Martin Sandbu’s column excoriates central banks for post financial crisis macroeconomic performance. He is right about a lot of things, so I am sure – and hope – his broadside is taken seriously.
But I don’t think he is right about this.
Martin’s piece fills a vacuum left by central banks and their finance ministry sponsors. [What? I hear you thinking.] Central banks themselves ought to be routinely, even institutionally reviewed. Stephen Williamson commented on Twitter [something to the effect] that he had never seen a central banker own up to a mistake. This is bizarre. We and they know that they make mistakes all the time, and recognition of that informs the next policy decision or policy reform. A well designed policy this period requires diagnosing the status quo, and understanding the extent to which we are where we are because of where we went wrong before. Treasury Committee conducted a brief review of post crisis monetary policy in the UK towards the end of Andrew Tyrie’s chairmanship, but the exercise fizzled out.
Seen through the economic spectacles that central banks use to observe the economy – their apprehension of the state of the art of macro – performance isn’t all that bad. Inflation undershot the target, but not spectacularly. This is indicative of the output gap – the amount of spare capacity in the economy – not being too great. Actual weakness in post financial crisis in output is therefore something new and ‘structural’. When necessary, the UK central bank tolerated a substantial overshoot up to 5.5%, weighing as it was asked the adverse consequences for the real economy if it had set policy tighter. It’s only a hypothesis that the large gap between a line extended out of the pre-crisis output trajectory and actual output has anything to say about the efficacy and competence of monetary and fiscal policy and their frameworks. The medium frequency moving average growth rate has moved around before, and it may have simply fallen again recently. Again, seen through the lens of central bank model spectacles, the absence of accelerating price falls is evidence that this is indeed what happened.
Added to this, conditional on the financial crisis happening [ie let’s leave aside the controversial question of what role central bank policies and frameworks had in that event], there is a danger of expecting too much from macroconomic stability efforts. Critics invite us to assess what happened against a perfect benchmark, but what actually would have been feasible given the speed with which politics and instruments work?
At this point, you might plausibly interject and say – well, so much the worse for those spectacles through which central bankers view the workings of the economy. But, I – and I guess they – have yet to come to a radically new world view that would explain why what they did was so badly wrong.
To the specific criticisms….
Martin wishes that central banks had not accepted the effective floors to their policy rates provided by current monetary institutions; he wishes that we had had more asset purchases. He thinks that consideration should have been given earlier to helicopter money. He also thinks that central banks are overly keen to normalise interest rates.
Responding properly to this wide-ranging critique is difficult to do compactly. So I’ll make just a few brief points.
First, some of the things Martin wants are not the fault of the central bank, or at least could not have plausibly been done unilaterally.
Implementing very negative interest rates and helicopter money falls into this bracket. I imagine that there might be a legalistic reading of the Bank of England Act that concludes that the BoE could do these things, but I don’t think this would have washed politically. [circumstantial evidence being the perceived necessity of government involvement at the instigation of QE; and political reaction lately to QE and low interest rates.]
It’s debatable whether the limits on the quantity or type of assets fall into this category [of being things that the central bank could change unilaterally]. The Treasury reserved for itself the right to set these limits. But the Bank of England Act reserves the right to set ‘monetary policy’, which could have been construed more broadly than setting Bank Rate. And anyway, the situation was probably one in which within reason those limits would have been modified as the central bank wished.
Second, aside from the smaller question of who ought to have acted so that the thing that needed to be done was done, there is the issue of whether these monetary policy reforms would have been appropriate at all. [And remember, that is taking as a given the premise that there was inadequate stimulus. Which is not above question].
I think that to the extent that there was inadequate stimulus this would have been better coming from conventional fiscal policy – which we now know had and has space to act more vigorously – rather than wholly new central bank policies like very negative rates or helicopter money. I would, however, go as far as to say a few things in the direction of Martin’s critique. One is that these policy reforms should not have been dismissed out of hand by those that did [Carney included].
A better response would have been to produce a serious evaluation of the costs and benefits, and put a contingent plan in place for their use, explaining what preparatory work was needed and was being done, and what kind of eventualities would trigger their use. If I recall correctly, Carney’s objection to helicopter money involved observing that the BoE paid interest on reserves. That was unsatisfactory as I wrote earlier on this blog. He was equally – and inappropriately – dismissive of thinking through negative interest rates [recall his put down of Andy Haldane’s think piece at Treasury Committee].
[To recap briefly why objecting to helicopter money on the grounds that the BoE is paying interest on reserves is not good enough: the BoE paid interest on reserves so that it could simultaneously hold interest rates above the natural floor [thought to be 0 at the time] AND do large amounts of QE. The consequence of paying them means that creating new reserves creates an every expanding amount of them without limit, as the interest on reserves is paid as reserves, which then bear interest, and so on. There is not a strong argument IMO against stopping doing this and allowing interest rates to fall, as a preparatory step before doing helicopter money. The effects of that can be monitored as the policy unfolds, and if it becomes over-stimulatory, it can be reversed without limit.]
As to whether central banks ought to have done more (and more exotic) QE purchases. More purchases would have come with fiscal, market-distorting and political risks – viz the reaction and analysis of what was done already. I doubt very much whether the amount of stimulus could have been made very much larger without these costs beginning to look large enough to offset the benefits.
To state in summary terms where asset purchase policies went wrong, I’d say the following: I think one can make a plausible case that the BoE should not have concentrated purchases on government securities at the outset; that the ECB’s eligibility policies meant that QE was directed most where it was least needed; and that the communication of these policies by many central banks was highly suspect at best: emphasizing channels of transmission that were probably not their [‘printing money’]; failing to disclose the exit path; and claiming too much for the policies in the absence of good evidence, initially.
Martin’s final complaint was that central banks have been in too much of a hurry to normalise interest rates. Here I am in sympathy with him. But I don’t think that the difference between what central banks should be doing and what they are doing [say, specifically, in the UK and the US] is large enough to be worth a broadside critique or make any great difference to the trajectory of output.
As an aside, I recall that Ryan Avent also takes this view [of the Fed in particular] and was sufficiently agitated about it to conclude that central bank independence over monetary policy was a bad idea. The fragility of politics in the UK/US/Eurozone and the capriciousness with which some finance ministries are being run, combined with not believing that interest rate policy has gone too far wrong, leads me to conclude exactly the opposite. That what central bank independence there remains [and with instruments arguably at their full extent already] is serving us very well indeed.
This brings me to what I think I would have set down as the real failure of macroeconomic policy recently. This is not the failure to pull the policy levers managing the last crisis, but the failure to draw up an institutional and battle plan for the next one.