UK Monetary Policy Revolution

A James Alexander post

The great mid-2015 tightening

From the August 2015 Inflation Report opening remarks:

Policy outlook

The MPC’s projections are conditioned on Bank Rate following the gently rising path implied by
market yields. Under this assumption, demand growth is expected to be sufficient to return inflation to the target within two years. Inflation then moves slightly above the target in the third year of the forecast period as sustained growth leads to a degree of excess demand.
As the UK expansion progresses, speculation about the precise timing of the first move in Bank Rate is increasing. This is understandable and is another welcome sign of the economy returning to normal. The likely timing of the first Bank rate increase is drawing closer.

The great mid-2016 loosening

From the August 2016 Inflation Report opening remarks  :

Policy trade-off

The MPC’s Remit recognises that when the effects of shocks persist over an extended period, the MPC is likely to face an exceptional trade-off between returning inflation to target promptly and stabilising output.
When this is the case, the Remit requires the MPC to explain how it has balanced that trade-off, including the horizon over which it aims to return inflation to target.

Fully offsetting the persistent effects of sterling’s depreciation on inflation would require exerting further downward pressure on domestic costs. And that would mean even more lost output and a total disregard for higher unemployment.
In the Committee’s judgement, such outcomes would be undesirable in themselves and, moreover, would be unlikely to generate a sustainable return of inflation to the target beyond its three-year forecast period.

As a result, in order to mitigate some of the adverse effects of the shock on growth, the MPC is setting policy so that inflation settles at its target over a longer period than the usual 18-24 months.


The BoE’s new monetary policy tool: toleration of above target projected inflation

A James Alexander post

Watching Bank of England Governor Mark Carney joust again with Jacob Rees-Mogg MP at the UK’s Treasury Select Committee yesterday got me looking back to the May press conference when Carney launched his warnings about the riskiness of voting Leave, that were then repeated at the May Treasury Select Committee hearings.

There was a lot going on at the time but Carney had a secret weapon, a new monetary policy tool whose importance is still being overlooked.

Carney took sides, but …

The intensity of the debate over Brexit was terrific during May and June. The Bank of England was clear that there could be financial chaos and a technical recession. There was only downside risk from the voting Leave. In that view the BoE was amplifying, but with authority, the typical consensus expert view. It took sides with the Cameron/Osborne government, clearly and simply, loyally.

Remain supporters amongst journalists and politicians were very pleased. Leave supporters were not. Rees-Mogg was entirely right to question the independence of the bank. If Carney had talked in any remotely balanced way about the potential benefits of Leave then he would have been fair but as Rees-Mogg noted, he didn’t take up that opportunity. All serious people agreed Brexit would be a disaster, and Carney is a very serious person indeed.

However, the sub-text was also crystal clear. And FX markets, a prime window onto, and channel of, monetary policy very much got the message. If the UK voted Leave then all the monetary policy power of the Bank of England would be brought to bear immediately to offset any shock to demand, due to fears about the supply side.

Once it was clear that the UK had voted Leave then the markets immediately knew what to expect from UK monetary policy. Potential rate cuts, QE and other liquidity schemes – plus the bonus of a dramatic and statesmanlike broadcast from Carney himself. Sterling fell 10% in response to the u-turn in monetary policy, UK domestic equities fell in response to demand shock fears caused by long-run supply side fears. Political turmoil didn’t help much either. But, it wasn’t a disaster. Financial institutions sailed through unscathed, many even profitably. There was no repeat of Lehman.

With one step he was free

In the hearing yesterday Carney was not exactly smug, but he did say he was “serene” about the new stance. He also elaborated about just how profound the 180-degree u turn on monetary policy had been. He said monetary policy was on a tightening bias as late as May/June, and the next moves in rates were due to be up. That had all changed now and he clearly was a much happier man as a result. His incorrect monetary policy stance of the previous year and a  half was now just a distant memory, “ancient history” as he called it.

No monetary shock here, so no demand shock either

While the vote to leave was a shock a bigger shock, a monetary shock, would have been if the Bank of England hadn’t intervened to offset the uncertainty shock.

