After reviewing the somewhat hapless comments of Monetary Policy Committee (MPC) member Charlie Bean yesterday,which had led to various jokes doing the rounds wondering if we should call him Mr.Bean or Charlie or both! I did not expect another MPC member to be hitting the news services so quickly.However in a reply to a comment on here I had indicated a behavioural pattern for the MPC in the post-Quantitative Easing(QE) era.
“I have remarked before on QE that there is no great need to put too much time into the MPCs explanations of it as like as a bus a new one will soon be along….. Somewhere in there is why they are struggling to get the message across combined with a failure to hit their inflation target.”
Whilst I expected new explanations and rationales I did not expect one so quickly,particularly as the MPC had seemed to have settled into a good cop,bad cop routine on inflation,with their words anyway. However at an arena which probably had not been so shocked since Hull Football Club Manager Phil Brown took the microphone and started singing in May 2009 to celebrate their premiership survival Adam Posen outlined his plans for the monetary policy of the UK and indeed the world.
What did he say?
At First Mr.Posen indicates that his words should be heard beyond the UK and are also a policy prescription for quite a few other countries.
I would like, however, to try to give some general assessment of the common challenges we face, and what I believe to be the appropriate monetary policy response, barring special circumstances. The case I wish to make is that monetary policy should continue to be aggressive about promoting recovery, and, subject to further debate, I think further easing should be undertaken.
This section has led to some debate on here as to whether he has been in contact with Mr.Bullard who has given speeches in a similar vein concerned with the US. This has significance because he is on the FOMC board which sets monetary policy for the United States and had given a very dovish speech before it eased policy at its August meeting with the so-called QE-lite. And in a further development in this area the Wall Street Journal reported this. As to whether they are in contact/concert or merely have similar views we can only speculate at this time.
He says he has made progress convincing his other colleagues to seriously consider that path.
Now Mr.Posen begins to make his real case and the bold type is my emphasis.
In every major country, actual output has fallen so much versus where trend growth would have put us, and trend growth has not been above potential for long enough as yet, that there remains a significant gap between what the economy could be producing at full employment and it currently produces. Thus, policymakers should not settle for weak growth out of misplaced fear of inflation.
So we are back to output gap theory again. Unfortunately this output gap theory has performed rather poorly in the UK and those with a “misplaced fear of inflation” would counter-argue that inflation even as measured by the disappointing CPI measure has been over target for 41 out of the last 50 months. When you add to this that we have just been through a severe recession these figures are even more remarkable. If you look at the RPI inflation measure then the situation is even worse, and just for good measure the GDP implied deflator is at 4.1%. So Mr. Posen to my mind is advancing a theory which has at best a tenuous relationship with recent UK economic experience.
Indeed we get some further views on inflation in the UK from Mr.Posen
If price stability is at risk over the medium-term, meaning over the two to three-year time-horizon for the MPC’sdecisions, it is on the downside…………..simple inflationary pressures from monetary policy trying to stimulate too much
I have put these quotes in because they illustrate two themes of mine about his views. Firstly he has believed that the dangers to prices have been on the downside last year and the year before and been wrong so perhaps he is trying for third time lucky? He does admit to “forecasting errors” in the speech but fails to point out how large or how consistent they have been. Secondly anyone who has experience of inflation in the UK knows that in our history having and then dealing with inflation has rarely been “simple.”
We also have a rather insidious phrase about which I will talk more later as it has echoes of policy mistakes made in the 1970s.
Inaction by central banks could ratify decisions both by businesses to lastingly shrink the economy’s productive capacity
Next we have an indication that Mr.Posen may not be very market-savvy or aware
If there was going to be a recovery that either was inflationary or otherwise meaningfully different from that established pattern, it should have been evident by now. Instead, we have seen global interest rates on long government bonds, determined by forward-looking markets, at historic lows.
You see the interest rates he is talking about have been driven lower by two things, central bank action combined with rumours and hopes of further central bank action. Mr. Posen is either unaware or unwilling to admit that he is locking himself into a closed feedback loop if he follows this measure. This goes as follows, he thinks he can intervene because these rates are at historic lows, but these historic lows are there because markets think that he (and others) will intervene. This way madness potentially lies. He seems to have forgotten or not be aware that markets are front-running central bank actions.
We then get more output gap type theory combined with activism which attempts to use Mr.Posen’s analysis of Japan to justify moves in the UK now and then another suggestion which indicates a lack of market awareness.
and ruinous global trade and exchange rate conflicts (thankfully absent in Japan in the 1990s and so far today) all cumulated into a prolonged terrible period.
