Monetary Policy Regime Change: Remit Fudged and MPC Nudged
For all the talk of “monetary activism”, what is striking from reading the monetary policy remit review is that HM Treasury is very, very conservative; small-C conservative. They fear a return to the 1970s. They fear loss of “credibility”. They fear the untried, the untested. Setting aside the relevance of those fears, we should perhaps recognize the value of such “institutional conservatism” at a time when the governance structures elsewhere in Europe are proving barely adequate in preventing the state stealing from its own citizens.
Can I find any positives in the Bank’s new remit? There is a lot of fudge and a lot of nudge. I hoped for a “regime change” which avoided both, but here’s a look at what we did get:
1. A “dual mandate” nudge: a slight de-emphasis of the “strictness” of the 2% target; and a slightly greater emphasis on short-run output stabilisation. Ed Conway discusses this point. The relevant paragraph from the review document follows:
2.17 The remit for the MPC set at Budget 2013 has been updated to clarify the trade-offs that are involved in setting monetary policy to meet a forward-looking inflation target. For clarity, the target “applies at all times”, as distinct from a requirement to be met at all times, because the latter could be mis-interpreted as strict inflation targeting with zero weight on the secondary objective, contradicting the flexibility to respond efficiently to shocks and disturbances that move inflation away from target. The MPC’s forward-looking policy decisions must be consistent with ensuring price stability in the medium term. The appropriate policy horizon is subject to the operational independence of the MPC.
This is also a fudge. It reads like the government wants a dual mandate without saying they actually want a dual mandate. Say what you mean, George.
2. A nudge towards a Bernanke-Evans rule – use of “forward guidance” and “thresholds” as an “unconventional policy instrument”. I think this is the most significant part of the remit change. There is a long and favourable discussion of forward guidance and managing expectations in the review document. This is very welcome, it implies the Treasury recognize the MPC’s abject failure to manage expectations over the last five years, and see that as a key problem.
The MPC are required to review the “forward guidance” idea and report back in the August Inflation Report. The review gives this hint:
3.30 Potential indicators that might function as thresholds for state-contingent guidance, aside from the unemployment rate used by the Federal Reserve, include the output gap, real GDP and nominal GDP. To be efficient, any indicator would need to have some relation to the objectives of monetary policy. To be credible and accountable, a threshold would need to be understood and verifiable. As such there is likely to be a trade-off in any choice of indicator for a threshold.
We will have to wait and see what Carney goes for. And so again, this is a fudge. Osborne is betting on Carney coming in and persuading the MPC to adopt a Bernanke-Evans-like rule, rather than requiring the MPC to run better policy starting tomorrow.
Carney could go further than Bernanke-Evans and set expectations around NGDP; the above text at least allows the MPC to explore that idea. That would not be a bad route to trialling a “back-door NGDP target” if the government wanted to avoid the complexity (and risks?) of changing away from the 2% inflation target. If you want to “keep the flame [of NGDP] alive”, run with that idea. It seems pretty remote to me.
3. An attempt at improved accountability around deviations of inflation from target, and the trade-offs required; from the review (emphasis from the original):
The remit goes further by clarifying that in exceptional circumstances, where shocks are particularly large and with persistent effects, the MPC is likely to be faced with more significant trade-offs between the speed with which it aims to bring inflation back to target and the consideration that should be placed on the variability of output. This therefore allows for a balanced approach to the objectives set out in the remit, while retaining the primacy of price stability and the inflation target. The remit requires that in forming and communicating its judgements the MPC should promote understanding of the trade-offs inherent in setting monetary policy to meet a forward-looking inflation target while giving due consideration to output volatility.
I’m not sure how much difference this will make. The MPC can easily claim they do this already.