The Bank of England blows its own trumpet but what purpose is it now serving?

23rd July 2014 by The Harried House Hunter

Today has seen the Bank of England reveal more details about its past and present economic policies. If we look backwards apparently its performance was much better than we thought! Let us investigate the thoughts of Paul Fisher who has given a type of valedictory statement to the Independent newspaper this morning as he reviews the end of his term on the Monetary Policy Committee which started in March 2009. The headline sets the tone.

‘The Bank delivered the recovery’

Not much sign of modesty and we observe plenty of self-awarded praise as the article goes on.

“A number of our policies had very big powerful effects on the recovery phase, and, without doubt, things would have been much worse if we hadn’t stuck to our guns”

Those reviewing a wage packet that has shrunk over this period may be wondering exactly how things could be worse? Especially as the fall in real wages was driven by above target inflation which Dr.Fisher and his colleagues continually told us was “temporary” and instead persisted for over four years. Actually Dr. Fisher is still at it.

even though inflation temporarily went up so high.

If we move to what sort of recovery we have had then it has taken us around 6 years to get back to the aggregate level of output we had before. That is not exactly inspiring and if we note that the population has grown we can only conclude that output per head has yet to return to pre crisis peaks. Still there is one area where I can sort of agree with Dr.Fisher and that is that the Funding for Lending Scheme he lavishes praise on does seem to have had “very big powerful effects” on house prices. Indeed today’s numbers from the British Bankers Association hint that this may be ongoing as you can see below.

Gross mortgage borrowing of £11.2 billion was 24% higher than in June last year…… Having declined during the early months of 2014, approval volumes turned up in June,

Sadly Dr. Fisher did not get asked about this from June 2013.

preferring to increase the size of the asset purchase programme by a further £25 billion to a total of £400 billion.

He would have put the monetary policy pedal even further into the metal just as the UK economy was about to enter a strong growth phase! If I was you I would think about that as he praises the concept of Forward Guidance.

Foreign exchange market rigging

This took place on Dr.Fisher’s watch as executive director for financial markets. But apparently all is well and the subject is a “non-story”.

Looking Forwards

The Bank of England has released the minutes for its meeting of earlier this month today. Whilst there are issues created by the policy of Forward Guidance there are some rumblings and hints at forward policy.

On one interpretation, the risk of a small rise in Bank Rate derailing the expansion and leaving inflation below the target in the medium term was receding as that expansion became more established.

But the majority view and quite a substantial majority was this.

there was little indication of inflationary pressures building and there was uncertainty as to whether there had been a more structural change in the relationship between the labour market and inflation. Moreover, there were early signs that global growth was weakening,

However one issue was entirely self-inflicted which is the one of the “output gap” which morphed into (labour market) slack.

 the degree of slack was highly uncertain,

Because estimates of the level of spare capacity had become more uncertain

there was uncertainty as to whether there had been a more structural change in the relationship between the labour market and inflation

uncertainty about the degree of slack had risen on the month

So they have put themselves in quite a muddle. Everybody can see that the economy is recording a fast rate of expansion yet apparently the “slack” is not falling. So the Minutes end with something of a teaser on interest-rates.

 although for some members the decision had become more balanced in the past few months than earlier in the year.

Tucked away in the Minutes we did get a somewhat odd rationale for raising interest-rates.

would allow the Committee to evaluate the sensitivity of households, firms and financial markets to changes in interest rates, following a long period during which Bank Rate had remained unchanged.

I find that fascinating as a succession of swingeing cuts from 5% to 0.5% did not seem to have that strong an effect but now we have rather an asymmetry displayed as a possible 0.25% rise needs an evaluation of “sensitivity”. If there had been “sensitivity” on the way down in interest-rates we would have escaped the credit crunch long ago.

Bank of England Agents weigh in

As we note that wage growth trends are uppermost in the minds of the Bank of England I note this observation today from the Bank’s Agents.

The majority of pay settlements had continued to be in the range of 2%–3%, although some contacts reported increasing overtime and profit/performance-related pay.

Where there were difficulties in attracting new recruits, or concern about staff turnover, some contacts had made higher pay awards to certain employees,

This looks more positive for wage growth than the official statistics on average earnings. The equivalent number there was 1% in May. Should it turn out to be accurate and feed into the official numbers then we can expect the subject on an interest-rate rise to come up with more force as we move into the autumn. It would also represent something of a victory for the business surveys which have been suggesting wage growth is better than the official numbers. The MPC Minutes reflect this.

