Forward guidance in the UK
Spencer Dale, James Talbot 13 September 2013
The Bank of England’s Monetary Policy Committee has recently provided some explicit forward guidance regarding the future conduct of monetary policy in the UK. This column by the Bank's Chief economist explains how the MPC designed its forward guidance to respond to the unprecedented challenges facing the UK economy and argues that forward guidance allows the MPC to explore the scope for economic expansion without putting price and financial stability at risk.
At its meeting on 1 August 2013, the Monetary Policy Committee (MPC) agreed to provide state-contingent forward guidance concerning the future conduct of monetary policy. The aim was to provide more information to help financial markets, households and businesses understand the conditions under which the current stance of monetary policy would be maintained.
monetary policy, Central Banks, Bank of England, forward guidance
Influencing household inflation expectations
Alberto Cavallo, Guillermo Crucas, Ricardo Perez-Truglia 10 November 2014
Although central banks have a natural desire to influence household inflation expectations, there is no consensus on how these expectations are formed or the best ways to influence them. This column presents evidence from a series of survey experiments conducted in a low-inflation context (the US) and a high-inflation context (Argentina). The authors find that dispersion in household expectations can be explained by the cost of acquiring and interpreting inflation statistics, and by the use of inaccurate memories about price changes of specific products. They also provide recommendations for central bank communication strategies.
Expectations about macroeconomic variables play an important role in economic theory and policymaking. Household inflation expectations, in particular, are key to understand consumption and investment decisions, and ultimately, the impact of monetary policies. Although central banks have a natural desire to influence expectations, there is no consensus on how household expectations are formed or what the best way to affect them is (see Bernanke 2007, Bachmann et al. 2012, Coibion and Gorodnichenko 2013, and Armantier et al. 2014).
expectations, beliefs, inflation, inflation expectations, monetary policy, US, Argentina, central bank communication, rational inattention, costly information, learning
How severe has the zero lower bound constraint been?
Eric T Swanson 08 November 2014
In December 2008, the Fed lowered the federal funds rate to essentially zero and has kept it there since then. This column argues that, contrary to traditional macroeconomic thinking, monetary policy has not been severely constrained by the zero bound until mid-2011. The results imply that the Fed could have done more to ease monetary policy between 2009 and 2011. These findings could also help explain why the fiscal stimulus package adopted in 2009 did not bring the expected success.
In December 2008, the Federal Reserve’s Federal Open Market Committee lowered the federal funds rate to essentially zero, and has kept it there ever since. Because physical currency earns an interest rate of zero, it is generally impossible for the Open Market Committee to lower the federal funds rate substantially below zero, since banks would opt to hold physical currency rather than earn a significantly negative rate of return on cash balances held at the Fed. This barrier is commonly referred to as the ‘zero lower bound’.
Global crisis Monetary policy
zero lower bound, monetary policy, Federal Open Market Committee
How to climb a mountain with both hands tied
Jean Pisani-Ferry 07 November 2014
A triple-dip recession in the Eurozone is now a distinct possibility. This column argues that additional monetary stimulus is unlikely to be effective, that the scope for further fiscal stimulus is limited, and that some structural reforms may actually hurt growth in the short run by adding to disinflationary pressures in a liquidity trap. The author advocates using tax incentives and tighter regulations to encourage firms to replace environmentally inefficient capital.
Against the background of lacklustre global demand, economic growth in Europe has weakened again. In the Eurozone, a third recession in less than seven years is a distinct possibility. Yet economic policy looks powerless. On the monetary side, although the ECB may still embark on a genuine programme of quantitative easing, such action is unlikely to deliver a major boost because the benchmark 10-year government bonds already yield just 1%.
Environment EU policies Macroeconomic policy Microeconomic regulation
Europe, eurozone, recession, stimulus, monetary policy, quantitative easing, fiscal policy, structural reforms, labour market reforms, liquidity trap, investment, Cash for clunkers, scrapping subsidies, environment, regulation, emissions standards
Policy uncertainty spillovers to emerging markets: Evidence from capital flows
Dennis Reinhardt, Cameron McLoughlin, Ludovic Gauvin 05 November 2014
In the aftermath of the Global Crisis, policymakers and academics alike discussed how uncertainty surrounding macroeconomic policymaking has impacted domestic investment. At the same time, concerns regarding the spillover impact of monetary policy in advanced economies on emerging market economies featured strongly in the international policy debate. This column draws the two debates together, and examines how policy uncertainty in advanced economies has spilled over to emerging markets via portfolio capital flows. It finds remarkable differences in the spillover effects of EU vs. US policy uncertainty.
In the wake of the global financial crisis of 2007–2008, advanced economies experienced heightened levels of uncertainty in macroeconomic policymaking. Against this backdrop, policymakers debated the domestic and global spillover implications of advanced-country policy uncertainty (e.g. IMF 2013). At the same time, the potential for monetary policy settings in advanced countries to spill over to emerging market economies (EMEs) via capital flows was hotly contested in both academic and policymaker circles (e.g. Fratzscher et al. 2013).
