Spencer Dale, Chief Liquidationist
Spencer Dale, Chief Economist at the Bank of England and leading MPC hawk, gave a speech last week entitled “Limits of monetary policy“.
In the first half of the speech Mr Dale talks mostly about “limits” with respect to the supply-side, considering whether more demand stimulus will provide more output or only more inflation, and the associated uncertainty. There is little new here, just an unhealthy dose of supply-side pessimism.
It is the second half of the speech which gets quite strange, bringing up “risks and costs” of “loose” monetary policy. Leaving aside whether UK monetary policy is “loose” (hint: really, it’s not), what has Mr Dale come up with?
For example, a recent literature has highlighted the possibility of a so-called ‘risk taking channel’ of monetary policy. As policy rates are reduced and the yield on short-term safe assets fall, investors may shift their portfolios towards increasingly risky assets. This is perhaps particularly likely to be the case if some institutional investors have to target nominal rates of return in order to match those on their liabilities. This might well be a good thing if risk premia are too high and there is insufficient risk taking. But it could also store up problems for the future. Rajan (2006), for example, argues that this search for yield was a key factor driving the increase in risk taking in the run-up to the crisis.
Mr Dale tries to sit on the fence here. But it’s a clear hint: if the Bank stokes up demand too much, we might just end up in another demand crisis like 2008. What can you say to this? Yet it gets worse:
In a similar vein, QE works by encouraging institutional investors to hold an increasingly risky portfolio of assets. This helps to increase the demand for debt and equity issued by UK companies. But it comes at the expense of increasing the risks borne by key parts of our financial sector.
More generally, the prolonged period of low interest rates and enhanced support may delay some of the rebalancing and restructuring that our economy needs to undertake. Underlying balance sheet problems can be masked, tempering the incentives to address them. Inefficient firms may remain in business for longer and so slow the reallocation of capital and labour to more productive uses. Low interest rates and the associated forbearance might even explain part of the puzzling weakness in productivity.
Is this any more sophisticated than 1930s liquidationism? That the “necessary“ liquidations are being suppressed, so the economy is somehow unable to “restructure”?
And what does Dale mean by an “underlying” balance sheet problem? Corporate balance sheets (in aggregate, or individually) cannot be considered in some vacuum without consideration of the path of future revenue. Almost any firm could appear ex post to have a “balance sheet problem” after a collapse in revenue of sufficient magnitude – whether that “problem” appears as an excess of debt (c.f. UK banks circa 2008) or perhaps an excess of capital assets.
Next up, Mr Dale is worried about having to sell off the Bank’s portfolio of gilts when they unwind QE:
But we should also recognise that we need to sell a huge amount of gilts back to private sector investors: around 40% of the total stock of conventional gilts. That will require a corresponding reduction in the other types of assets held by private sector investors. Achieving this portfolio rebalancing without unsettling the government bond market and, equally important, causing a substantial crowding out of private sector debt will be a delicate task.
I don’t follow this. Selling the £350bn of gilts on the Bank’s balance sheet will require a reduction in the £350bn of monetary base currently held by the private sector. That’s (about) it, no? And citing an excessive future supply of gilts as a risk in providing demand stimulus is particularly ironic. It is exactly (or at least mainly) the lack of demand which is causing that excessive supply of gilts right now, via the lack of tax revenue and hence deficit. Fix that problem and the gilt market will look after itself.
The last “risk” considered is the dreaded “central bank credibility”. Dale is worried about the the “blurring between fiscal and monetary policy” and of appearing to monetise fiscal deficits, and that:
Central banks need to be clear about the limits of monetary policy in order to protect our long-term trust and legitimacy.
I guess that’s reasonable from a certain angle: it is worth emphasising that monetary policy cannot prevent supply-side shocks, for example.
But central bankers who want to protect the “long-term trust and legitimacy” of the institutions they represent are surely divorced from reality, if they think it wise to publicly fret about the “costs and risks” of providing UK demand stimulus – three quarters into a double-dip recession, four years into the “Great Recession”.