Central Banks have a big problem with the future

A feature of 2019 so far has been a succession of U-Turns by central banks and by two of the world’s major central banks in particular. This has been most marked at the US Federal Reserve where it was not so long ago that some were suggesting we would see four interest-rate increases ( of 0.25%) this year on the road to what was called normalisation. Regular readers will recall that we were one of the few places that were troubled by the fact that we simply do not know what and where normal is anymore. But for our purposes today the main issue is that the US Federal Reserve looks set to cut later this month and perhaps one more time in 2019. Should that scenario come to pass then the previous concensus will have been wrong by a net 6 interest-rate changes. Seeing as interest-rates are so low these days that is quite an achievement.

This is on my mind because if we take the advice of Kylie Minogue and step back in time just under 7 years central banks were heavily influenced by this from Micheal Woodford and Jackson Hole.

The first of these is forward guidance — explicit statements by a central bank about the outlook for future policy, in addition to its announcements about the immediate policy actions that it is undertaking.

This was always going to be adopted as it flattered central banking egos and provided an alternative at a time when central bankers were afraid of being “maxxed out”. But as my opening paragraph pointed out it has been a complete failure in recent times in the United States where it began.

Europe

This has been something of a two stage failure process for Forward Guidance. The opening part got some intellectual backing last September from Benoit Coeure of the ECB.

Communicating our expectation that the ECB key interest rates would remain at their present levels at least through the summer of 2019 was therefore consistent with the “risk management” approach to monetary policy that the Governing Council has repeatedly applied in recent years,

This had two steps as it was perceived like this.

Yet, on my next slide you can see that, at some point in early 2018, markets expected the ECB to hike its deposit facility rate one month after the expected end of net asset purchases.

So that was a bit of a fail and it continued long after this speech. It was something I found hard to believe but the idea that the ECB would raise interest-rates in 2019 was like these lyrics from Hotel California.

And in the master’s chambers
They gathered for the feast
They stab it with their steely knives
But they just can’t kill the beast.

It seemed to exist in an evidence-free zone but somehow survived. But events recently took a dreadful turn for it and by implication ECB Forward Guidance.

In the absence of improvement, such that the sustained return of inflation to our aim is threatened, additional stimulus will be required……..This applies to all instruments of our monetary policy stance. Further cuts in policy interest rates and mitigating measures to contain any side effects remain part of our tools.

So the interest-rate rises had not only morphed into unchanged but now we were being forward guided to a cut. Could that be any worse? Apparently it can as the incoming ECB President switches to downplaying the size of the interest-rate cuts on the horizon.

*IMF SAYS THERE MAY ONLY BE LIMITED ROOM FOR ECB RATE CUTS ( @lemasabachthani )

But apparently forward guidance is another beast that our steely knives cannot kill.

We remain able to enhance our forward guidance by adjusting its bias and its conditionality to account for variations in the adjustment path of inflation.

Bank of England

Gertjan Vlieghe has given a speech on this subject and he is in the mood for change and I do not blame him but sadly it does not start well.

In particular, communicating more about the Monetary Policy Committee’s preferred future path of interest rates
would be easier to understand than our current approach.

Preferred? I would prefer England to win the cricket world cup final on Sunday but a balanced reality involves looking at the strengths of New Zealand. Also it is not often central bankers do humour and when they do it is mostly unintentional.

Global central banks have changed their outlook for policy significantly in recent months.

He has a go at placing a smokescreen over events as well.

and the UK outlook for monetary policy continues to be materially affected by Brexit uncertainty.

This is misleading in my view mostly because none of us know what will happen so we cannot allow for it. Even if you think there is an effect right now then it is too late to do anything about it because an interest-rate move takes around 18 months to fully impact.

It feels for a while that we are getting some honesty.

Before diving into the details of the argument I want to stress that a far bigger challenge to monetary policy is
that the future is uncertain, and my suggested communications improvement will not change that. Today’s
preferred path of interest rates will change tomorrow, if the economy turns out differently from what we
expected.

But sadly as so often with Gertjan he drops the ball at the crucial point.

But I am arguing that we can achieve a modest improvement in the understanding that
businesses, households and financial markets have of what our objectives are, and what we think we need
to do to meet those objectives.

Most people only vaguely know who they are at best, so they idea they will be hanging on their every word is laughable. Financial markets do, of course, but how much of the real economy gets missed out?

The next bit reminds me of this from Queen.

Is this the real life?
Is this just fantasy?

Here is Gertjan pedalling hard.

