Hawks, Doves, and Forward Guidance
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was appropriate and the onus on policy at this juncture was to reinforce the recovery by ensuring that stimulus was not withdrawn prematurely, subject to keeping inflation on track to hit the 2% CPI inflation target in the medium term.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.