Andrew Baker of Queen's University Belfast posted a couple of comments over the weekend that I held back and, with his permission, post now as a blog.
Andrew started by saying in response to the suggestions by Andy Haldane on increasing inflation rate targets that:
IMF staff have been floating the idea of moving inflation targets to 4% for the last 18 months or more, mainly with a view to the Eurozone, so as to give the ECB more room for easing (18 months ago) and so as to reduce the value of debt in some euro zone countries.
He then added:
I have four questions:
1. Going to 4% in the UK would seem to me to be ineffective, because there is consistent undershooting of a 2% target. Consequently how would this deal with immobilised monetary policy? It seems to me it doesn't, but going to 4% maybe something you want to do in the medium term, but it does not immediately increase the policy armoury? Can anyone explain Haldane's thinking, it looks to me like a fairly desperate attempt to defend inflation targeting over the medium term, which doesn't really get to the root of the problem?
2. This raises the question of how 2% became more or less the norm around the world. It always struck me this was a very loose and intuitive figure. And once it became established it was about signalling credibility by conforming to the norm. I am not aware of research showing how this was an optimum level for society as a whole in terms of its distributional effects. If we accept the basic premise that high inflation hits those at the bottom of the income stream, with least disposable income most, can anyone point me to research that shows that 2% was optimum for low income groups? I'm not aware of any, and I suggest no such research was conducted, because the justifications for CBI were all about symbolic credibility and not optimum distribution and collective societal welfare. Happy to be shown to be wrong if anyone can point to research showing the distributional benefits of 2%? I suspect 2% was like the 3% of GDP for fiscal deficits in the Maastricht criteria, — it was a back of the envelope calculation that was literally plucked out of the air — and became the norm, and therefore ‘credible' and the definition of ‘credibility'.
3. Surely the analysis has to begin with diagnosis — what is the primary macroeconomic problem and then you ask — what monetary policy can do to tackle that — for example if you define this as a short fall of demand together with depleted infrastructure (broadly defined) that is neglected by private sector funds, than you ask how monetary policy can be adjusted and experimented with to help — in relation to those problems. Haldane seems to be suggesting deflation/ disinflation is the problem. The question surely is whether this is a symptom of something more fundamental? If you moved to full on long term deflation that would be a problem no doubt, but it is not cause, — you need to identify the cause. He seems to be hinting at prolonged stagnation — so you surely ask what is the root cause of that?
4. Haldane's main concern seems to be to defend CBI. Fair enough I accept a central bank should have a price stability mandate and latitude to deliver that through interest rates. But why is it a problem to acknowledge reality and say you having one mandate/ target/ policy rule that applies all of the time is unrealistic? The nature of capitalism over the long run is that strange things happen that confound conventional expectations every 40 years, or so. Surely if you are going to do institutional design for central banks you need to distinguish between normal and non-normal times (when inflation is very low and unemployment quite high), and in those circumstance you need to build in experimental and contingent clauses, — that ask the central bank (to do extra stuff QE of different forms) — we've already been doing it informally. Is the suggestion that this destroys anti-inflationary ‘credibility'? This seems to me to be nonsense. The greater danger is informal instruction. Having contingencies were the central bank accepts treasury instructions under specified circumstances while still retaining some autonomy, actually seems to me to be a way of maintaining a more nuanced, and sophisticated modified form of CBI. If your position is CBI in its current terms is a sacred cow and a box that must not be opened, it seems to be to a completely untenable position in the current circumstances. So what am I missing here, from those so reluctant to put this issue of CBI on the table?
Before concluding:
The purpose of all of the above was to say when you begin to analyse CBI it starts to look like a social construction, based on certain accepted ‘norms', where following the ‘norms' signals ‘credibility'.
But ‘norms' cannot stay the same forever, because circumstances and context can and do change. If the norms and the policy rules they give rise to become redundant and cease to act as a reliable guide for policy (for nearly a decade), — where is the ‘credibility'? At that point you have to redesign them and come up with a more sophisticated and contingent institutional design. This seems too big a mental block/ hurdle for some to jump over. I'm trying to work out why. And the best I can come up with is the fear that if you start to change and tamper with central bank institutional design you will lose everything and anti-inflationary credibility will suddenly evaporate. I don't think that is a fully thought through tenable or entirely rational position. There is a mental block based on fear, out there on the subject of central bank institutional design. Very damaging — because we really need a sensible debate about this.
I think this conclusion is likely to be correct.
Call it clinging to straws.
And yes, we do need that debate on this.