Moreover, the Swedish central bank reported that the quality of its own internal deliberations and discussions
with staff had improved, and that discussion of monetary policy by external observers had become “less
speculative”

Meanwhile if we go back to real life.

The Riksbank has become pretty much a laughing-stock.

Comment

As you can see Forward Guidance has been one of the failures of our times. On an internal level down keeps being the new up but also it is part of a framework where the environment keeps getting worse. What I mean by that is after all the policy accommodation economic growth now has a “speed limit” of 1.5% and 2019 is proving to be a difficult year for the world economy. It flatters central banking egos, gives markets a hare to chase and journalists something to copy and paste, but not so much for the real economy.

The piece de resistance to all this is provided by Gertjan who you may recall has been Forward Guiding us to interest-rate increases for a while now. He has another go.

This would justify further limited and gradual rate increases, such that we might reach 1.00% in a year’s time,
1.25% in two years’ time, and 1.75% in three years’ time, with large uncertainty bands around this central
path.

You may notice the use of the word “might” here. Whereas he seems a lot more sure about this road.

On balance I think it is more likely that I would move to cut Bank Rate towards the effective lower bound of close to 0% in the event of a no deal scenario.

Just for clarity the Bank of England now thinks this is at 0.1% after assuring us for quite a long period ( Governor Carney repeated it more than once) that it was 0.5%.

So if we just look at Gertjan’s career at the Bank of England he looks ro be pointing us towards a situation where he has twice “Forward Guided” us to interest-rate increases and then cut them! I await your thoughts on how useful you think he will have been in such a scenario?

24 thoughts on “Central Banks have a big problem with the future

  1. The only forward guidance I believe in, is yours, Shuan! They are always wrong and you are always right, and unfortunately don’t get paid a 6 figure salary + gold plated pension.

  2. Hello Shaun

    re: accommodation economic growth now has a “speed limit” of 1.5%

    I note the correlation to the increase in world oil demand from 2018 to 2019 ( projected) is 1.4%.

    perhaps oil demand is better measure of world GDP than some think.

    Forbin

    • The ‘some’ are brainless. The world’s economy is built on oil and its derivatives.
      I’m tempted to say ‘fossil fuels’ in general, but then I know I will attract the ‘dreaded downticks’ from the glassy-eyed believers.

  3. Great article as always Shaun.

    I would argue that the central banks policies have been very successful. They’ve made a total mess out of the situation and have not been held acountable. Despite not working the first time around, they’re going to repeat the same policies again and again.

    Apart from you, no-one in the media challanges them. And off they go retiring on pensions (the likes of which the private sector cannot have) and receiving knighthoods.

    I was recently reading about negative yielding junk bonds in the EU. You can guarantee the ECB will be buying up this dross with its printed cash and selling the tax payer down the river.

    Meanwhile the publics ire is directed towards investment/retail banks and brexit. The central banks are like teflon.

    Thank heavens you’re fighting the fight. Keep going.

    • Hi Anteos and thank you

      Sadly the media only rarely challenge our central banking overloads. As you know I steer clear of politics but to be fair one politician did raise a valid question to the Fed earlier this week.

  4. What I struggle to understand is how they get it so wrong when economies are only moving slightly in one direction or another; unlike the wild swings of the past. Could it be that they place far too much emphasis on decimal point predictions and try to micro manage economies accordingly? I do not believe that anyone can measure an economy, let alone forecast it, with more than a few percentage points accuracy either way. They knee jerk react in advance based on predictions that are of little value and end up looking stupid. Garbage in, garbage out.

    • I wonder whether its the case that the UK in particular are talking up rates due to a hidden agenda in preventing the £ going too low. I appreciate a weak £ helps exporters but we import more than we export so a stronger £ assists inflation.

      However with inflation falling in most of the developed economies weak or falling that psychology may not be needed as much in the future.

      I don’t think I am the only one who reads between the lines Shaun tends to look at detail and scrutinises what the economists and bankers says and that shows a well clued up economist.

      All that said the rounds on you Shaun if I ever find myself in the same pub in London cheers.

  5. Shaun, It is the subject of our times. However when I talk to my friends and colleagues nit many are ready to discuss an emergency interest rate that has persisted for 10 years. That is 10 years of blue flashing lights…

    I hear that The Fed is cutting because of an insatiable demand for dollars, the 5% deficit in the US is gobblung them all up. The strong dollar and comparatively high rates are causing ripple effects across the world.

    As they try to stoke inflation and demand with helicopter money, issue CB digital currencies and see off the Brexit economic fiasco I am thinking that Gold is looking attractive…

    Paul C.

  6. Wasn’t that long ago that the UK banks were pushing fixed rates mortgages, the press suggesting they consider the public take that course of action as well due to hints of interest rate cuts.