If it had decided to defend the currency with a monetary tightening, that would have been truly disastrous. Some central bankers have made that mistake in the past and it never ends well.

If it had appeared to stand pat and just keep its tightening bias, that would still have been a shock. Some central bankers have done that too, and it didn’t end well.

The BoE had primed markets that it would respond appropriately and it did. GBP immediately fell 10%, and then rates were cut and QE was expanded. Osborne’s replacement, Philip Hammond, also made it very clear that the response to the Brexit shock was monetary, not fiscal.

The BoE even said it would also tolerate an above target inflation rate – all in order to ensure financial stability and a return of inflation to 2% in the longer term. That “even ” is subtle, but very powerful.

Overshoot of projected inflation now tolerated

Why did Carney never say during 2015 that it would tolerate a period of above target inflation in order to bring current inflation up to target. Well, the obvious answer is because the BoE took its own projections seriously, and they showed inflation returning to 2%.

Those projections always showing this happening kept monetary policy tight, with promises of more tightening to come if those projections showed an overshoot. The fact that this stance meant constant under-shooting was lost on the BoE.

Is this a new tool?

After the Brexit vote the UK central bank seems to have added this new weapon to its toolbox: Toleration of projected overshoots to its inflation target at a time when actual inflation is stubbornly below target.

The BoE tolerated current inflation above target when it was above target, but what else could it do? It was a fact, but was it a choice too? We don’t really know. We do know that it wouldn’t tolerate inflation projections going above its target until we had the vote to leave, now we do.

Perhaps this new tool could also be used by other central banks. Temporary overshoots of projected inflation in order to get current inflation up to target. Are you listening at the Fed, ECB and BoJ?

BoE, grudgingly, will “tolerate” above target inflation projections: money stays tight

A James Alexander post

The BoE of surprised markets by not only doing the 25bps rate cut expected but by unexpectedly restarting the QE programme. An addtional £60bn of bonds will be bought, taking the total up to £425bn.

The currency fell at least 1.5% against most currencies. However, purer domestic stocks only rose between 0.5% and 1.0%. The FTSE 100 rose 1.5% reflecting the drop in GBP. Gilt yields responded with shock to the extra buying as the 10 year gilt yield plunged back to post-Brexit lows.

The drop in gilt yields further flattened the interest rate curve and the short to medium term end remained inverted out to 4 years. This bond action is not a good sign. And the gilt moves were contrary to the BoE’s expectations:

In addition to cutting Bank Rate, supported by the introduction of the TFS, the MPC has voted to expand its asset purchase programme for UK government bonds, financed by the issuance of central bank reserves. This will trigger portfolio rebalancing into riskier assets, lowering the real cost of borrowing for households and companies. 

Inflation expectations will have moved very little. This is probably because of the very grudging nature of the BoE “toleration” of above-target inflation. It is actually not even that, it is only toleration of above-target projected inflation:

Thus, in tolerating a temporary period of above-target inflation, the Committee expects the eventual return of inflation to the target to be more sustainable.

Carney’s monetary tightening of 2015 did for Osborne, Hammond should watch out

The toleration of below target inflation has been so pervasive that the BoE was perversely threatening to raise rates for most of 2015 and so consistently tightening monetary policy. The complacency of George Osborne, the previous Chancellor of the Exchequer, towards this policy probably contributed more than anything to his downfall.

I expect Philip Hammond the new Chancellor wanted more, but has not got it. He needs to make sure he doesn’t just leave the BoE to make such disastrous mistakes. His letter to Mark Carney hints at more flexibility than the BoE likes to use. He needs to alter this wording to make it clearer that nominal economic growth has a higher priority than CPI targeting:

As set out in the MPC’s remit, active monetary policy has a critical role to play in supporting

the economy. In these uncertain times clarity about our macroeconomic framework is vital.

I confirm that the government’s commitment to the current regime of flexible inflation

targeting, with an operational target of 2% CPI inflation, remains absolute. The target is

symmetric: deviations below the target are treated the same way as deviations above the

target. Symmetric targets help to ensure that inflation expectations remain anchored and

that monetary policy can play its role fully. 

