Home > Fiscal Policy, Monetary Policy > The MPC Exists to Make “Difficult” Decisions

The MPC Exists to Make “Difficult” Decisions

Now I’m forced to defend Cameron against the Keynesians… it’s a joyless task being a monetarist blogger this week.

Simon says that Cameron’s comments yesterday were rather… audacious.  I wouldn’t disagree with the thrust of the argument, that Cameron is taking liberties in claiming explicit support from Carney.  A defence of Cameron would be Carney’s specific choice of wording in the press conference in response to a question from Philip Aldrick:

“There’s also obviously the rebalancing that’s necessary on the fiscal side, which is in train.”

He did not say “The government’s foolish, reckless, and unnecessary fiscal consolidation.”  He did not go the Bernanke route and openly call for more fiscal stimulus, or perhaps just less fiscal austerity.  Instead, he said “the rebalancing that’s necessary on the fiscal side.” – my emphasis, but his choice of words.

Now we have the transcript, I can also quote Carney’s response to Bill Keegan, which is most interesting on this topic.

William Keegan, The Observer: Mr Carney, the MPC is responsible for monetary policy. To what extent do you think the government’s fiscal policy is inhibiting the reduction in unemployment that you so clearly seek?

Carney: Well, a couple of things. First, what we seek is price stability as defined by the 2% inflation target. And the challenge for the MPC is to chart the best path back to that 2% inflation target, given the weakness in activity, given the slack in the labour market and given the initial conditions – given that we’re starting with inflation at 2.9%. And we fully recognise that there has been a prolonged period where inflation has been above target.

So we’re balancing the need to get inflation back, and our primary responsibility of getting inflation back to the 2% target, with due consideration for output and employment. So, just to be absolutely clear, this is about us fulfilling our primary objective, which is inflation, and given the circumstances, doing it in a balanced way.

Carney continues talking about thresholds after that.  Eagle-eyed readers might pick up on which macro variable (hint: starts with “2%”, ends in “inflation”) Carney wants to talk about in response to a question about fiscal policy.

This clearly support’s Simon’s argument that fiscal policy has made monetary policy “difficult” insofar as fiscal policy changes have pushed up the CPI.  But I really, really dislike that framing.  The whole reason we have nine uber-smart macroeconomists running UK monetary policy is that they are supposed to make “difficult but correct” decisions about UK monetary policy.  “Politically unpopular” decisions, if you like.

We did not have Gordon Brown, Alistair Darling and George Osborne running UK monetary policy for the last fifteen years because economists thought that people like Gordon Brown, Alistair Darling and George Osborne would make “easy and incorrect” decisions about UK monetary policy, and politicians were co-opted into that view.

So I am wholly unsympathetic to seeing economists criticise politicians for making life “difficult” for the MPC.   (As an aside, Mervyn King was clearly sensitive to this issue.  That is why he sat through the 2011 Inflation Report press conferences with a smug look on his face, facing down the press time and time again as they implored him to raise rates and get inflation down.  He knew that in 2011 he had an acid test of the MPC’s ability to make “difficult but correct” decisions.)

Simon is clearly right when he says:

In the UK, however, it appears that it is inflation rather than (maybe?) the (perceived?) inadequacy of monetary policy instruments which is restraining further monetary stimulus.

But this does not go far enough.  We have had an absolutely clear opportunity for the MPC to decide the extent to which inflation restrains further monetary stimulus.  I do not expect they will get such an opportunity again for a long time.  And the economists on the MPC have decided that it is absolutely correct to place low inflation above all else in steering a course for UK aggregate demand.   That is the “difficult decision” our uber-smart macroeconomists have taken, and the rest of us must now suffer from.

  1. W. Peden
    August 9, 2013 at 13:35

    Great post.

    I have no idea what the operational meaning of ‘difficult’ is within Wren-Lewis’s model. Does he mean political difficult? Does fiscal austerity make monetary policy more costly? Make it more likely to require unconventional measures that are unpredictable?

    Or is this just Wren-Lewis’s way of keeping on the “right side” of the austerity debate even when he can’t bring himself to support any models that would lead him to be able to repeat the standard criticisms of it?

    The hard, cold fact is that once the liquidity trap claptrap is disposed with, all that remains in the austerity debate is a boring set of public finance questions.

    • August 9, 2013 at 14:41

      Thanks, and yes that’s a good question about what “difficult” really means. I guess Simon thinks in terms of the CB’s loss function. Indirect tax rises are skewing the “square-of-inflation gap” input to the loss function, and that is messing up the output of the function?

  2. W. Peden
    August 9, 2013 at 15:50

    That would be a sensible complaint in 2010/2011 when we had the VAT increase, but since then there hasn’t been any big indirect tax rises.

    Even that’s not an argument against austerity, but against austerity via raising indirect taxes.

  3. W. Peden
    August 9, 2013 at 15:51

    (Not that ‘austerity’ is a scientifically defined term either. It’s a political term.)

    • chrisA
      August 11, 2013 at 15:11

      Simon, you talk about monetary policy being more risky than fiscal policy, as monetary policy has not been tried. But Japan tried fiscal policy for many many years and got nothing for it but excessive corruption and the biggest national debt in the world. Japan was a very rich country at the start of this, do you really think that the UK in 2010 could have seriously tried this option even if it had been shown to work? Can you really say that say a 300% of GDP debt level is less risky than a bit of QE and maybe higher inflation and a debt level a third of that?

    • James in London
      August 11, 2013 at 19:17

      And, Simon, the Chancellor did specifically task the new Governor and the MPC with assessing the need for changes to UK monetary policy. The MPC could have chosen targeting the market’s NGDP forecast as a condition, but they airily dismissed this route. Why don’t you join Market Monetarists in supporting this option?

      They chose unemployment with so many other conditions that the market now has to forecast both unemployment and the MPCs forecast of inflation 18-24m ahead. Surely this would count as a bit of a failure of nerve. And the markets even said policy was tighter after the announcement than before, a double fail.

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