January 2016 newsletter – The Monetary and Financial Policy Conference 2015

The Money, Macro, Finance Research Group have established a new annual conference to engage constructively with policy developments at the Bank of England. Chair Jagjit Chadha (Kent) and Secretary Richard Barwell (BNP Paribas Investment Partners) report on the conference attended by macroeconomists from academe, the City, policy-making institutes and the main consultancies and hosted by Bloomberg.

The first Monetary and Financial Policy Conference (MFPC) organised by the Money, Macro Finance research group, on behalf of the UK macroeconomics community, was held at Bloomberg's HQ in the City of London on 25th September with some 120 economists present. The agenda illustrates,1 that this new annual conference intends to engage constructively in all areas of Bank of England policy and initiates an inclusive forum for the debate of monetary and financial policy in the UK. A broad church of central bank watchers from academics to market economists to policy wonks and even, may the spirit of Keynes forgive us, journalists were welcome.

It was just a fraction over 23 years since the UK fell out of the ERM and began a long walk (occasional march) to price stability with an Inflation Target. The establishment of operational independence of the BoE and the MPC was a crucial addition less than five years later. The Long Expansion continued — seemingly without limit — until the financial buffers were hit in 07/08. Since then we have had near continuous policy evolution — with an historic low in Bank Rate, record levels of peacetime borrowing, QE and the inception of radical reform of the banking and financial sectors. And although we are not yet back to normal times, we seem to be approaching the end of the crisis (a rather dangerous statement) and so even if not, the time seemed right to start a collective process of understanding better our current position and the cases for further reform of the monetary and financial constitution. The FPC arrived on the scene more recently but is potentially no less important and should soon be joined by a Prudential Regulation Committee: a veritable triumvirate forming the core of our new monetary and financial constitution.

The conference would also like to encourage market economists working on the UK to come out from behind the purdah of compliance and share their results with the wider community of economists: ‘Follow Willem’s lead.’ Ultimately we also want to encourage more academic research on the questions specific to UK policy. The papers and presentations will be stored on the MMF Group pages and will be accessible to all — from school kids to MPC members. The advisory group set up this conference to foster more and better — if that is not a contradiction in terms — UK-oriented macro research.

Dealing with a low natural rate
Sir Charles Bean (LSE) asked ‘Are Low Rates Natural?’ and wondered what might be done to increase the effectiveness of monetary policy. Charlie did offer some grounds for hope that natural rates might rise a little in the future as the headwinds of demography and balance sheet repair in the aftermath of the crisis started to abate. However, if low rates were here to stay it may not make much sense to raise inflation targets as we would lose the benefit of ‘stable prices’. The correct response seemed two-fold first to assign monetary policy to inflation control and (macro)prudential policy to maintaining financial stability, with the latter trying to ensure that the financial system was robust. And, secondly if possible, it was better to raise the natural rate through structural and fiscal policies.

Huw Pill (Goldman Sachs) presented a paper on the UK Monetary Regime after the Crisis that was co-authored by Alain Durré, Cristina Manea and Adrian Paul. The pre-crisis consensus was that the central bank should use its balance sheet to accommodate liquidity shocks but not credit shocks (threats to the solvency of the banks), nor should the balance sheet be used to finance governments, interfere in money markets or engage in industrial policy by subsidising certain sectors/companies. However, in a crisis the theoretical distinction between liquidity and credit shocks is blurred and central bankers are aware that unconventional monetary interventions are potentially welfare enhancing. Unconventional monetary policy may be superior to simply cutting the policy rate in response to this hybrid liquidity/credit shock but these interventions have a clear fiscal dimension (for example, credit easing involves a transfer from the public to the private sector) and they argue that the ‘fiscalisation’ of central bank balance sheets potentially threatens the long-run pursuit of price stability.

Charles Goodhart (LSE) argued that the financial crisis exposed the Achilles Heel of the workhorse model of modern money-macro: that the framework cannot easily accommodate defaults, and in particular the defaults of financial intermediaries. Goodhart challenged their claim that money (financial quantities) is (are) irrelevant outside of crisis conditions and was open to reforms which could ease (without eliminating) the lower bound constraint and was not instinctively opposed to the principle of helicopter drops.

Sushil Wadhwani (Wadhwani Asset Management) made a number of comments in his remarks. First, he noted that the QE had delivered mixed results, in terms of the impact of asset purchases on both equity markets and the real economy. Second, he raised the concern that markets might therefore reach the conclusion that the policymaker's conventional cupboard is almost bare if the economy is hit by another shock, and that realisation might lead to a tightening of financial conditions which could exacerbate the downturn if that shock arrived. Third, he challenged the resistance to helicopter money as a policy instrument, arguing that it was likely to be more effective than other means of stimulus at the lower bound and easier to implement than deeply negative policy rates and argued that it would therefore be wise for central bankers to establish a framework now for implementing helicopter drops for monetary policy purposes before a politician set the ground rules in their favour in some future downturn.