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I think the phrase I have been looking for on this is ‘Central Banking’s Pandora’s Box.’ In that I suspect there is a belief out there that if you open the debate on how best to design central banks institutionally (and how we can do this better than current arrangements given the changed context of the world – it’s not the 1990s anymore after all), all the good stuff (hard won anti-inflationary credibility) will mysteriously fly out of the box and vanish, and all the bad stuff (inflationary expectations) will coming rushing in and fill the central bank box. I know Pandora’s box is an evocative and gripping tale, but it is only a tale. For the record, I think there are merits in giving a central bank some for of autonomy to deliver a price stability mandate in normal times, but you need more than just that institutionally, but what and how to get there and how to design that is the hard part.
Surely the debate needs to be much broader than just central bank independence, but instead should be a continuation and deeper examination of the parliamentary debate Money Creation and Society which started in November 2014 and clearly showed MP’s on all sides of the house struggling to explain how money works and why banks have the power to create unlimited credit in society. As long as states/central banks primarily use the very blunt instrument of interest rates to control banks inevitable exuberance to overextend credit and create asset bubbles, we are all at the mercy of a system that continues to punish the vast majority of people in society for doing what the banks need them to do to survive i.e. borrow money at interest to purchase the essentials of life such as a home (not to mention the extortionate practice of credit cards and high interest loans for personal consumption)
http://positivemoney.org/2014/11/press-release-uk-parliament-debated-money-creation-first-time-170-years/
“all about symbolic credibility and not optimum distribution and collective societal welfare.
I think we can be clear about that -I thought the 2% was all about supporting creditors and leaving the indebted in the proverbial creek and feudal vassals of the banking system?
It seems reasonable to observe that one of the key factors of the present inertia on this issue is conceptual.
The fear of mainstream economists is generated by the Pandora’s box conceptual framework they are operating under in which they genuinely believe their models represent reality and are therefore sacrosanct. In that regard they appear to be adherents of the end of history school. This point was discussed last week on this site where the gist of the argument was the need for economists to operate under the scientific methodology in which theory was subordinate to reality rather than, as at present, the other way around.
The conceptual framing and narrative needs to be shifted from this Pandora’s box imagery, which is of no practical value, more towards the box used in the Schrodinger’s Cat conceptual framework.
Thanks for going back to that
But I think Pandora has to be addressed on the way to finding the cat
Your opening analysis is good
It’s pretty clear to me that the political philosophy here is about moving on from independence to dominance. That is the end game and independence is just a foot in the door so they can move onto the next step of supposed ‘experts’ overriding parliamentary and government decisions.
The reason is clear – to embed the One Theory to Rule Them All into the structure of the system and prevent any possible political change. We’ve seen it writ large in Greece and we saw it last week with Carney’s overtly political comments over PQE that would have got any other Civil Servant the sack.
The idea that inflation hits the poorest in society is nonsense – because the government determines their income levels via tax credits, state pensions, National savings interest rates, personal pensions (via index linked gilts) and the minimum wage.
Inflation hits creditors the hardest because they have a fixed investment. From ordinary people’s point of view it rots the debt and increases their equity. Productive asset prices, equity, wages and profits all track up with inflation.
So you have a mainstream who says ‘inflation hits the poor’, yet main reason inflation has to be anchored is to the stop a ‘wage/price spiral’. The two are inconsistent beliefs.
The central bank is part of government, and it is time that the central bank was merged with the bond issuing part of government to form a single department of government responsible for the yield curve. Then whether it is dominant or subservient depends upon the political philosophy of the government of the day.
It’s time for economists and bankers to realise that they are proffering Opinions and Beliefs, not the one and only truth.
The system has to support change and different ways of operating – otherwise governments can change nothing fundamental.
John Smithin (“Macroeconomic Policy and the Future of Capitalism”) makes the simple argument that having spent time and effort amassing savings you want to preserve their value and this necessitates a “real” interest rate of return. The call for independence of central banks can be somewhat blunted by governments offering such an amenity to individual citizens through savings schemes which are quantity limited but not time limited and for non-financial businesses time limited but not quantity limited.
Agreed, when the political right start showing concern for the poor, we know they are lying – just like they usually are!
There’s two aspects to the question of central bank independence. Firstly, is the BoE genuinely independent now or just pretending to be? Would they just go off and buy £375 billion worth of bonds of their own volition?
Secondly, should the central banks be independent? In other words should they have control over monetary policy whereas govt has control over fiscal policy? Is this separation of ‘control levers’ a good thing?
The right questions
I remember an episode of Yes, Minister when some political analyst suggested that each project should be indicate success and failure parameters before it is approved. This caused a massive uproar as it would allow people to decide if civil servants have managed a project properly.
I see the current framework as very much in line with the above sentiment: the government is required to state explicitly what it wants to achieve (with the 2% target being the current interpretation of its long term goal) and the bank has to achieve the target with the instruments at its disposal.
I think the inertia in changing the target is somewhat useful: there is value in keeping the monetary arrangement stable as uncertainty could be very expensive in terms to investment. But the current system allows changes. Even the dismissal of the governor is a simple parliamentary vote away anyway.