Consistent with this view, some survey indicators of wage growth had been rising for some time, most notably the REC survey measure of the pay growth of new employees. This had risen to a record high, reflecting firms’ reported difficulties hiring suitable workers.

Comment

Some might consider that the Bank of England is flying blind right now. It no doubt would prefer its recent actions to be considered more in the light of the “masterly inaction” suggestion of the apocryphal civil servant Sir Humphrey Appleby. However you regard it the rather troubled journey it has taken through the labour market as it has switched from aiming at a 7% unemployment rate to apparently using wages as a measure of “slack” undermines both the concept and credibility of Forward Guidance.

We observe that the monetary policy of the UK is currently being set under my “dark side” theory by the financial markets and they have tightened policy. The clearest signal is the exchange-rate which in trade-weighted terms has risen to 88.93 compared to the recent low of 77.86 in March 2013. Applying the Bank of England’s own rule for the impact of this brings us to 2.75% in Base Rate terms or 11 of the increases it seems so afraid of. Added to this we have seen other interest-rates rise as for example the five-year Gilt yield has risen from around 0.9% then to 2% now. We have moved in the Mark Carney era so far at least from active to passive monetary policy.

Let me leave you with a question which strikes at the heart at the operations of the Bank of England. If we returned to elected politicians being in charge of monetary policy right now, what do you think would change if anything?

16 thoughts on “The Bank of England blows its own trumpet but what purpose is it now serving?”

  1. Londoner says:

    Nothing?

    1. Anonymous says:

      Hi Londoner

      It feels like that to me too….

  2. therrawbuzzin says:

    As far as I’m concerned, forward guidance hasn’t been discredited;
    if you tell people what your future concerns are, and the future perameters for change of policy, it might well be very helpful.
    If, however, you lie about the driving perameters, then get caught lying, obviously, there are problems of credibility.
    The problem is the guide, not the idea of guidance.

    1. Anonymous says:

      Hi therrawbuzzin

      When things are so volatile and subject to change do you not think that Forward Guidance makes the Bank of England a hostage to fortune? After all it has had a shocking forecasting record which came home to haunt it as the unemployment rate rushed through the 7% unemployment rate indication a long way before it was supposed to.

      1. therrawbuzzin says:

        I understand your point, but if Carnage had been honest and said that interest rates would remain low until the banks had restuffed their balance sheets, and could afford some loans to go belly-up, or had said, things are too volatile to assess where we’ll be in six months, but here’s our main aims…
        In both instances, forward guidance is fine.
        I still think that Carney’s only problem was seeking a politically acceptable perameter for interest rate rises, instead of the truth, and that is damning, as it makes him an unaccountable politician.
        “Hostage to fortune?” Do you mean economics isn’t a science?

  3. Anonymous says:

    What would change with elected politicians in charge ?

    I’d hope to see a reduction in the BOE wages bill. I’d hope they employ economists who weren’t incredibly well connected to Goldman Sachs.

    We would have a single chancellor with whom the buck stops – the person responsible for both setting interest rates and for balancing the budget. These things don’t act in isolation.

    I’d comment that the politicians are responsible QE and other market manipulation. Printing money and manipulating markets are rightly considered crimes when anybody else does it, why should our elected politicians have immunity ?

    1. therrawbuzzin says:

      The supposed ethos behind the depoliticisation of monetary policy was to prevent chancellors from meddling for political gain!!!!!
      Now we have bankers setting monetary policy for banking sector, politicians feign unaccountability, and monetary policy is removed from the democratic process.