The BoE can’t control CPI but invents a projected CPI to control and thus is free to do anything

The problem is that the BoE targets a fiction which, as its author, it closely controls: the central projection for CPI 2-3yr out. Several times over the last 18 months it has modelled an upside breach of the central 2% projection. Sometimes it has threatened to tighten as a result, sometimes it hasn’t – but always promises vigilance and a bias to tighten. It is inconceivable the BoE would ever project a downside miss to the target in 2-3 years’ time.

By continually overestimating current but not future inflation, monetary policy remains tight forever. Remember that CPI inflation has been consistently below 2% for several years yet Carney has been tightening for nearly 18 months with his threats of rate rises, and only rate rises, sooner or later.

Brexit: a convenient excuse for the BoE’s failed projections

The result of this focus on projected and not actual CPI has been a slow strangulation of real and especially nominal economic growth. By ignoring the terribly weak NGDP growth of the last 12 months Carney is now almost happy to have something else to blame other than the BoE’s own failure to not only act to boost aggregate demand earlier –  but for contributing to the slowdown.

Much of this revision [to RGDP forecasts] reflects a downward adjustment to potential supply that monetary policy cannot offset. However, monetary policy can provide support as the economy adjusts. 

The Bank’s excessively strong negative views on the future trade policy of the UK remain notable and are a continuation of the anti-Brexit campaigning we saw during the referendum debate. The BoE has been so wrong about so much when it comes to forecasting, that it really should show more humility, and stop targeting its own “fiction” of future inflation.

The bond markets clearly do not believe the BoE inflation projections. Carney should be a worried man. The BoE expected investors to flee UK bonds post-Brexit. They flocked to them. The BoE expected its corporate bond QE to lead to investors fleeing UK government bonds. They flocked to them instead. Carney stated that the bank had done huge amounts of thinking about this package. Clearly perspiration is no substitute for inspiration.

“Playing the fiddle while Rome Burns”


As James Alexander wrote in the previous post, according to the London Times:

The Bank of England has cut its growth forecasts and signalled that interest rates may rise earlier than expected.

Higher savings levels as families grapple with their debts and weaker productivity than the Bank was projecting three months ago weighed on the outlook for the economy, also hitting jobs.

However, the Bank said inflation would overshoot its 2 per cent target within two years, putting an early interest rate rise on the table.

The MPC must be “MWI” (that´s “meeting while intoxicated”) because the story told by the following pictures is a very sad one!

After more than 15 years of great nominal stability (only more recent period shown), the BoE, like the majority of central banks, thought that nominal spending (NGDP) had to be “jerked down”.


For the past two years it has been trying to “jerk-it-down” even more.


No wonder real output growth “acknowledges” the “jerking-down”


And what about inflation? After a spell at zero it is just positive, but the “farsighted jerks” think that in two years’ time it will likely be “2.1%” and so “we have to act shortly”!


OMG: BoE in 2008 redux

A James Alexander post

The Bank of England appears to have learned nothing at all about the 2008 Great Recession. They are on the verge of making the exact same mistakes as Meryvn King and many other central bank chiefs made in that fateful year. Carney is fretting about headline inflation and other matters while watching NGDP expectations drag down RGDP into a recession.

Rate rise back in the cards as Bank cuts forecasts” warns the headline attached to Philip Aldrick’s lead article in the Business section in The (London) Times today after yesterday’s press conference with Governor Carney at the BoE.

We have finally come to this, 2008 redux. The real economy is slowing, perhaps teetering on a recession. Yet a modest uptick in projected inflation two years out leads the Governor of the Bank of England to passively tighten monetary policy with threats to actively tighten.

The famous fan charts from the BoE show a tiny shift of the centre point in 2018 above 2%. It leads to a furrowing of Carney’s brows and leads him to give dark warnings about having to raise rates. Sterling even rose at first versus the USD despite all the Brexit fears and recession fears pushing it lower.

JA-Fan Chart_1

Yet the same set of data has fan charts for RGDP that show growth dropping below even the poor levels of recent years.