    I tend to think the banks tend to do that kind of action when they think the opposite will occur.

    BOE Vlieghe speech this morning made a strong hint to me that its more likely that the BOE will cut rather than increase rates. One has to bear in mind the world economy is slowing in any event and even without BREXIT there is downward pressure on interest rates now.

    Quite honestly I think its as well putting the thoughts out there now and seeing what happens with the £ and if they then cut interest rates to almost zero it may not have much affect when they do.

    I had to laugh at Branson’s comments yesterday when he said the £ could end up at parity with the $ on a no deal. One financial commentator did not appear to agree as if the £ did slump that many would be attracted to UK assets some being property.

    To be honest it would benefit me with zero interest rates as I took a lifetime mortgage out with the Woolwich at 0.38% over base 10 years ago and my mortgage payments will be a small fraction of what most people pay.

    Guardian article:
    https://www.theguardian.com/business/2019/jul/12/no-deal-brexit-could-mean-near-zero-interest-rates-says-bank-policymaker-gertjan-vlieghe

    • Sorry guys error in my post>

      First paragraph:
      “Wasn’t that long ago that the UK banks were pushing fixed rates mortgages, the press suggesting they consider the public take that course of action as well due to hints of interest rate cuts.” Should have said interest rates rises but assume readers figured that out!

      In the meanwhile Bloomberg today says Merril Lynch thinks the UK will cut interest rates twice before May next year:
      https://www.bloomberg.com/news/articles/2019-07-12/bank-of-england-to-cut-rates-twice-by-may-merrill-lynch-says

      • Hi Peter

        Vlieghe is an interest-rate cutter like so many at the Bank of England. There is no concrete plan to reverse QE and there has been no real effort to raise interest-rates as it has taken us over 5 years to get a 0.25% rise in net terms. When it came to a cut they did so at the next meeting.

        For now the Bank of England is a passenger as it waits to see what the Federal Reserve and the ECB actually do.

  7. Pingback: Central Banks have a big problem with the future - Free World Economic Report

  8. Great blog as usual, Shaun.
    Yesterday the Bank of Canada released its July MPR and to no-one’s surprise announced that the overnight rate would remain at 1.75%. In sharp contrast to his predecessor, Governor Poloz has never been much of a fan of forward guidance. However, he has taken things to an extreme by essentially starting each new interest rate announcement from scratch, so journos are discouraged from reading too much into a phrase being omitted from the current announcement that was in the previous one. Nevertheless it still happens. The last sentence of the May announcement is: “In taking future policy decisions, Governing Council will remain data dependent and especially attentive to developments in household spending, oil markets and the global trade environment.” The last sentence of the July announcement is: “As Governing Council continues to monitor incoming data, it will pay particular attention to developments in the energy sector and the impact of trade conflicts on the prospects for Canadian growth and inflation.” Greg Quinn of Market News asked Poloz (at the 16:35 mark on the tape) the reason for the omission of “data dependent” from the release. Poloz was outright rude in his response: “That’s a serious question? Really? Just trying to make sure.” Actually, it is not only the phrase “data dependent” that is gone, but also the reference to future policy decisions. Since the next announcement, on September 4, will be the last one before the October federal election in Canada, the change certainly suggests that for the next announcement, the decision, likely to hold at the current level, is baked in, and the Bank of Canada will just monitor developments, without letting them influence its decision. I suspect that is the case, even if Poloz denies it.
    The July MPR contains a technical box on “Risks associated with global trade policies” that considers upside and downside trade scenarios going forward. The upside scenario returns the world to “pre-2017 trade arrangements”, although if you read the fine print that’s not really a fair description: “Brexit is averted”, which does fit in, but “the Canada-United States-Mexico Agreement is ratified”, which has nothing to do with the pre-2017 world. The downside scenario imagines the US government imposing tariffs on all imports to 25% with its trading partners raising tariffs to the same rate on American imports in retaliation. The upside scenario only has Canadian real GDP 2% higher at the end of 2021 as compared to the baseline scenario, while the downside scenario has it 8% lower. Poloz denied unconvincingly that the much bigger potential downside risk envisaged showed that the Bank of Canada was more inclined to lower rates than raise them over the policy horizon.
    Lately under Poloz the Bank of Canada seems to be getting increasingly politicized. Why assume Brexit never happens, as opposed to a Brexit that has no impact on tariff rates between the UK and the EU27? Why is it necessary to make the US government the instigator in a world-wide tariff war, especially when the Canadian economy is now being hit hard by Chinese trade actions? Justin Trudeau has long fancied himself the global leader of the Anti-Trump Resistance Army. However dimwitted that may be as an aspiration, Trudeau is a partisan political leader and has the right to make that choice. However it ill behooves Poloz to turn himself into Trudeau’s loyal ATRA lieutenant.

