Dear Mr Carney... Memos to the new Bank of England governorPublished Thu 13 Jun 2013
What we need from the Bank of England right now is some straight talk.
In announcing the new monetary policy remit, the chancellor pointed to the well-known 'short-term trade-offs that must be made between inflation and output variability' and instructed the Bank to 'promote understanding of the trade-offs inherent in setting monetary policy' in its communications.
In plain English, the quicker the Bank steers inflation back to its long-run target of 2.0 per cent, the slower the recovery in both output and employment from the lows of the recession will be. I believe everyone can agree the Bank's thinking on this trade-off has been opaque at the best of times, and an improvement in its communications on the topic would be a most welcome development.
Unfortunately, the Bank seems so far to have interpreted its new instructions in such a way that this observer still has absolutely no idea what the Bank's views of the trade-offs are, except that it seems to think current policy is just about right. Nowhere have I seen the Bank disclose any methodology for evaluating the size of the trade-off, or any guidance on the weight the Bank places on either side. As the chancellor wrote to your predecessor: 'Transparency plays an important role in communicating the trade-offs inherent in setting monetary policy.' I completely agree, and would encourage the Bank to use an explicit evaluation of the trade-offs to put the ball into the Treasury's court in terms of deciding at what level the trade-off is acceptable within the context of the policy remit.
It is my belief is that a substantial portion of what can only be described as an ongoing epidemic of human misery might actually be preventable, rather than inevitable. That the Monetary Policy Committee is making its judgments in the light of totally unspecified considerations about the magnitude of potential trade-offs between risks around the inflation target and those to employment and output is simply not good enough.
In fact, the idea that economic conditions as currently forecast should be considered an acceptable monetary policy outcome without any meaningful acknowledgment of the size of the trade-offs involved makes me incredibLY ANGRY...
HULK WOULD NOT SMASH MANKIND ON CROSS OF 'RISKS TO 2% INFLATION BROADLY BALANCED AT LATTER END OF FORECAST PERIOD'. HULK SAYS IF BANK PRESENTS TRADE-OFFS TO CHANCELLOR, CHANCELLOR FORCED TO MAKE DECISION. HULK WANTS BANK TO MAKE CHANCELLOR CLARIFY LEVEL OF HUMAN MISERY REQUIRED BY REMIT. HULK HOPES CARNEY'S REPUTATION FOR STRAIGHT TALK NOT GET SMASHED BY PUNY MONETARY POLICY COMMITTEE.
It is becoming clear that something extraordinary is happening to the very nature of value in our economy. This is partly due to the unconventional policies which have been deployed to combat the ongoing financial crisis. But it is also due - and this is less well appreciated - to a sudden explosion of technological breakthroughs.
The world is changing like never before, mostly on account of increased connectivity, knowledge sharing and information access. This is having a significant impact on output, money and value. In the next few years a large number of jobs are likely to be lost to technology. Self-driving and electric cars, automated manufacturing and 3D printing are among the disruptive inventions that sit just around the corner. But there are important technological advances which have already started to impact our productivity and efficiency in ways we don't fully appreciate yet. Everything from smartphones, which allow us to work 24 hours a day from anywhere in the world, to smart logistics and big data analytics, which help to eliminate the need for physical stock and inventory and so cut waste. The utility of goods is also being extended thanks to a growing number of resale websites. These allow existing inventory to compete on the marketplace with newly manufactured goods, deflating prices like never before.
Those who have been completely disenfranchised from the economy meanwhile are turning to collaborative solutions to meet their lifestyle demands. Transactions in this space have a tendency to circumvent traditional money markets almost completely. It is from this world that bold new alternatives to state and central bank money are emerging. Some are totally uncollateralised parallel currencies which aim to compete with legal tender; others are collateralised options that hope to increase monetary velocity independently of bank lending. These peer-to-peer initiatives only add a complex new layer to an already swollen and little-understood shadow banking sector.
Given these developments, has the governor considered that it may be time to rethink how we measure GDP? Also, should the Bank of England now launch a digital legal tender of its own to cater to these evolving modern currency demands?
Welcome to Britain Mark - I learned my economics at Queens in Canada and love the country. But the first thing you need to realise is Britain is not Canada. Don't assume anything works the same!
It's not clear what more monetary policy can do at present to get us out of the hole we are in: don't hold back from saying that. If we want to boost the economy then fiscal policy has to play its part, and you need to say that loud and clear. Don't just say what George Osborne wants - having appointed you, you are now practically untouchable. You are only there for five years but you can set up the right legacy now.
Do look at nominal GDP targets and other approaches to monetary management - especially important so we do not raise interest rates too early in the cycle.
