Monetary Policy Committee member Adam Posen wants the world to do more Quantitative Easing

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

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12 thoughts on “Monetary Policy Committee member Adam Posen wants the world to do more Quantitative Easing

  1. Notayesman :- A very good analysis and I agree with your criticism of his pointing to low gilt yields as evidence of their being a remote threat of overheating. Perhaps he would point to those bits of his speech that talk of risk aversion ( flight to so-called quality) which he sees as a very serious threat to GDP/return to trend growth.To be fair I think he would prefer QE directed towards risky private assets but sees the danger of the BoE collaring the entire market for these in the UK. I think you are right on the exchange rate matter. He points to evidence that UK QE did not devalue sterling but he doesnt project what a new bout would do, because he doesnt know.

    Isnt it more a case of Mr Posen wanting to use monetary policy for more than inflation-control. I thought he was worried about the following : if we dont do something to regenerate mothballed capacity, it will be put out of use permanently at horrendous social cost – that scenario could be consistent with higher inflation. He points to an unprecedented synchronised loss of global capacity which he fears will be irrecoverable and he thinks central banks and governments need to do more to avoid the tipping point, globally coordinated. So, I dont think he looks at UK in isolation.

    I entirely agree that he doesnt analyse the problem Bernanke pointed to : central bank interventions and exploding balance sheets could/are themselves distorting asset class behaviours which may lead to new bubbles exploding everywhere at different times.

    You might disagree with him, but I think he is right to get this publicly debated.His expertise on Japan must have some useful application. I would rather us all know before-hand what these powerful people are thinking, rather than moaning about decisions after they have been made. Many serious questions here about the role of central banks, their democratic mandate and the depth of the problem. Thank you again for your analysis.

    • Hi Shireblogger: don’t you think that the almost 20 years now of economic doldrums and deflation in Japan was largely caused by the same policies which Posen is now advocating? The desire is to prevent a property collapse where so many have paid ridiculously over-value for property and now have large mortgages with negative equity. His approach is exactly what the Japanese did to attempt to prevent over-geared Japanese companies and property values from collapsing. It did not work and has now resulted in the Japanese government now having huge debts which it cannot pay-off. All it has done is to delay the necessity of an economic correction.

      The difference is that it was mostly indigenous Japanese savers who purchased Gilts to finance the Japanese government’s ongoing profligacy, rather than mostly foreign investors. That will not happen in the West generally, so the outcome of such foolishness will be quite different and much more severe.

      • Thanks,Drf. I am no advocate of QE and have been very sceptical of the portfolio transmission claims which justify its use in the UK. Buying gilts, and then leaving it to financial intermediaries to do what they deem best with the created liquidity is highly questionnable. The problem ( as I see it) is that the UK is over dependent on bank lending to fund SMEs ( the driver of our growth). The banks’ own funding is propped up on, in part, illiquid legacy mortgage-backed securities created in a global property boom. The BoE’s liquidity operations – SLS,Discount Window,Long term repos etc. have temporarily liquidated some of these lumpy assets to oil the wheels at taxpayers’ risk. Fine, you could allow the housing market to collapse and correct and flush down the pan permanently SME’s only source of funding to await a new credit market to grow. How large a commercial crash will then ensue?Its not all about house values, is it?

  2. When the MPC was formed by Gordon Brown I assumed at the time that the members were political appointments in that they were people whose views Gordon Brown approved of even though he was at pains to say that the MPC was completely independent. I think events subsequently and the decisions made by the MPC have reflected a left wing bias.

    I thought with a change of government that the MPC members would be changed so as to reflect the views of the LibCons but so far the MPC has remained the same. Either the LibCons are happy with the MPC as it stands or they are unable to make any changes. I agree there should be some mechanism whereby changes in the membership of the MPC should occur and maybe election of members would be the way forward. At the very least there should be periodic reviews of their performance (although I don’t know who by, the Treasury perhaps). At the moment this doesn’t seem to be happening.

  3. Posen may well be wrong about future inflation but right about the need for more QE.

    How so? If high future inflation levels are dominated by rocketing commodity and energy prices, this could simply be a reflection of increasing global demand for scarcer resources, and the West increasingly becoming price-taker as emerging economies become price-setter (and/or as politics increasingly interferes with international trade). Under these circumstances, high UK inflation would not be due to domestic inflationary pressures, and would not necessarily require a monetary policy response. Indeed, the blind persuit of price stability via higher central bank interest rates may cause much wider economic instability and damage to fragile growth.

    It is true that we will never know how successful QE has been, in that we do not know what position the economy would now be in had QE not occured. This does not preclude the possibility that QE may already have been hugely important in maintaining demand. A new round of QE may indeed be just what is needed to lift us out of our current stasis, and if domestic inflationary pressures are detected then policy can surely be tightened at that point?