    • Hi Andrew and thanks for the update on the Bank of Canada

      I am afraid the central banking technocrats quite quickly morphed into politicians like it has been a 60s science fiction movie. As to the rudeness, it usually means they have been caught out.

      But for now Governor Poloz has it easy because he can do nothing at the next meeting and wait until after the election. By then he will have a much clearer idea of the scale of the easing coming from the US Fed and the ECB and can respond. In a way Deputy Governor Wilkins was kind of hinting at this in her opening statement.

      “Activity here at home is being supported by a policy rate that’s lower than south of the border. By the second half of this year, growth should be similar in both economies as they converge on their respective potential level of activity.”

      It is not only growth which will be more similar…

  9. Hi Shaun

    There was a time when central bankers were not only not seen: they were also not heard and we were probably better for it.

    Too much reliance has been made on monetary policy in the last ten or fifteen years and not enough on fiscal policy – largely due to austerity and the effect pf neoliberal thinking on the size of the state.

    The rapid build up in debt since the 2008 crash has meant that the natural rate of interest has been falling for some years and continues to fall so the CBs have been more concerned to keep the economic plates spinning in the Ponzi scheme we call the economy rather than pursue the futile objective of normalising rates in an economy that only bears a passing resemblance to normality.

    In my view we’re about to be hit by a double whammy: recession and high inflation. We are overdue the first and the second will be the result of the fall in sterling currently in progress and with no sign of stopping. Not only are we likely to see rates cut in the next few months but a renewed bout of “looking through” a rise in inflation – yet again.

    If these people had any sense they’d just keep quiet.

  10. Hi Shaun,
    You may remember I had a bet with my neighbour that the emergency base rate would last 10 years. I lost the bet because the rate went up to 0.75% 7 months before the deadline.
    The basis of that bet is I thought reducing the rate to the emergency level is a trap. I still think it’s a trap. The MPC may wriggle a bit but I doubt I’ll live long enough to see the rate reach 2%

    The spin of Forward Guidance is irrelevant when the time-value of money is virtually zero.

    And that’s part of the reason we have high debt, poor wage growth and a sluggish economy.

    As always I could be wrong – and lose another bet.

    • Hi Eric

      You were right. So was Elvis.

      “We’re caught in a trap
      I can’t walk out
      Because I love you too much, baby”

      Although Colonel Abrams was more thorough.

      “Oh, oh, I’m trapped
      Like a fool I’m in a cage
      I can’t get out
      You see I’m trapped
      Can’t you see I’m so confused?
      I can’t get out
      You see I’m trapped
      Like a fool I’m in a cage
      I can’t get out
      You see I’m trapped
      Can’t you see I’m so confused?
      I can’t get out!”

      • Thanks Shaun,

        KAOS villain: “You’ve fallen into my simple trap, Agent 86.”
        Maxwell Smart: “Huh! I’ve fallen into simpler traps than this.”

        Get Smart! – from the 1960s. Those were the days when the Chief Cashier was more well known than the Governor.

  11. Shaun, I finished reading Vlieghe’s paper. There is pretty solid experimental evidence from a Bank of Canada working paper by Oleksiy Kryvtsov and Luba Petersen:

    Click to access wp2013-44.pdf

    that it is detrimental rather than beneficial to the conduct of monetary policy to provide projections of the bank rate: “Hence, in our experiment, subjects relied mostly on recent data and a qualitative understanding of the working of the economy to form their forecasts… Our findings suggest that subjects avoided costly effort associated with information overload by using simplifying heuristics.” And later they note: “Many subjects noted that they initially used the interest rate forecasts to aid in their decision making, but later ignored the information, since it did not appear to be helpful for their forecasting accuracy.” The answer to “Can more information be a bad thing?”, the ultimate criticism of providing bank rate forecasts considered by Vlieghe, would appear to be yes. The ever so charming Luba Peterson presented her work at a Carleton University seminar in 2016. I remember Nick Rowe, an economist on the C.D. Howe Institute’s Monetary Policy Council. summarized her communications advice for central bankers as: “Just say two percent”, which was only a bit of an oversimplification of her message.
    It seems to me that Vlieghe wants to have it both ways. He claims the central bankers are not bound by their interest rate forecasts and can change them as much as they please. However, if they do that what is their value to the economic participants in forming their expectations?

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