take their plans to “do public works and create jobs”, get in their time machines, and bugger off back to the 1970s. The hawks were totally victorious today.
I must end with a special mention for one Mr. Ed Balls MP, whose response to the IR provides us this with this priceless quote:
Given the high inflation we have seen over the last couple of years it will be very important that the MPC stays vigilant to inflationary risks.
Thanks so much for that one, Mr. Balls. Apparently, those who failed to learn from Japan are indeed doomed to emulate it.
The Committee intends at a minimum to maintain the current highly stimulative stance of monetary policy until economic slack has been substantially reduced, provided this does not entail material risks to either price stability or financial stability.
In particular, the MPC intends not to raise Bank Rate from its current level of 0.5% at least until the Labour Force Survey headline measure of the unemployment rate has fallen to a threshold of 7%, subject to the conditions below.
Very, very weak. From the press conference intro:
Today’s Inflation Report contains for the first time, in Chart 5.10 on page 47, the MPC’s projection for unemployment. It shows that, with Bank Rate remaining constant at 0.5% throughout the 3-year forecast period, the MPC’s best collective judgement is that the median unemployment rate at the end of the projection period is 7.3%. Chart 5.11 on page 48, also new in this Report, shows that unemployment is judged by the MPC to be as likely to reach the 7% threshold beyond the three year forecast horizon as before.
The MPC expects to fail. As with the Fed, we could have unemployment at 8% for the next century and the MPC cannot be judged to have deviated from its guidance.
Markets dropped on this announcement, so this is an effective tightening of policy versus what was expected. Osborne’s gamble failed.
[If you're not interested in aimless musings skip this post and wait for 10:30am tomorrow.]
Maintaining optimism about UK monetary policy has been a masochistic experience in recent years. Lars excepts to be disappointed tomorrow and yet finds reason for optimism in the medium term. I’m the other way round. I am hopeful the MPC will not screw up tomorrow.
But if the MPC do disappoint, perhaps they’ll do so in a similar way the Fed disappoints now. We’ll get a mediocre recovery and that will be sufficient, as Simon says, to remove any political motivation for further macro policy reform; possibly for a long time. We are already five years on from the worst AD collapse since the 1920s, and for the first time now contemplating a real policy reform. Maybe somebody believes Ed Miliband is hiding an inner Shinzō Abe? I don’t.
Duncan Brown urges caution. In my view, the cautious thing to do is to follow a path which is least likely to leave an extra million people unemployed and many more underemployed, not to worry about whether there “could be” structural issues in the UK economy. And I agree with all the reasons to believe in structural issues which Duncan gives – they could all be true. But running inflation as “high” as 6% didn’t cause Tory voters to collapse in the streets in the 1980s, the last time we saw NGDP growth north of 8%. They’d all cope again for a couple of years now; if that makes me one of Mervyn King’s hopeless “dreamers“, so be it.
But back to tomorrow. Osborne’s Treasury has invited the Bank of England to adopt something close to Michael Woodford’s ideal of optimal policy. I think that’s way ahead of what the average UK economist thinks should or could be achieved with UK monetary policy, and Osborne & co. deserve credit for that. (See the FT year-end survey for a nice range of views; from Adam “The Dove” Posen saying that flexible IT has “served us well”, to the guy from the “NEF” blabbering on about a Green Investment Bank.)
If our nine elite macroeconomists reject “Plan Woodford”, what does that say about the state of macroeconomics – or our macroeconomists? Nothing very impressive, I feel.
T-12hrs and counting… good luck, everybody.
I was right about Carney’s vote but wrong about the relevance. The absence of any MPC member voting for QE in June raised Sterling and lowered equities; perhaps not quite as much as the MPC announcement moved us in the other direction, but still we have dumb example of “Bank offsets Bank”. (And yes, look; expectations really do matter!)
Here are the key points of the MPC hawks’ view in the July minutes:
27. For most members, the current policy setting was appropriate and the onus on policy at this juncture was to reinforce the recovery by ensuring that stimulus was not withdrawn prematurely, subject to keeping inflation on track to hit the 2% CPI inflation target in the medium term.