  4. All very nice until the unions start pushing for inflation style increases in wages and then increases that keep them ahead of inflation.

    I believe the BofE, working to an economic agenda, might have forgotten the unions because this is where their agenda will be decoupled from economic theory and a Conservative government might just be the catalyst to bring this pack of cards down

  5. Its like rational expectation hypothesis never existed. Can they not see that people behave rationally when they think a Govt is trying to inflate away their wealth by printing money by simply buying commodities. Its a self fulfilling process where the QE money doesnt touch real GDP but simply goes on assets.

    I can only assume the MPC is trying to fool people for long enough hoping that things recover. If they really believe in the output gap and that printing money can drive real GDP then the 70’s will be re-lived. A sad state of affairs.

    • The situation that we are in is ridiculous! If the previous premier had been sound of mind then we would have had a recession in 2001. Instead we got bank easing and then eventually QE.

      Although I work in the public sector – due to recognising the economic situation and grasping any job! There is a need to cut down the public sector. Personally, I would suggest cutting all of the savings from the Health service!!! Why, you may ask, but if you knew that consultants are allowed to plan ther own time, using junior doctors to undertake the main work then you might understand. As the system stands, consultants are untouchable and unable to be made redundant. However, they receive incremental increases (averaging 1.5% per year)together with clinical excellence awards (average 3% but usually based on research work – thereforth not clinical).

      To cover the fact that Consultants cannot be made redundant, even more nurse posts are eliminated or low paid support staff that can actually determine whether savings are realised are made redundant.

      As an example: I saw on the news, a consultant and his team on a charitable mission in Africa were undertaking 60 procedures a week, whereas in the UK he only undertakes 4-6 procedures a week. I suspect that the symptoms in Africa were easier to read but personally find that a tenfold reduction in activity, because of tests etc, is not bearable by this state. To my mind, this is really down to the risk analysis that is becoming so ingrained in today’s society meaning that we cannot compete internationally. We probably have more HSE staff measuring risk than we have productional staff!

      Regards

      Facefacts

    • Hi Ian

      As I reported in my update on the Charlie Bean interview they appear to be living in a world where savers are asked to be rational but borrowers are assumed to be irrational. After all why pay it back when official policy appears set to keep bailing you out….

      According to Adam Posen commodity price rises either aren’t happening or they are not a potential cause of inflation. Again this seems to be relying on the view that if you keep telling people something they might in the end believe it.

  6. The idea that QE hasn’t had much affect the first time around reminds of the position of Patrick Minford in the early 80s: monetarism wasn’t working “as it should” (i.e. the real world wasn’t conforming to the theory) because policies weren’t monetarist enough.

    Theories provide insights. Don’t get hung up on them.

    Shaun, can you summarise the basis of your position on an output gap not existing to any great degree? If you’ve covered this point in detail in previous posts just point me in that direction. Thanks

    • Hi Sean
      I am sure I have explained it before but probably in several different places in my QE and inflation sections. However I am not particularly arguing that there is no output gap I would argue the following.

      The concept of an output gap is itself is simple: the difference between the economy’s output and an estimate of the economy’s potential output.

      However we immediately hit a problem as we have to replace output with measured output or in essence our GDP numbers. At the best of times they are subject to revision but at the worst of times like we have just been through they are usually subject to more revision (usually recessions are revised upwards in output terms). Then to just to to the mix this recession so far appears to be more unpredictable than most.

      To my mind the concept is already in trouble but there is a further problem and that is that potential output is an entirely theoretical concept. Exactly how do you measure this and how do you test that it is correct? For example I read one time some good analysis in the FT pointing out that the new Office for Budget Responsibility and the Treasury had different levels for it and that the OBRs forecast implied that the output gap shrank in 2009 when the economy itself was shrinking!

      Furthermore an output gap is for an economy as a whole,surely there have to be differences between industries, for example banking has plainly had all sorts of changes during the credit crunch but someone producing aspirin or Ibruprofen might be pretty much unaffected,what about services versus manufacturing? Farmers?

      In addition it implies a steady-state for the economy if you think about it rather than the more dynamic reality. As if we have some sort of stock which should be growing collectively whereas I think that the pattern is more broken and dynamic. I am afraid that straight lines or curves on a chart do not always represent reality.

      I am reminded of a quote “I may not know very much but at least I know what I do not know….”

      So I think that those that advance the theory are advancing something they cannot possibly be sure about and in fact has weak evidence over actual evidence such as inflation numbers. Just to be clear these are not perfect either but they are at least some representation of reality. So either we do not have an output gap of the size that Spencer Dale thinks or it is having weaker effects than usually expected. We simply do not know….

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