We Need Better Policy, Not Better Central Bankers
Chris Giles reports that the Chancellor is wavering:
George Osborne is cooling on the idea of changing the Bank of England’s inflation target to one aimed at the amount of spending, top Treasury officials have told the FT. The chancellor now thinks there is sufficient leeway in a “flexible” inflation target for the central bank to boost growth.
The chancellor, who met Mark Carney, the BoE governor designate, for a drink on the sidelines of the World Economic Forum in Davos on Thursday night, is worried that Mr Carney accidentally set up unrealistic expectations of a revolution in monetary policy in a December speech.
The chancellor still wants the new BoE governor to be more active in ending economic stagnation, but does not believe that the bank needs to target nominal gross domestic product to ensure such a change.
Aides to the chancellor say he thinks a move to make the inflation target more flexible is likely to be sufficient, even if that might require a change in the annual remit given to the BoE.
That is depressing. Here is how the OED on-line dictionary defines the word “policy”:
a course or principle of action adopted or proposed by an organization or individual
The monetary policy regime we’ve had in the UK since 2008 has been highly discretionary. It has not been based on principles. If Osborne thinks the Bank of England needs a more “flexible” target – more discretion – he has the analysis completely backwards.
Back in 2007 if you thought about which people you wanted running central banks, you’d come up with guys like Mervyn King, Ben Bernanke and Lars Svensson. Uber-smart macroeconomists with impeccable academic credentials. If all that results from the current debate about monetary policy is that we appoint central bankers we think are really smart, and give them discretion to “do the right thing”, market monetarists have mostly failed.
Some say we need tight money to get inflation down. Some say money is already easy and we need loose fiscal policy. I say, if it walks like a duck and quacks like a duck, it’s probably a duck. The above chart looks like a severe failure of demand-side policy in the United Kingdom over the last five years. Severe failures like this happen when we have the wrong monetary policy. Not because fiscal spending was a couple of % of GDP too low, or taxes were a couple of % of GDP too high.
The failure of 1970s is also obvious in that chart; pushing demand up faster and faster for ever-decreasing returns. But does 2008-2013 look anything like the 1970s? No; quite the contrary. It looks like we have compressed demand tighter and tighter. Yet here is Mervyn King last week:
In assessing the current [monetary policy] framework, however, there are two factors that should not be ignored. First, the primary responsibility of any central bank is to ensure stability of the price level in the long run. To drop the objective of low inflation would be to forget a lesson from our post-war history. In the 1960s, Britain stood out from much of the rest of the industrialised world in trying to target an unrealistic growth rate for the economy as a whole, while pretending that its pursuit was consistent with stable inflation. The painful experience of the 1970s showed that this illusion on the part of policy-makers came at a terrible price for working men and women in this country. The battle to bring inflation expectations down was long and hard, and involved persistently high levels of unemployment. Wishful thinking can be indulged if the costs fall on the dreamers; when the costs fall on others, it is unacceptable.
Look at the words he chooses to use: “unrealistic”, “painful experience”, “illusion”, “terrible price”, “wishful thinking”, “the dreamers”. This is an unrepentant defence not just of the 2% inflation target as the optimal policy regime, but of UK demand management on his watch. He’s saying “this is as good as it can get, buckle down and take your medicine”. It is this or the 1970s!
On the basis which theory says we should judge the stance of monetary policy under “flexible IT” – the deviation of forecast inflation from desired inflation, the Bank of England has found the “discretion” to fail abysmally – and yet the Governor insists everything is just fine.
The “discretion” of central bankers is a problem which echoes around the world. The ECB – which has never even hit the ZLB – uses tight money to depress Eurozone AD and force sovereign governments to do supply-side reform. The Bank of England throws multi-billion-pound bungs at the banking sector (aka the “Funding for Lending Scheme”) in the name of “creditism”. The Bank of Japan refuses to even try hitting the inflation target set by the newly elected government. Lacking any sense of irony, the Riksbank has set out to “prove” that household debt “causes” an AD collapse, by explicitly running tight monetary policy in response to the growth of household debt – to Svensson’s evident disgust.
None of this should be an acceptable state of affairs in a modern democracy. Institutions run by unelected technocrats should not have free reign to depress the economy as they see fit. The “flexible” inflation target offers them that freedom. We cannot and should not rely on finding “heroic” Central Bankers riding in from the West to bravely rescue us when the current round of “heroic” Central Bankers has thrown the economy off the cliff.