JA-Fan Chart_2

Never was there more need of a switch to NGDP targeting that allows flexibility of inflation targeting to be combined with what is going on in the real economy. Sure, the BoE can’t raise RGDP growth in the long run as they can’t directly impact productivity but they can prevent recessions – and thus lost real output and in the long run lead to higher levels of RGDP than if there were recessions.

Many of the headlines are about Carney’s views on Brexit, but they hide a more damaging ducking of responsibility to ensure price stability, unless there is a major negative impact on economic growth. Raising rates now, or even threatening to do so, is having a major impact on economic growth.

And there certainly will be no price stability if we have a recession. Inflation is bound to slow dramatically. Two wrongs (deflation and recession), no right.

UK NGDP growth weakening. Blame it on Carney, not ‘Brexit’

A James Alexander post

The chickens continue to come home to roost for the Bank of England and its masters at the UK Treasury. The pathetic attempt of the a UK government minister to blame Brexit worries for the UK economic slowdown was truly breath-taking in its cheek. George Osborne recognises the problems caused by weak nominal growth but has failed persistently to show political leadership to do anything about, allowing the Bank of England to wallow in its hawkery about non-existent inflation threats.

Mark Carney tightened monetary policy throughout 2015, first by declaring that the next move in rates would be up and then in July confidently declaring that rate rises “will likely come into sharper relief around the turn of this year (2015)”. He has attempted to back pedal a few times since then over precise timing, but his tightening bias has been reiterated, most notably when he declared in February all members of his MPC believed the next move in rates would be up.

Ever since Carney sat on his laurels at the end of UK’s QE, and especially since his fatal Summer speechifying, UK nominal and real growth has been decelerating. We don’t have an Atlanta Fed-style “nowcast” for UK GDP but we can make a pretty good guess how badly things are turning out ahead of the release of 1Q16 data next week.

  • We already have Carney’s constant tightening bias.
  • We know the trend in NGDP is really poor.
  • This week we have seen retail sales growth slow (hitting the largest component of GDP) and the other side of the coin, personal income in the form of wage growth, also slow.

JA Brexit_1


JA Brexit_2

Although quite volatile, the nominal wage growth figures had shown some encouraging trends up to 2Q15 until Carney put a dramatic stop to any real return to prosperity with his hawkishness.

It would be absurd to suggest that Brexit uncertainty is having no impact on the economy. It has hit the currency after all. But any currency weakness will actually work as nice countercyclical aid  to any potential economic damage from Brexit.

By far the biggest problem is the stance of UK monetary policy in the face of collapsing nominal growth. Carney follows most other central bankers and the economics consensus in believing that low interest rates mean easy money. Clearly, it cannot be true when actual (even if 4Q15 was revised up a bit) and expected nominal growth is so incredibly low.

JA Brexit_3


UK Socialists show interest in NGDP Targeting, BoE proxy moans

A James Alexander post

Scott Sumner is both warming up to Bernie Sanders and getting excited by growing signs of acceptance for Market Monetarism. In the UK we seem to be getting both things in the one package.

Writing in the Financial Times our new, “hard-left socialist”, senior opposition spokesman on finance, Shadow Chancellor of the Exchequer John McDonnell, has said he is interested in NGDP Targeting.

McDonnell has created a group of leading, if left-leaning. macro-economists to advise him on macro-economic policy. Their first job is to lead a review of the Inflation Targeting mandate of the Bank of England. The group includes many names familiar to Market Monetarists like Adam Posen, David Blanchflower and Simon Wren-Lewis. We know them because of their willingness to debate about NGDP Targeting and even broadly accept it as at least partially useful – though they all prefer active fiscal policy at the ZLB over what they consider to be unconventional monetary policy.

“The last time the Treasury tweaked the MPC’s remit was in 2013, when George Osborne, chancellor, clarified that the committee need not force inflation back to the target by the fastest possible route if a slower one would be better for growth. We will consider whether such trade-offs should be formalised. And we will look at more radical ideas, such as introducing a target for nominal gross domestic product — a suggestion Mr Carney broached in 2012.”

This is great news.

The diehards at the Bank of England won’t like it. An initial response from one of the leading UK economist who often represents mainstream BoE views was distinctly lukewarm.