He appears to be unaware or is deliberately ignoring the way we are drifting towards competitive devaluations and possible beggar-thy-neighbour actions in trade. I wrote on this topic on the 23rd of this month and followed it up with an article on central bank currency intervention on the 27th. My fear and I believe it is backed by recent evidence is that we have no room for complacency in this area and need to work hard to avoid it. Sadly a lot of the pressure is being created by central bank moves, in my opinion, and here Mr.Posen and I completely disagree as he asserts that QE does not affect exchange rates.
After another burst of telling us inflation is not going to be a problem due to the output gap -perhaps he thinks if he keeps repeating this phrase he may gain some subliminal advantage- Mr.Posen gives us his solution or in fact as even he appears not to have complete faith in his solution we in fact get two!
What is his answer to the problem?
Speaking for myself, I believe that if we were to loosen monetary policy further, it must primarily take the form of large scale asset purchases (LSAPs, to use the acronym du jour).
So this is his plan but in spite of having already spent some £200 billion he does not know what the effects will be.
The magnitude and timing of the impact of additional LSAPs on the macroeconomic outcomes we care about – prices, output, employment – remains somewhat uncertain…….while QE is clearly having some benefit in the UK and elsewhere, – that is, one cannot simply map from so many billion in government bonds bought to so many percent higher inflation or lower unemployment.
Indeed he is so unsure of the results that he feels he needs a plan B.
In case such QE were to prove insufficiently effective or were financial fragility to become acute again, I would still want preparation ahead of a ‘plan B’ of large-scale non-Gilt asset purchases, in close coordination with HM Treasury.
I find it intriguing that Mr.Posen states that he is unsure of the effects of his QE or LSAPs but is so sure that it will not lead to inflation which strikes me at a minimum to lack logical consistency. This is in spite of quoting a report from Fathom which says.
They note that UK inflation forecast errors of late have been positive and tended to reinforce each other.
Er well yes, And the same man who is so sure of himself now was a supporter of the error-strewn forecasts. We then get more
Ultimately, though, the MPC has to look forward, and except for the coming VAT increase, all determinants of inflation suggest that declines in UK inflation will occur over the next two to three years to well below target.
Regular readers of my articles will be aware that I often refer to the Commodity Research Bureau’s spot index as a guide to commodity price trends to give a clue to possible future inflationary trends. It would appear that Mr.Posen believes that commodity prices have no influence on inflation as a measure which is up by some 29% over the past year is hard to ignore otherwise.
If we were unclear we get a final conclusion.
I have tried today to convey my reasons for believing that in general terms it is right for central banks to undertake more monetary stimulus in the coming months, and why we should do so through LSAPs, even if we cannot guarantee that such measures on their own guarantee recovery.
Comment and Analysis
There is a lot of ground to cover here and before I start I would like to welcome the fact that Mr.Posen has made his views available for debate. However even on this front and in spite of his denial in the speech he has declared his hand before an MPC meeting and this is a clear break in a long-standing convention. If I were Mervyn King I would be very annoyed at this.
I have written about the increase in the role of central banks in the worlds financial markets and have a theme that they are not in control of events as much as they think that they are. Indeed I have suggested that they have exceeded the abilities of their “pay-grade.” An example of this is the Bank of Japan’s currency intervention which with the US dollar being at 83.62 Yen as I type this is at best a partial success after only a fortnight and poses a real challenge for the BoJ going forwards. In spite of their failure on various fronts (which to be fair there is some acknowledgement of in the speech) however Mr.Posen is absolutely confident that we need more of it.
Furthermore he feels that in the field of monetary policy we need more activism and that there is a type of holy grail out there and if he can find it then he and the MPC can save us from oblivion and possibly from ourselves. Am I alone in seeing almost a messianic image here? There appears to be little acceptance of the damage he may cause and not a lot of realisation that many will question the thoughts of a man whose forecasts in his own words have often “tended to reinforce each other” in the wrong direction. Indeed those with recollections of the policy mistakes made in the 1970s where monetary policy activism went very awry may well experience a cold chill down their spine at this point. He appears to be thinking that central bank moves can have a permanent influence on the economy just like others did in the 1970s. Sadly for their views and even more sadly for those who will not retire on an index-linked pension such plans contributed to a difficult period for the UK economy with high inflation.
I am left with a point I have made before. If Mr.Posen believes that his first effort at QE has failed why does he expect a new version of it to succeed? I think he needs to be more than “uncertain” about the results and since I am not on the MPC I can be clear that I would vote no.
Also I have a further thought and it does indicate quite a change. As the role of the Monetary Policy Committee has changed and expanded more than could have been forecast when it was introduced in1997 there need to be new checks and balances on its power. My suggestion for a change is that MPC members should stand for election as they are currently much more powerful than many of our elected representatives