You need to make sure we have decent governance at the Bank and that the Monetary Policy Committee and the Financial Stability Committee work together - otherwise a fatal tension will develop. Growth is crucial, but don't let the banking sector lobby for any weakening of the moves towards higher capital ratios and the like on the basis of it.
Listen to your independent MPC members - do not ignore and sideline them as your predecessor tended to do. Create an atmosphere of challenge and creativity in the Bank, not just a bureaucracy there to support what the boss thinks. Be a transparent institution and publish more on the Bank's forecasts, modelling and thinking. The Bank is very powerful now, with few countervailing forces or centres of expertise on macroeconomics. Accountability demands openness.
Get out around Britain and smell the coffee (and the labour market). There are massive regional inequalities emerging and the Bank must make - and be seen to make - decisions for the whole country, not just for London and the south east. Good luck!
Since you're no doubt getting a great deal of advice about how to address the current downturn, let me step back and look at the longer-term picture. Central bankers, including your predecessor, have fallen down on the job by not taking asset bubbles seriously. Contrary to the folklore that was popular during the days of the 'Great Moderation', it is not easy to clean up the mess after an asset bubble has burst.
Collapsed asset bubbles are likely to lead to periods of prolonged weakness, as we are now seeing in the UK, the eurozone and the United States. The basic point is simple: large asset bubbles distort the economy. In the case of the housing bubbles that afflicted most wealthy countries in the last decade, these led to excessive building and extraordinary levels of consumption through the housing wealth effect. There is no easy way to replace these sources of demand when a bubble bursts.
This means that it is incumbent on central banks to prevent the growth of dangerous bubbles. Higher interest rates are one possible tool, but it is worth trying less drastic steps first.
The initial route is simple: talk. Central banks have the public's ear. If they not only argue for the existence of a bubble but carefully document the case with research as well, it will be harder for the public to laugh off the evidence. This may not work, but what's the downside? Talk is cheap.
Second, there are regulatory tools that can be used to try to stem the flow of finance that fuels a bubble. These should be used to their fullest possible extent.
Higher interest rates are a last resort, but are certainly preferable to the alternative, allowing bubbles to grow as large as those we saw in the last decade.
Targeting 2.0 per cent inflation is something that only matters to economics nerds and bankers - bubble-fighting is an agenda that makes a difference for the whole country.
The problem: You arrive with high expectations. Ringing endorsements from across the political spectrum. A track-record of success. And you clearly have an engaging personality.
Since expectations are so high, there will be a natural tendency for the defining narrative to be one of disappointing achievement. The media will be looking to find an overarching story on which to peg all news. The overarching story could be 'tensions with the chancellor grow', or 'Bank chief lives high-life in London'.
You will also have hundreds of media requests, and you will need to plan an engagement strategy with utmost care.
The solution: You need quickly to establish your own overarching narrative. It should give your decisions a context. Something like 'making safe growth possible'. Whatever your key message is, it needs to be a mantra, endlessly repeated, and it needs to be backed up by clear arguments and facts. Write it all down on one slide.
In terms of how you engage with the media, be extremely careful not to have favourites. Prestige, distance and formality are your friends. Communicate through speeches, press releases and testimony to parliament rather than TV sofas and background briefings. Communicate through the media rather than to the media. Take more of your speeches out of London to emphasise that you recognise that your remit extends beyond the Square Mile.
And if a man dressed as a sheikh offers you a deal you can't refuse, call me.
Wage settlements are subdued and more than 2.5 million people are out of work in the UK, so any new top priority for the Bank of England has to be to boost aggregate demand. With possibilities for expanded government spending blocked by the ideological fundamentalism of the parliamentary majority, the interest rates the Bank of England controls at rock-bottom, and quantitative easing of unknown effectiveness, only one obvious lever remains: the exchange rate.
It is time for the governor to announce that a (somewhat) weaker pound is in Britain's (short-run) interest - and to make it so.
Memo from: Frances Coppola, who blogs on finance, economics and music on her Coppola Comment blog
In this era of monetary dominance, the general policy stance is established by the central bank. However, the effectiveness of monetary policy diminishes as interest rates approach zero, and it may also prove inadequate when small adjustments are needed in particular sectors, or where transmission is impaired due to a damaged financial sector. Under these circumstances, there may be a role for targeted fiscal tools to reach the parts that monetary policy cannot reach.
Targeted taxes can be used to create proxies for interest rates. For example, since physical cash poses a problem for negative interest rate policy, imposing a tax on vaulted cash and/or on large or frequent cash withdrawals might be more effective than attempting to introduce a negative interest rate on physical cash.