  4. Anonymous says:

    Great column, Shaun. I notice that Mr. Fisher pooh-poohed the idea that interest rates should have been higher in the UK before the financial crisis. A lot of monetary economists would disagree with him on that. British-born David Laidler, probably Canada’s best-known monetary economist, co-authored a 2008 paper in which he says (p. 8-9): “Not surprisingly, the UK retail price index (RPI), which does account for owner-occupancy costs and is roughly equivalent to the Canadian CPI, has risen significantly faster in recent years [than the UK CPI]…Had the Bank of England been targeting this index _ or even the variant that it targeted before 2003, which ignores mortgage interest while accounting for other owner-occupancy costs _ it is hard to believe that UK monetary policy would not have tightened sooner, with salutary effects not just on inflation, but on the local housing market, too.”

    http://www.cdhowe.org/unstable-foundations-asset-markets-inflation-targets-and-canadas-2011-policy-choices/4663

    It is a mystery why the authors would think that RPI would be a better inflation target indicator than RPIX, but the rest of their analysis is quite sound. Andrew Baldwin

    1. Anonymous says:

      Hi Andrew

      Thanks for the link and the reminder of David Laidler who wrote one of the textbooks I studied back in my days as a student at the LSE. As too the analysis I agree that ether variant of the RPI would have been a preferable inflation target in the boom that preceded the credit crunch. The MPC should have objected to the 2003 target change.

      There was something else in Dr.Fisher’s analysis which was somewhat odd. He told us this.

      “That had given us an overvalued exchange rate.” which led to this “That was pushing up the exchange rate giving us a big current account deficit.” Except after the 20-25% devaluation the UK was left with a big current account deficit. So it was a shame that he was not challenged on this point.

  5. Forbin says:

    Hello Shaun,

    “Some might consider that the Bank of England is flying blind right now…..”

    some of us think they’ve always been flying blind !

    With bogus made up figures for GDP GNP, CPI , etc, etc its no wonder they are like a stopped watch – right about twice a day !

    The obvious solution is to either make the Governor an electable position ( like you would like – and I’d vote for you 😉 )

    or

    bring the job back to the Chancellor – wasn’t my mate GB who though up this stupid idea in the first t place?

    honestly I can’t see either happening as its just too cozy for Banks and pollies .

    Forbin,

    1. Anonymous says:

      Hi Forbin

      I agree that the MPC has become institutionalised. In fact our establishment like it so much that they have created the FPC for our banks and financial sector. So if things get difficult they now have two unelected Quango’s to deflect the flack and take the blame. It has become the modern method of government.

    2. Eric says:

      Hi Guys, I wouldn’t trust them to fly anything. The MPC’s performance over the last 5 years brings Alice to mind – lost deep in the woods and wondering which path to take.

  6. Ianjones says:

    Surely the main reason interest rates went so low was because debt exceeded the income available to pay it off plus the interest. By bringing in the FLS, all they’ve done is raise long term debt on short term rates using the Govt balance sheet to fund it. As Govt debt is also still growing very quickly it is obvious that the Bank will be forced to keep rates low and printing money regardless of the inflation rate. They’ve lost control.

    1. Anonymous says:

      Hi Ian

      I have thought for a while that central bankers were trapping themselves into a situation which required ever lower interest-rates. None of the major central banks has broken that cycle yet….

  7. Noo 2 Economics says:

    Hi Shaun,

    “If we returned to elected politicians being in charge of monetary policy right now, what do you think would change if anything?”

    If you consider the answer to that question to be “nothing” then doesn’t that negate your calls for democratically elected BOE officials?

    On a more rambling set of gripes:

    “there was little indication of inflationary pressures building”. Hrrrmph! My model already shows inflationary pressure building, resulting in 2.5% -3% CPI by year end. The only thing now that can derail my prediction is an ever strengthening GBP.

    “Moreover, there were early signs that global growth was weakening,” Yes there were signs that I saw in November/December last year!! My model now shows global
    growth either flat lining or marginally strengthening from September onwards but certainly not weakening!!

    “uncertainty about the degree of slack had risen on the month”. I have no uncertainty at all – there isn’t any, but wages are held low because jobs are quickly outsourced overseas if workers in England won’t accept low pay. Of course this does not apply to high skill jobs where I expect wage levels to continue increasing as there is a distinct shortage of skilled labour in the UK.

    Shaun, are you sure these aren’t the minutes from the early part of this year? If not how do they keep their jobs?

    1. Anonymous says:

      Hi Noo2

      I do not think so as elected Bank of England officials would stand on a specific platform rather than the general one of MPs currently. There would be an opportunity for dissenters to stand and present different arguments.

      As to your view on wage pressure I spoke to someone who works in recruitment in the construction industry earlier and he agrees with your version of what is happening to wages.

      I am afraid that they are the minutes from July 2014….

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