Monetary PolicyPosted by Huw Dixon Sun, June 24, 2018 19:27:47
Well, not much has happened in terms of interest rates since
my last post in November: interest rates still stuck at 0.5%. However, excellent news that Jonathan Haskell
is to join the committee. Well, there has been prevarication and
procrastination. Interest rates were set to rise, and then not. Mark Carney
continues to have a depressing effect on Sterling. His latest magisterial
intervention was the interview with Kamel Ahmed on the BBC on 19th
April. Prior to that expectations had
been gathering for a 0.25% increase in interest rates. In the interview he stressed the possibility
that increases might happen later rather than sooner. Sterling was then at
$1.43. After that interview, Sterling fell
and has continued to fall, reinforced by the May 9th MPC decision to
keep interest rates fixed. Sterling is now at $1.33. The “Blame Brexit” P.R. campaign has been
kept up. Of course, Brexit and weak
growth have had an effect on Sterling, but I would suggest that Carney’s
interventions have (as usual) talked down Sterling. Andrew Haldane voted for a rise in rates on
20th June (joining Saunders and McCafferty), leading to speculation in the press that maybe
there will be a rise in August.
When I contrast the lack of forward guidance and clarity in
what the MPC policy is, the contrast with the FED is complete. As early as
2014, the FOMC (the US equivalent of the MPC) had clearly laid out a plan. Raise interest rates, and then start to run
down the holdings of Treasuries accumulated under QE. The interest rate rises started in December
2015, with the rate hitting 2% in June this year, with the possibility of more
in the pipeline. The FOMC has regularly updated its policy statements on the
issue and indeed at the end of 2017 it has started to slowly unwind QE by
letting its holdings of treasuries and Mortgage backed securities decline. In contrast, the MPC has not issued a formal
statement on interest rate policy and unwinding QE.
History will not judge the Carney governorship kindly. However,
to look on the bright side, the Bank has started to talk about real interest
rates. Gertjan Vleighe gave a speech
talking about them last November. Excellent news. I am not sure I buy his idea that “low rates”
can be a normal state of the economy (the
example of world war two and the years just before and after has little
relevance for today). However, once you
accept the idea that the equilibrium real interest must be non-negative, it at
least puts a floor on sensible nominal rates (they should be no less than
inflation). Assuming inflation will be
on target, that would imply nominal
interest rates of at least 2%.
Also there is talk of Carney’s successor. Luckily the menopausal Broadbent has ruled
himself out. In my opinion, the idea of a Goldman Sachs alumnus as governor of
the Bank is not a good idea. There are
some excellent people for the job: Sir Charles Bean (Mervyn King’s number 2) to
name one. But why not go for a non-banking person. Kate Barker would make an excellent choice in
my opinion. She is a leading business economist and was on the MPC from 2001 to
Monetary PolicyPosted by Huw Dixon Sun, November 12, 2017 09:47:05
I am in China at present, but the recent increase of the interest rate to 0.5% even made the news here. However, welcome as the increase is, all it does is to reverse the disastrous mistake of the post-Brexit cut of August 4th 2016. Let us recall the nonsense spoken by Carney at the time. Carney argued that Brexit would lead to job losses of 250,000 and that further interest rate cuts were in the pipeline, as was a further extension of QE. “There is a clear case for stimulus, and stimulus now, in order to have an effect when the economy really needs it,” he said. The result was a slump in Sterling. In the aftermath of the Brexit vote, sterling had fallen from around $1.45 to $1.30. After the Bank's new policy it fell to $1.20 and below, to lows not seen since the 1980s. What happened after the recent reversal? Well, we see sterling back at its immediate post-Brexit level (todays rate is $1.32). And, recall that for most economists the post-Brexit world looks rather more dark than it did in mid-2016.
Since its August cut, there has been a largely successful public relations strategy of blaming all of the increase in inflation on Brexit. However, whilst Brexit played a role, the Banks own policy of easy money played only a slightly smaller role. I have not done the exact calculations or simulations, but as an off-the-cuff-Ball-park I would apportion "blame" for the increase in inflation about 60% to Brexit and 40% to the Bank of England. There has been a 3% increase in inflation since mid 2016. If the Bank had kept the interest rate unchanged at 0.5%, we would have now had inflation around 1.8%. The Bank's post-Brexit cut and general loosening added another 1.2%.