Tony Yates even addressed himself to the NGDP Targeting idea:

“I’ve blogged a lot about this before, and haven’t the heart to repeat it here.  Very briefly.  Growth targets would not make a whole lot of difference.  Levels targets rely on being a rational expectations nutcase, and even then would probably be incredible.”

The attack on Rational Expectations is the oddest thing. It’s not clear what his problem with RE really is. It’s very hard to figure out. Yates is clearly a clever guy, but like most central bankers and their supporters, they distrust markets and prefer discretion. Yates seems to think that elite central bankers sitting around a table with lots of different models, lots of data and super-smart intuition is better than clear rules. We only need to ask how that worked out in 2008 to see what was wrong: internal politics, confusion and hopeless or downright counter-productive signalling. To recognise that central bankers were the prime cause of the recession is a step too far for the self-same central bankers and their proxies.

From an earlier anti-NGDP Targeting piece Yates demonstrates clearly the knots he ends up tying himself in when thinking about RE:

“Policymakers at the BoE used an RE model, but when they thought it was relevant, would often adjust forecast profiles by hand afterwards to try to offset what they thought were the effects of rational expectations.  (Highly unscientific and hopelessly imprecise in doing it this way, but well-intended).  However, whether central banks assume RE or not, it’s not a good defence of a regime that it works well in a false world those central banks happen to believe in.”

Who’s the nutcase?

Update. Excellent blog from Ben Southwood at the Adam Smith Institute.

How to avoid sunburn, or the sorry state of UK monetary policy

A James Alexander post

When Mark Carney was appointed Governor of the Bank of England back in 2012 hopes were high. The Bank of England was mired in failure. For Market Monetarists it had a poorly understood monetary policy that could and should have been more proactive in 2007-2009 that directly led to the UK’s experience of the Global Financial Crisis being so much worse than most other countries. Whatever the cause, the BoE had totally failed to ensure financial stability. Somewhat surprisingly, it actually got more powers as a result of the crisis rather than less. Perhaps the price of gaining more power was that an outsider had to be appointed Governor to reform the Bank.

Carney certainly started with a bang. He made his famous speech on Guidance in late 2012 while still basking in the glow of being Governor of the very well-regarded Bank of Canada. The Canadian central bank had had a good crisis, although this was not really much to do with Carney who had been appointed only in February 2008. While he acted as a decent firefighter, drawing on his time in investment banking, the principles of flexible inflation targeting and tight banking regulation had been established for a couple of decades.

Much new blood has since been brought on board and there has been a major internal shake up. But has anything really changed? Not by the evidence of this woeful article by one of Carney’s new faces Kristin Forbes.

“As the summer holiday season begins and the date of an interest rate increase draws nearer, this is a good time to remember the importance of timing.

With both sunshine and inflation, there is a peril to living only in the moment. One should plan for the future – especially if precautionary actions take time to be effective. But it is also important to monitor last-minute changes in the weather forecast – or in the economic outlook – and adjust your plans accordingly.

We all know the enjoyment of that first day on holiday. It is tempting to stay outside all day – whether you prefer to doze, read a good book, or go for a swim or for a long run. But linger too long in the sun and your skin may take on a slightly pink glow.

While you probably won’t want to move from your comfortable spot in the sun, if you ignore the warning signs you may have a painful sunburn that evening. Yes – you can treat the sunburn, but it might spoil the rest of your holiday. Better to take preventive action.”

Is there where the level of monetary economics has got to at the Bank of England? Maybe the elite macro specialists on the MPC have to dumb down to get their point across to the readers of the Daily Telegraph but this is ridiculous. Ridiculous and wrong.

Wrong because the BoE appears to have learnt nothing from Japan’s decades of failed monetary policy. Creating a 2% ceiling and constantly threatening to raise rates any time there is the faintest whiff of prices rising ensures you will never come close to the 2% target. The market automatically tightens policy with its reaction to “good” economic news by raising short term rate expectations and by buying the currency. This tightening slows the nominal economy. “Bad” news then becomes good from prospective loosening of policy – the currency weakens and short term rate expectations fall back. Repeat.