The near-money nature of short-term government debt and its wide use as collateral enables it to be used to transmit monetary policy directly to non-banks. The Funding for Lending scheme uses treasury bills as a monetary policy instrument, but unfortunately relies on banks to achieve its effects. As the financial sector is still healing, we should look for similar combined monetary and fiscal initiatives that reflate the economy directly, rather than forcing damaged banks to lend.
Fiscal tools are very powerful and if used in an undisciplined way can lead to high inflation, collapsing bond yields and a currency free-fall. They should only be used within a monetary policy 'envelope'. But under current conditions, combined monetary and fiscal approaches may achieve the best results.
The economic history of the UK over the past 30 years is one of successful microeconomic reform, interspersed with episodes of disastrous macroeconomic mismanagement. Unfortunately, we are living through such an episode at present. What can you do to help?
This is the slowest recovery in the UK's recorded economic history. This reflects both the aftermath of the global financial crisis and a mistaken policy response. David Cameron called that response 'fiscal conservatism and monetary activism'.
The 'fiscal conservatism' side of it clearly had a substantial and negative impact on growth. The halving of public sector net investment especially is now almost universally recognised as a major policy error.
But the impact of 'monetary activism' is far less clear. Although the Bank of England did indeed expand its quantitative easing programme, this has become subject to diminishing marginal returns. Many members of the Monetary Policy Committee seem to have lost faith that more QE will achieve much.
Meanwhile, the financial sector remains dysfunctional. It is manifestly failing to fulfil its primary function of channelling credit to the real economy.
Up to now, the response of the policymaking establishment has been to pass the buck. Your predecessor, Mervyn King, blames the supply side of the economy, and says 'generalised monetary stimulus' is not the answer, while the chancellor has encouraged a view that your arrival will somehow transform the impact of monetary policy.
We know that you will be more willing than your predecessor to consider changing either the remit given to the Bank, or the way the Bank implements policy, perhaps by not just keeping interest rates low but committing in advance to keeping them low, as the US Federal Reserve has done.
But such changes are no panacea. There is a case for changing the remit - but then the Bank (rightly) has not made hitting the inflation target a short-term priority over the past few years anyway. Markets already expect interest rates to stay low, so for the Bank simply to promise that this will continue might not change much in the real world.
The point is that the changes currently being mooted are not about policy - they are about communications, expectations and targets. But if we want things to be different, then we will have to do something different, not just talk about it. And the current governor is right about one thing - monetary policy alone is highly unlikely to be enough to put us back on track for sustainable and balanced growth.
This will require you and the chancellor to work together, not to try to shuffle responsibility on to each other. You could both start by taking the advice of others, such as Adam Posen, who has called for aggressive action to boost both private and public investment; Angus Armstrong, here at the NIESR, who has put forward radical proposals for reform of the UK mortgage market; and the London School of Economics' Growth Commission, which has pointed to years of inadequate investment in skills, infrastructure and innovation.
All these measures would be good for the economy both in the short term - boosting demand, and hence output and jobs - and in the longer term, by helping to address the UK's chronic problem of underinvestment in both the private and public sectors.
With your arrival, as well as the IMF's belated but welcome recognition of the need for fiscal stimulus and the almost-complete consensus among economists that the UK needs more investment, there is now an opportunity for the policymaking establishment to change course. We would all be better off if you took that opportunity.
Welcome. I write to urge you to cool expectations that Britain can live by monetary policy alone.
Our political establishment is reluctant to discuss this in public, but Britain ranks alongside Japan as the most indebted of the larger economies. McKinsey estimates UK private debt at an extraordinary 427 per cent of GDP, vastly exceeding gross public debt at 94 per cent of GDP. By contrast, American private debt is half the UK's, at 198 per cent of GDP.
Since 2008, the US has succeeded in deleveraging private debt by 14 per cent of GDP. British private finance sector debt has continued to grow since the crisis; and, as a consequence of the government's policy stance, public debt is rising too.
Public and private investment has slumped, unemployment and underemployment remain far above longer-run normal levels, deflation threatens, and austerity is shrinking UK incomes. This makes it hard for indebted private firms and households to deleverage, invest and spend.
Monetary policy alone is ineffective: Britain is too indebted to respond to monetary stimulus. As McCulley and Poznar have argued, fiscal policy can solve monetary policy's problem by becoming a borrower and spender of last resort. And monetary policy can solve fiscal policy's problem of government debt by monetising some portion of it.
Given Britain's huge private debt, coordination between monetary and fiscal authorities is essential if the UK is to avoid decades of stagnation - or, worse, an Irving Fisher-style debt-deflationary spiral.
So your first task, I suggest, is to persuade the chancellor that financial stability depends on this coordination.