So, the Bank has at last reversed the mistake. Will they start the path back to normal: long-run nominal rates equal to the target plus a real rate of 1-2% (i.e. nominal rates around 3-4%)? The next couple of meeting of the MPC are crucial here. Will common sense prevail, or will there be prevarication and procrastination?
Monetary PolicyPosted by Huw Dixon Thu, June 22, 2017 16:57:09
We have seen two recent pronouncements by leading Bank of
England MPC members: Governor Mark Carney at the Mansion house and Chief
economist Andrew Haldane in an interview with the Telegraph. But first, we have the very welcome announcement
that the new committee member replacing Kirsten Forbes is a real economist, Silvana
Tenreyro a Professor at the LSE. Just to explain why this is a welcome
appointment. The Chancellor is responsible
for the appointment, which is made through the cabinet office. Under George
Osborne we saw a shift in the type of person being appointed. Out went established academics like Mervyn
King, Charlie Bean, Martin Weale. In
came “city economists” from investment Banks.
Ben Broadbent (Goldman Sachs), Michael Saunders (Citi), Gertjan Vlieghe (Brevan Howard hedge fund). This is the first appointment under
Hammond. It is like for like: a serious
academic for a serious academic. However, I think we can heave a sigh of relief
that it is not another “city economist”.
I see two problems with appointing more than one city economist to the
MPC. There is the issue of regulatory capture. The Bank needs to be independent of the City. The
Bank has a regulatory role to maintain financial stability: since the
investment banks have been major sources of instability it is strange to have
their people at the top of the bank. The
Bank is supposed to be keeping inflation on target in the interest of the whole
nation. Its current policy of allowing
inflation to rise and failing to keep interest rates up with inflation (and
hence plunging the nation into financial repression) might be interpreted as
acting in the interests of the very investment banks and hedge funds from which
the MPC members have come. Now of course, city economists are perfectly capable of doing the right thing. Michael Saunders is one of the three who recently voted to raise rates: respect. However, perceptions matter and there is the possibility of a conflict of interest. The next
appointments will be a real signal, enabling Hammond (or his successor) to show
that the Osborne era is over and that the MPC and Bank of England needs to be independent
of the investment banks and the City. Mr
Osborne of course has since become part of the city, with his appointment in February
2017 as part time advisor to BlackRock, the world’s largest investment Bank.
made what in my opinion was an amazingly reckless speech at the Mansion house.
Inflation is currently just short of 3%, the upper limit of the range. Three members of the MPC voted to raise
interest rates. The real implications of
having interest rates at 0.25% whilst inflation is 3% are really hitting home
to the public and politicians. Carney is
of course distracting us by blaming Brexit.
I opposed Brexit (as did nearly all economists), but it is rich for the
Bank of England to blame inflation on Brexit when the Bank has done nothing to
restrain inflation, which is its main job. Real interest rates have tumbled and
now stand well below minus 2. The Bank’s
own forecasts in mid 2016 predicted a rise in inflation to 2.8% by mid 2017. The surge in inflation was foreseen, but the
Bank did nothing. In fact, it made
matters worse by cutting interest rates by 25 Basis points post Brexit vote. A classic “Greenspan put” as seen in the run
up to the 2008 financial crash. Now, almost 12 months on, his Mansion house
speech was a loud and clear statement that “Now is not yet
the time” for interest
rates to rise. In effect, he is talking
down sterling at a moment when inflation may well break through the 3% barrier.
If it does go above 3%, I think that
Carney should be made to step down. Keeping
interest rates at near zero when inflation has risen by almost 3% is just
stoking up some huge problems and possibly another crash. The correct policy would have been to start
raising interest rates gently last year, with the aim of getting to a level of
the inflation target plus 1-2%: that is 3-4%. The US Fed is doing this. Unlike Carney, Janet Yellen is a serious
economist who understands these issues and has not spent time in an investment
bank or hedge fund.
is a serious academic economist. In the recent Telegraph
interview, he said “might have to rise this year to nip inflation in the
bud and prevent a sharper jump in rates in future”. The
phrase “to Nip inflation in the bud” is a bit rich: the inflationary horse has
already bolted. Any bud nipping was due
last year. The MPC needs to look ahead.