The ability to modify the target gives the government a lot of control on the Central Bank anyway. The UK system doesn’t really have a strongly separated executive anyway, so it’s fairly easy for the government to pass any laws it wants. The US or European situation is very different. In such circumstances legislation can be easily stopped, and CBI is much stronger as a result, but in the UK it seems a fairly minor issue frankly.
My personal opinion is that helicopter money would be a mistake today, but it could be useful in the future. But I don’t really see what difference it would have made. It’s not like a conservative government is likely to use helicopter money in the future anyway given its reluctance to use normal fiscal policy… The case for further state investment in infrastructure is somewhat stronger, but it is less strong than a few years ago I think…
The bank has missed the target for a year now… I think it’s too early to state they are not trying to hit the target. If they fail to hit the target for 3 years, I think there is a strong argument that they need to change the way they operate, but it’s still way too early to determine that I think…
I will print out two sentences from the above comments that encapsulate the whole problem:
1.
“Haldane seems to be suggesting deflation/ disinflation is the problem. The question surely is whether this is a symptom of something more fundamental? If you moved to full on long term deflation that would be a problem no doubt, but it is not cause, — you need to identify the cause. He seems to be hinting at prolonged stagnation”
2.
“As long as states/central banks primarily use the very blunt instrument of interest rates to control banks inevitable exuberance to overextend credit and create asset bubbles, we are all at the mercy of a system that continues to punish the vast majority of people in society for doing what the banks need them to do to survive i.e. borrow money at interest to purchase the essentials of life such as a home (not to mention the extortionate practice of credit cards and high interest loans for personal consumption)”
A stagnant economy is inevitable when you have a consumer led economy with consumers who are over-laden with debt – personal in the form of credit cards and mortgages on under-supplied housing and public in the form of taxes higher than they would otherwise need to be alongside ill-thought through attempts at austerity in order to “balance the books”.
The debt needs to be progressively removed from the system and the system changed so that [a] the debt does not immediately regenerate and [b] the economy doesn’t metamorphose into an inflationary vortex.
An (over) simplified paraphrase of Andrew’s questions might be as follows:
1. Why does Haldane think increasing the inflation target to 4% would be effective?
2. How did we arrive at a 2% inflation target to start with?
3. Are we missing the root cause of the problem?
4. Why are some people unwilling and/or unable to put the issue of CBI (Central Bank Independence) on the table?
I agree that we need a debate on this. And we don’t need to be afraid of fear.
My own take is that economics is a complex discipline, and many people feel incapable of discussing it logically. Even within the mainstream economics profession, there is a lack of understanding that leaves the theorists literally clutching at straws (and dumbfounded after the 2008 crash). All the variables are complex, and inter-related. Any change in one is bound to cause a change in the others. What is needed is to take all the variables together in a single, symbiotic view.
But this task is beyond human capability. The neoliberal mindset favours deductive, computational methods to solve complex problems. Therefore they will grab at any factors they can hold constant, at least to a first approximation. CBI would be one such constant. With it, they can perform their calculations based on reasonable expectations. Without it, they are in a land of uncertainty. And they think, surely their predictions based on known factors are much to be preferred than anyone’s guess on the unknown?
Such is the problem, and it has its origin in the conceptual methodology of neoliberal economics. There is a solution, but as the problem is complex, the solution must be complex too. Just as the mathematicians introduce complex numbers to solve their equations which have no real solutions, so economists must introduce a complex variable, viz. the human mind, to solve their macroeconomic problems that have no real solution. I don’t have space in this comment to go into detail here, but suffice to say it involves real people applying their minds to real problems in an intelligent and reasonable way, just as Richard Murphy is doing.
One further observation. Not everyone feels confident talking about economics. When the best available intellectual edifice assumes CBI, then those who are not experts are bound to draw on the beliefs of those who claim they are. The result is that the idea of CBI gains currency.
Andrew is right to refer to a ‘mental block based on fear’ on central bank institutional design, although this is not just a fear of losing control and credibility. For the rich, a central bank with powers to resist a Labour government committed to social justice promises some protection.
That fear is rational but worries around control and credibility are not confined to the wealthy and can be challenged. To do this we have to move beyond arguing about ‘central bank independence’ and whether it does or should exist. That allows people to invest these words with their own hopes and fears which obstruct further discussion. I’m willing to concede the phrase if it allows us to move onto debating substance as then we can make progress. Andrew’s observations on the inflation target, diagnosis and circumstances start to do that.
John McDonnell wants to review the BoE’s mandate on issues such as jobs, prosperity, investment and inequality, as well as inflation. We should also examine tools and powers, accountability and transparent mechanisms for co-ordinating fiscal and monetary policy. The relationship of the Treasury to Parliament and other departments as well as to the BoE also needs consideration.
In all of this we must be as specific as possible to bring the debate out of the ideological shadows into the light of practical proposals.