Macroprudential policy
Charles Nolan (Glasgow) and Alfred Duncan (Cambridge) saw the establishment of the UK Financial Policy Committee as a landmark development in macroprudential oversight. But they argued that its purview may be overly narrow because macroprudential policy ought to be concerned with the overall efficiency of the financial system rather than new instruments per se. There was no clear agreement how that efficiency ought to be measured. Macroprudential policymakers should have a role as much concerned with providing authoritative, public advice on areas of policy relevant to aggregate financial efficiency as with imposing additional restrictions on bank lending. The issues that have dominated the monetary practice debate of involving independence and transparency loom large under the macroprudential regimes as well.

Sir Paul Tucker (Harvard Kennedy School) suggested that the question of monetary and macroprudential mix has echoes of the debate on monetary-fiscal policy but was in many respects quite different. The MPI question required a reverse of the brain drain to monetary policy and primacy of the questions of resilience and allocative efficiency, as well as policies on resolution. Douglas Gale (New York University and Imperial College) wondered if there should be fewer ad hoc policy recommendations as there were both co-ordination issues in general equilibrium and MPIs might be better concentrated on design and regulation rather than ‘lever-pulling’. 

Uncertainty matters
Nick Bloom (Stanford) presented research on the macroeconomic importance of uncertainty about the conduct of economic policy. Although there is a well-established theoretical literature that explains how uncertainty can drive macroeconomic outcomes, the next step is whether we can accurately measure how uncertain households and companies are about the future direction of policy and whether the measures we can produce help explain macroeconomic dynamics. Bloom’s measure of policy uncertainty — the EPU index — is based on the relative frequency with which newspaper articles discuss issues that encompass the economy, policy and uncertainty each month.

When Bloom applied his methodology to the United Kingdom (in this case using only 2 newspapers) he found that international events account for the majority of the spikes in uncertainty with the post-crisis peak coinciding with the acute phase of the Eurozone debt crisis. Bloom also presented evidence of the macroeconomic significance of uncertainty: at the micro level, when policy uncertainty rises those companies that are more exposed to government spending suffer more volatility in the stock market’s valuation of their business and tend to cut back investment in physical capital and jobs; and at the macro level, the rise in policy uncertainty during the crisis is found to explain a 2 per cent fall in output. However, perhaps the point in the presentation that attracted the most attention in the discussion was Bloom's mention of the result in the theoretical literature that an increase in uncertainty can blunt the impact of policy stimulus.

Shamik Dhar (FCO) noted that if the problem was uncertainty about the conduct of economic policy then Bloom’s research invited us to conclude that the solution was surely rules-based policy, which most macroeconomists believe would be a mistake. Dhar also observed some curious features of Bloom’s estimates of policy uncertainty: the trend increase in uncertainty in the United States since 1960 (which Paul Tucker attributed to the increasingly polarised nature of the US political system) and the fact that uncertainty does not appear to fall back during the supposedly tranquil Great Moderation. He then raised the chief concern with the overall strategy of identifying changes in uncertainty -—that it likely conflated shifts in first and second moments.

Gareth Ramsay (BoE) began his comments with an observation that for much of the Great Moderation the Monetary Policy Committee had been criticised for exaggerating the extent of macroeconomic uncertainty via excessively wide fan charts around the Committee’s central projection, and yet with the benefit of hindsight those fan charts did not appear wide enough. Ramsay then discussed some of the ways in which the MPC had attempted to reduce the uncertainty around the conductof monetary policy — through the communication around the Bank’s QE programme and latterly via the calibration of the Committee’s forward guidance on the future path of Bank Rate. Finally, he turned to the same theme as Dhar: the difficult of distinguishing between changes in confidence and changes in uncertainty and the unstable correlation between these measures of sentiment and activity.

Prior to the Housing Panel, the room was polled as to whether there was a housing crisis in the UK and 74 per cent of the attendees thought that there was. The panel chaired by Angus Armstrong (NIESR) outlined many of the key issues. Stephen Aldridge (Department for Communities and Local Government) outlined the impact of Help to Buy but also the extent to which the constructions sector had been so heavily hit by the financial crisis. Kate Barker (author of the Housing Supply Review and formerly of the Monetary Policy Committee) repeated her call for joined up policy-making across the FPC, PRA, FPC and HMT. George Buckley (Deutsche Bank) worried about the impact on housing of policy hikes, which would affect affordability and the budgets of exiting owner/occupiers. David Miles (Imperial College, Monetary Policy Committee member 2009-2015) was clearly concerned about the sensitivity of the overall mortgage book to changes in policy rates and this underpinned a need for gradualism. John Muellbauer (Nuffield College, Oxford) outlined issues of affordability, as well as the need for to change fiscal policy analysis so that it focussed to NET Debt/GDP, where (at least) saleable assets, including land, in public ownership are netted off gross debt.

Introduced by Diane Coyle (Manchester), Willem Buiter (Citibank) was given the final word and summed up the day’s proceedings and called for more consideration of the consolidated monetary-fiscal balance sheet, the development of more instruments and more MFPC meetings! In conclusion, we could not know how our idea to organise this conference would be received. But the response from all has been remarkable. All speakers and discussants gave their time freely and most generously. We are grateful to the Royal Economic Society and the Economic and Social Research Council for co-funding, and to the Bank of England for co-funding the MMF and to our gracious and generous hosts Bloomberg.