Anyway, at least he is starting to think in the right way. More important is his statement “to prevent
sharper rises in the future”. Yes, keeping
rates so low can actually be a threat to the financial stability the Bank is supposed
to be maintaining. Sharp rises in the future are just what is required to
trigger a financial crash. Well said
Andy! Raising interest rates has become
not just an issue of avoiding financial repression and keeping to the Bank’s inflation
target, but also protecting the very stability of the financial system.
Monetary PolicyPosted by Huw Dixon Mon, May 15, 2017 15:19:08
Inflation is getting very close to the 3% upper limit and is well above the 2% target. This was not unexpected: it was indeed predicted by the Bank last year. As I argued last September (2016), interest rates should have been increased then in order to keep inflation closer to target in 2017. However, many forecasters predicted inflation might well rise above 3% in the next few months. For me IF inflation exceeds 3%, this will be a defining point in the recent history of monetary policy. It will demonstrate that Financial repression is the real policy of the MPC and inflation targeting is only secondary. If inflation crosses the 3% line, there is little excuse for Carney. He will blame Brexit. This has been a very successful diversion of attention away from the fact that the increase in inflation was easily avoidable in September last year. A modest rise in interest rates (maybe in line with inflation) would have been enough. The reason the Bank of England is responsible for setting the interest rate is that it is supposed to target inflation. If it is proving unwilling to do this, then its independence is really something we should all question. Blaming Brexit for a failure in monetary policy is a lame excuse.
So what would a sensible policy be? Simple. If we take the view that the real interest rate is 1%, the current nominal rate should be increased until it is equal to this 1% plus the inflation target of 2%: that is 3%. The long-run real rate might indeed be higher, indicating a long-run nominal rate at 4-4%. However, let us take things step by step...3% is at least in the ballpark.
Monetary PolicyPosted by Huw Dixon Mon, February 27, 2017 22:06:36
Can there be an equilibrium real rate of interest that is
negative? In general, the answer is no. If we think of a steady-state where
consumption is constant, then because the household discounts the future, the
real rate of interest has to be strictly positive. The real interest rate corresponds to the
marginal product of capital. In a representative agent economy, a negative real
interest rate is possible as a transitory phenomenon, and would correspond to a
decumulation of capital indicating that the capital stock was too large and
hence the household would seek to reduce it by maintaining a high level of
consumption with possible dis-saving (consumption in excess of income). A
negative real interest rate would be a temporary phenomenon on the path to
steady-state: along the path, as the capital stock is reduced, the real
interest would get back into the positive territory. In the Ramsey model, a
very large initial capital stock yielding a negative marginal product would
result in a high level of consumption which fell over time, with
Matters are different in OLG models, which are not in
general dynamically efficient. In a simple exchange economy without production,
it is possible to get a negative real interest rate in equilibrium. If current consumption is cheaper than future
consumption, you need to give up more now to get less in the future. The key assumption needed is that there is no
storage or capital: one generation trades with another. Eggertson et al (2017)
have a model where people live for three periods: they have endowments middle
age and when old: they borrow when young.
Assuming that the endowment is largest in middle-age, consumption smoothing
indicates that they will borrow when young, and save when middle aged to
augment their retirement consumption (the old consume everything they
have). At any time, there are all three
generations living together. The middle aged at time t can only save for when
they are old in t+1 by lending to the young at time t, who will repay the old
at t+1. Here, the young demand loans
(consumption) from the middle aged; the middle aged lend to them so that next
period they get paid back and their old aged consumption is increased. The real interest rate here can be positive
or negative, depending on the balance between the supply and demand for loans.
In order to link this monetary policy, we need to introduce
nominal wages, nominal prices and a nominal interest rate. Making various
assumptions, Eggertsson et al show that there can exist “a unique, locally
determinate secular stagnation equilibrium” (Proposition 1, page 21. Figures 4 just above the proposition make the essential
role of deflation clear).
However, the secular stagnation
equilibrium must have deflation: negative inflation. If inflation is positive,
then there will be full employment. This
is because the mechanism reducing output is the increase in real wages. So, in
a secular stagnation equilibrium, the nominal interest rate is at the ZLB (zero
lower bound), output is below full employment, inflation is negative and real
wages above their full employment level (due to downward rigidity). The actual real interest rate is positive
(equal to minus the deflation rate): it is a hypothetical real rate that is
negative (the real rate that would restore full employment). The ZLB does not lead to an equilibrium
negative real interest rate: it prevents the real interest rate from becoming
negative when inflation turns negative.
