MPC on Safe Assets: Higher Gilt Yields Would be Good
So close and yet so far. This is a comment on safe assets from this month’s MPC minutes:
This improvement in risky asset prices came at a time when the underlying risks to the global economy remained material. Much of the increase could be attributed to lower rates on safe assets, such as some government bonds, which raised the current value of future flows of income from risky assets. These low rates, in turn, reflected both a global mismatch between strong desired savings and weak investment plans, and the policies undertaken by various central banks to underpin nominal demand and meet their inflation targets. At some point, higher prices of risky financial assets would in all probability make investing in the real economy a more attractive proposition, leading to higher aggregate demand. A sustained rise in demand would, in due course, mean a rise in interest rates on safe assets and, potentially, some unwinding of the rise in risky asset prices.
If only some central banks could work a little harder to “boost” nominal demand rather than just “underpinning” it. The doves (King, Fisher, Miles) say ease, noting correctly that easing monetary policy now will mean interest rates rise sooner than otherwise:
Earnings growth had fallen and there was little sign of any de-anchoring of inflation expectations. Further asset purchases now would facilitate an earlier normalisation of the monetary stance when that became appropriate. Against that backdrop, it was appropriate to reduce labour market slack more quickly than was envisaged in the Committee’s central projections. The impact of such a policy on inflation was uncertain. The initial impact of faster demand growth might be to reduce cost pressures by improving productivity.
But the hawks say no, and the hawks win:
Inflation had been above the target for a considerable period and there was tentative evidence that measures of medium-term inflation expectations were becoming more sensitive to short-term news in inflation. Moreover, financial markets were not expecting further asset purchases at this meeting and might, at the margin, reassess the Committee’s tolerance of elevated inflation should additional stimulus be injected.
In other words, the most important thing for UK monetary policy is that everybody believes that the MPC are inflation hawks.