For some of these members, asset purchases remained an effective tool with which to inject more stimulus, although an expansion in the purchase programme was not warranted at this meeting. But for others, the benefits of further asset purchases were likely to be small relative to their potential costs. In particular, further purchases could complicate the transition to a more normal monetary policy stance at some point in the future.
The hawks worrying about “normalisation” are still shooting themselves in the feet. Ensuring the UK has weak NGDP growth forever means we are likely stay on the ZLB forever. Failure to learn from Japan’s “lost decades” makes MPC members – supposedly Britain’s elite macroeconomists – look embarrassingly ignorant.
Over to the “doves”:
29. For the other members, further stimulus was warranted. Domestic activity was recovering as quickly as envisaged in the May Inflation Report, but the pace remained too slow to begin to close the economy’s margin of spare capacity.
An expansion of the asset purchase programme remained one means of injecting stimulus, but the Committee would be investigating other options during the month, and it was therefore sensible not to initiate an expansion at this meeting. Given the already large size of the asset purchase programme, there was merit in pursuing a mixed strategy with regards to the different policy instruments at the Committee’s disposal. The Committee’s August response to the requirement in its remit to assess the merits of forward guidance and intermediate thresholds would shed light on both the quantum of additional stimulus required and the form it should take.
That last paragraph has Carney written all over it, and brings us to “forward guidance”. This has been much discussed in the media, I’d highlight Chris Giles and Simon Wren-Lewis for anyone not already a keen reader of both. (And I’ll take on that Luddism challenge, Simon, in another post.)
The key question for me is how Carney will bring the MPC hawks and the doves to a consensus on “forward guidance”. What are the choices? This is my view:
1) Do nothing. HMT requested an “assessment” of forward guidance and “intermediate thresholds”. The MPC could say “here’s an assessment; here are the costs and risks; we choose to exercise our operational independence and prefer no change in policy. Thanks for the advice, George, and good luck with the election.” I think this is highly unlikely but not impossible.
2) Something like the Bernanke/Evans rule. Forward guidance with thresholds around real variables; keep rates low until the unemployment rate gets below 7%, or something similar. Possibly tied to an open-ended QE program (Paul Fisher mooted open-ended QE earlier in the year). I think this is possible, it’s clear Carney is keen on this route. But I think there will be very strong resistance from Bank insiders and MPC members, who think this runs the risk of repeating the mistakes of the 70s and targeting a “too low” level of unemployment.
3) A Woodford/Sumner rule (if we’re going to give it a name, is there a more appropriate name?) This means forward guidance with thresholds around nominal wage or nominal GDP growth; keep rates low until some measure of nominal wages are growing at 4%, or nominal GDP is growing at 4-5%. Again possibly tied to a QE program. Given sufficiently conservative (low) thresholds for NGDP or wage growth, I think it would be possible to get the hawks on board here. MPC forecasts already have an implicit path of NGDP. Endorse that and commit to hitting it. Some MPC members are particularly concerned about the nominal wages, so that could be a consensus winner.
It will be a close race between (2) and (3), in my view, but if I had to bet all-in, I would pick (3) as most likely to gain support of the hawks.
There are two ways the MPC is likely to fail:
a) I cannot see how it will be possible for the MPC to form guidance around a level target rather than a rate target. It is hard to avoid the constraint of the inflation rate target here.
b) A “thresholds” approach fails the test of proper Svenssonian monetary policy – you must target the forecast. Scott and others have written about this many times in the context of Bernanke/Evans rule.
The reference in the minutes to “different policy instruments” is ambiguous – it may refer to guidance itself as an instrument. But I think it’s almost certain that the MPC will engage in a significant expansion of “credit policy” at the same time as forward guidance, under the umbrella of Funding for Lending or some other disgusting banking-sector subsidy wrapped up as a “liquidity injection”.
That would represent an alignment of the New Keynesian stars, and would be no doubt celebrated by fiscalists, creditists and everybody who rejects the view that “money always matters.” Michael Woodford specifically called out the BoE’s Funding for Lending scheme as an appropriate ZLB policy tool in his Jackson Hole speech endorsing NGDP level targeting.
So there will be no test of monetarism from the Bank; we will remain with a muddled New Keynesian policy framework and ”anything but money” as the tools of policy – but with luck the Bank will produce better policy anyway.