Have we observed
negative inflation? In the UK and the US just the occasional month in 2016 and
(depending on whether you use CPI or RPI) perhaps for a month or two at the
height of the crisis. Japan has had more
disinflation since the late 90s (disinflation “peaked” at just over -2% in
2009). The Eurozone is a mixed bag: the
aggregate inflation rate has mainly been strictly positive with a few
exceptions as in the UK and US. For
individual countries the story is more heterogeneous. So, if we look at the
major economies, there is no evidence of sustained disinflation that might give
rise to the high real rates required for Eggertsson Stagnation. In fact we find
the exact opposite. The ZLB is combined not with negative inflation, but
positive inflation. Rather than positive real rates, we find real rates are
This brings us to
the most important an obscure part of the paper: section 8, the model with over
100 equations. Here there are lots of
generations and capital is introduced. The key equations are buried in the
appendix: A81 and A82. The marginal productivity for capital A81 is the usual:
the marginal product of capital will be strictly positive. Then there is
A82. This is a little different: there
is a price of capital goods term. Greg Thwaites has developed a model of
falling real interest rates driven (in part) by the falling price of investment
goods. There has been a downward trend in the prices of investment goods
(relative to consumption goods), which means that savings leads to more
investment (but possibly lower investment expenditure). This can drive down the
marginal product of capital. However, in Thwaites model the real interest rate
may be low, but is always positive. So what is it in the Eggesrtsson model that
can give you their figure 7: secular stagnation with strictly positive
inflation (recall, this was impossible in the world of proposition1). I must
admit, that I have read the paper and am none the wiser about how this might be
possible. The paper just presents a
calibration and reports that this is what happens. Unlike the world of
proposition 1 there is no clear story or intuition.
I do not doubt that with sufficient
inventiveness a model with equilibrium negative real interest rates can be
constructed. But it would not be a basis for monetary policy. Monetary policy
needs to be based on robust models that have passed the test of time, not on
exotica. I will continue to believe that real interest rates should be strictly
positive in equilibrium.
Monetary PolicyPosted by Huw Dixon Thu, January 26, 2017 14:58:24
It is getting more and more unreasonable for the MPC not to raise interest rates, at least to keep in line with inflation. The ONS has announced that the UK had growth of 2% in 2016. What possible reason could the MPC have for not at least keeping the real interest rate zero, if not 1-2%.......The nominal interest rate should be raised immediately to at least 1%. It should have been raised a few months ago, but better late than never.
There can be no possible reason to leave interest rates at 0.25% when inflation is going to be above 2% for quite some time.
Monetary PolicyPosted by Huw Dixon Sat, January 14, 2017 16:47:40
The Monetary policy committee (MPC) in the UK seems set to repeat the imposition of financial repression we
saw in the period 2010-12. That is the aggresive reduction in the real
interest rate by failing to keep the nominal rate up with inflation.
Inflation looks set to rise to 3-4% in 2017-18, with nominal interrest
rates left at 0.25 or 0.5% (as seems the plan), that means a negative
real interest rate of -2.5 to -3.5%. Now in 2010 that may have been an
excusable policy: we were in the extraordinary times of the
immediate aftermath of the finacial crisis. However, there is no
justifucation in the current state of the economy for reducing real
rates so rapidly to such a low negative rate. The role of the MPC is to
target inflation, which requires nominal interest rates to rise at
least as much as infation is expected to increase (i.e. the Taylor
principle, that real rates rise when inflation rises above target).
Real interest rates should almost never be negative. Prior to the 2008
crisis, the only time real interest rates had been negative was back in
the 1970s during the "Great Inflation". Back then there was an excuse:
people did not really understand inflation and how to cope with it.
The failure to keep real interest rates positive is widely seen as
simply bad policy. Since then, real interest rates have nearly always
been positive, with nominal rates being around 1-2% higher than
In the last year, we finally had a return to a
positive real rate: the policy rate was 0.5 and inflation was around
zero. However, the MPC and Governor Mark Carney have openly stated that
they intend to keep the policy interest rate at its current level
whilst inflation will be well above target. This will be seen as an
historic failure of judgement by the MPC. Financial repression on this
scale will lead to a massive redistribution of income, with the Bank of
England in effect becoming a major instrument of fiscal policy, taking
from savers and pensioners and giving to borrowers. This sort of
redistribution is not what the MPC is about. Its role is targeting
inflation, something which it seems to have forgotten.