These rapid market reactions show that Forbes is just wrong about lags. It is very tired, old school, thinking indeed:

“But unfortunately monetary policy works with lags much longer than a sunburn affects your skin. An increase in interest rates is generally believed to take somewhere from one to two years to have its maximum impact. Maintaining interest rates at the current low levels during an expansion risks creating distortions.”

Wrong because the underlying concept of “full capacity” causing inflation has been falsified for many years. Monetary policy causes inflation, or rather, nominal growth, not full employment. It is perfectly possible to have full employment without inflation. The long-run Phillips Curve is vertical – the somewhat painful lesson of the 1970s stagflation. At very low levels of inflation the Phillips Curve does, in the short-run, well, curve, due to downwardly sticky wages.

Wrong because even on their own terms of Inflation Targeting UK inflation is dead in the water. Forbes’ claim this is simply false

“Much of the weakness in core inflation can be explained by low energy prices and sterling’s strength, suggesting that core inflation should begin to recover from current low levels as last year’s sharp fall in energy prices rolls off.”

The Daily Telegraph helpfully supplies some charts in its article reporting on Forbes’ comments showing exactly what is going on with inflation.

Wrong because there is so little evidence presented for the damage to the economy from waiting too long. it is just asserted continually by hawks regardless of the dangers in acting too soon, a much bigger issue as the ECB so painfully found out in 2011 when it caused the second leg of the Eurozone crisis via the two rate rises.

“Therefore, interest rates will need to be increased well before inflation hits our 2pc target. Waiting too long would risk undermining the recovery – especially if interest rates then need to be increased faster than the gradual path which we expect.”

The phrase “well before” tightened policy the moment it was read, judging by the moves in Sterling overnight. It is scary that our MPC members can be so irresponsible.

Of course, she also raises the bogeyman of wage-push inflation still surprisingly current in central bank circles by worrying about wage growth. This stance is especially cruel on the mass of the population as it will ensure no real wage growth over the medium term, and probably no falls in inequality as it seems that the low paid suffer more from a weak labour market than the higher paid. The current modest uptick in wage growth to something still below the good but not great growth rate of the Noughties is something to be nourished not crushed, The danger the MPC seems oblivious to is that even talk about crushing it will kill it.

All these common mistakes seem to flow from the addiction to Inflation Targeting. Ultra-low inflation is not and never should be an end in itself. Prosperity is the end we all should seek. If ultra-low inflation conflicts with prosperity then the Inflation Target should be ditched. To be fair to Forbes she is mostly parroting Carney – more shame on him!

Two cheers for David Miles

A James Alexander post

David Miles is leaving the Bank of England rate-setting committee at the end of August and has been giving a few farewell interviews.

To his credit he never voted for a rate rise (or cut) during his term in office, but he does feel a bit frustrated for having “done nothing”. What he doesn’t understand is that monetary policy has loosened and tightened a lot during his time on the MPC nonetheless.

Any given rate stance of a central bank can be tight or loose monetary policy depending on NGDP Expectations. And those expectations have moved around a lot over the six years he’s been on the MPC, as it includes the early recovery from the GFC and the 2011 ECB-caused Eurozone crisis.

He’s done lots despite not tinkering with rates. And credit to him especially for not joining the UK hawks on the MPC in 2011 voting for rate rises.

Miles’ interview with Bloomberg does, however, contain this very common error, one central bankers on both sides of the Atlantic seem to be making:

Miles cautioned that delaying an increase might require faster tightening.

“The longer you leave it, the slightly more steep that trajectory becomes,” he said.

What is the evidence for this theory, or rather fear, of having to “catch-up”? None is ever presented. Have underlying inflation expectations ever shot up so fast that a central bank is forced to slam on the brakes? Of course not. Underlying inflation expectations change glacially slowly.

Headline inflation may jump about but VSP central bankers should be able to rise above such noise.

To make their lives easier central bankers should switch from Inflation Targeting to Expected NGDP Growth Targeting, and then they won’t get distracted by hard to measure inflation, wage growth or even employment/unemployment figures. In fact, central bankers could be replaced altogether for a machine that followed this simple rule.