What about Brexit? Well, Andy Haldane (the chief economist at the Bank of England) has admitted that the Bank's forecasts overstated the effect of the Brexit vote on the real economy. The real effects of brexit have yet to come into play (Brexit has not happened yet). However, the implication is that the post Brexit cut in interest rates needs t be reversed: I have yet to see the MPC indicating that this is what it intends to do.
In the US, interest rates are rising: this is something that the UK would be well advised to do immediately. A policy of financial repression is not what the UK economy needs in 2017.
Monetary PolicyPosted by Huw Dixon Sun, February 02, 2014 22:40:33
has been a bit of a flutter of memes recently about new Keynesian
economics. Noah Smith digging out Robert
Barro’s 1989 harangue and Lars Syll’s comment that new Keynesian = new
thought I would add my thoughts into the mix. To understand this you really
need a grasp of what has been going on in macroeconomics for the last 50
years. There is Keynes’s economics (the
stuff in the General Theory and lots of other writings) and “Keynesian”
economics that was developed mostly after Keynes had died. Keynesian economics was the stuff in
textbooks like IS/LM and AS/AD that dominated macroeconomic thinking until the
end of the 1970’s. Don’t forget, some of the key new classical results such as
policy neutrality and the neutrality of systematic monetary policy were derived
in this “Keynesian” framework by simply adding rational expectations (this
happened in the second half of the 1970’s with the “rational expectations
revolution”). Indeed, Milton Freidman said that “we are all Keynesians now”. For nearly all macroeconomists, there was
short-run nominal rigidity (IS/LM), but in the long-run all wages and prices
were flexible and you end up at the natural rate. This was called the neoclassical synthesis,
which I for one always associate with Don Patinkin’s masterpiece “Money,
interest and prices”.
there was an academic consensus about the basic analytic framework for modelling things. There was certainly disagreement: at the time
lots of people did not like rational expectations. Also, there were many who thought that the
IS/LM framework left out a lot that was essential to Keynes’s original thought:
the title of Axel Leijonhufvud’s book “of Keynesian economics and the economics
of Keynes” says it all. I could also reference Robert Clower and Hyman Minsky.
Robert Lucas was putting forward a rather different view that we could
understand everything in terms of competitive equilibrium and Keynesian
concepts such as involuntary unemployment were just hokum. However, I think that it is fair to say that
up until the late 1970s, most macroeconomics, whether monetarist or Keynesian,
adopted the same basic setup.
changed in the 1980s. The idea that you could explain economic fluctuations
using competitive equilibrium developed into the Real Business Cycle
approach. As the name implies, it was a
real model and did not even have money in the model or any concept of
inflation. In this period there was the first group of work that was at the
time designated new Keynesian
. The key idea here was the introduction of
imperfect competition into macroeconomics (much as the young Paul Krugman was introducing
imperfect competition into the new international trade models), which made
possible the explanation of nominal rigidity based on an optimizing theory of pricing behavior
based on menu costs or bonded rationality (along with other ideas).
In the mid 1990s the new neoclassical synthesis
bought these two strands together:
the new Keynesian models of nominal
rigidity were combined with the RBC model of household behaviour (Euler
equations and all that). Now of course, whilst some people stressed the Keynesian
aspects of this (for example David Romer in his J.Econ perspectives paper in
1993), others saw it as a neo-monetarist exercise: for example Miles Kimball in
his 1996 paper “The Quantitative Analytics of the Basic Neomonetarist Model”.
there has always been an underlying idea that the prevailing macroeconomic framework,
whether 60’s Keynesian, 80’s new Keynesian or 90’s first generation
neoclassical synthesis models are really “Keynesian”. Yes, they have nominal rigidity. However, there are lots of elements of the
economics of Keynes that have been left out. It is exactly the same now. The first generation new Keynesian models
became the second generation models (as exemplified by the Smets and Wouters
model, for example).
am not a historian of economic thought, but certainly from my recollection, the
criticisms made of the so-called Keynesian/new-Keynesian models have always
been much the same: they include amongst other things the inadequate treatment of uncertainty, money,
the assumption of a unique equilibrium. So no change there then.
you call the existing crop of models “new Keynesian” or “neo monetarist” is
really a matter of taste. However, one thing
is for sure: whilst the choice of name might have political or ideological
overtones, it sure as hell makes no scientific difference as to how good the