International finance Macroeconomic policy Monetary policy
capital flows, Capital inflows, emerging markets, policy uncertainty, spillovers, global crisis, monetary policy, macroeconomic policy, risk aversion, home bias
US rate hike fears are unwarranted
Mickey Levy 03 November 2014
The Fed is stretching out its zero interest-rate policy waiting for labour market improvements. As unemployment fell the emphasis shifted to wages, which are an even more problematic measure of economic conditions. Basing monetary policy on a notoriously long cyclical laggard is prone to policy mistakes. This column argues that moving up rate hikes would be wise and prudent.
How often have we heard the phrase “If the Fed hikes rates too early, the economic recovery will be derailed”? It is ingrained in the Fed’s mindset and statements like it appear frequently in the media. Yet the history of Fed rate hikes during previous economic expansions suggests that such fears are unwarranted, and the current 5½-year-old expansion is on sound footing and would fare just fine, and would even be enhanced, if the Fed began hiking rates. Normalising interest rates should be welcomed, not feared, by the Fed.
monetary policy, interest rate hikes, forward guidance
Monetary policy and long-term trends
Charles A.E. Goodhart, Philipp Erfurth 03 November 2014
There has been a long-term downward trend in labour’s share of national income, depressing both demand and inflation, and thus prompting ever more expansionary monetary policies. This column argues that, while understandable in a short-term business cycle context, this has exacerbated longer-term trends, increasing inequality and financial distortions. Perhaps the most fundamental problem has been over-reliance on debt finance. The authors propose policies to raise the share of equity finance in housing markets; such reforms could be extended to other sectors of the economy.
There has been a long-term downward trend in the share and strength of labour in national income, which is depressing both demand and inflation. This has prompted ever more expansionary monetary policies. While understandable, indeed appropriate, within a short-term business cycle context, this has exacerbated longer-term trends, increasing inequality and financial distortions. Perhaps the most fundamental problem has been over-reliance on debt finance (leverage).
Financial markets Macroeconomic policy Monetary policy
monetary policy, Inequality, debt, leverage, wages, labour share, globalisation, consumption, propensity to consume, fiscal policy, Ageing, interest rates, investment, asset prices, housing, house prices, exchange rates, global crisis, mortgages, sub-prime crisis, Macroprudential policy, structural reforms, balance sheets, deleveraging, equity, shared-equity mortgages, Help to Buy
The impact of the maturity of US government debt on forward rates and the term premium: New results from old data
Jagjit Chadha 02 November 2014
The impact of the stock and maturity of government debt on longer-term bond yields matters for monetary policy. This column assesses the magnitude and relative importance of overall bond supply and maturity effects on longer-term US Treasury interest rates using data from 1976 to 2008. Both factors have a significant impact on both forwards and term premia, but maturity of public debt appears to matter more. The results have implications for exit from unconventional policies, and also for the links between monetary and fiscal policy and debt management.
Revisiting the supply effect
The question of the impact of the stock and maturity of net government debt on longer-term US Treasury yields, and the potential implications for central bank balance sheet policies, matters for monetary policy.
Financial markets Macroeconomic policy Monetary policy
public debt, yield curve, debt maturity, term premia, interest rates, open market operations, monetary policy, QE, US, Federal Reserve, market segmentation, Greenspan Conundrum, debt management, fiscal policy, unconventional monetary policy
“Mensch tracht, und Gott lacht” – what’s the best guidance on monetary policy?
David Miles 22 October 2014
Many central banks embrace forward guidance by announcing expected interest rate paths. But how likely it is that actual rates will be close to expected ones? This column argues that quantifying such uncertainty poses great difficulties. Precise probability statements in a world of uncertainty (not just risk) can be misleading. It might be better to rely on qualitative guidance such as: “Interest rate rises will probably be gradual and likely to be to a level below the old normal”.
“Mensch tracht, und Gott lacht” is a Yiddish proverb – men plan and God laughs. Woody Allen puts the same thought this way: “If you want to make God laugh tell him about your plans”. Some people might see these words as a fitting epitaph for forward guidance on monetary policy. The Bank of England has certainly faced a good deal of criticism for the guidance that it has recently been giving, as has the Federal Reserve in the US.
forward guidance, unconventional monetary policy, monetary policy, Central Banks, central bank communication, interest rates, uncertainty
The halo of victory: What Americans learned from World War I
Hugh Rockoff 04 October 2014
World War I profoundly altered the structure of the US economy and its role in the world economy. However, this column argues that the US learnt the wrong lessons from the war, partly because a halo of victory surrounded wartime policies and personalities. The methods used for dealing with shortages during the war were simply inappropriate for dealing with the Great Depression, and American isolationism in the 1930s had devastating consequences for world peace.
World War I had important consequences for the structure of the US economy and its role in the world economy. This was especially true in the world of finance. The US transitioned from being a debtor nation to a creditor nation, and financial leadership moved from London to New York. But equally important were the lessons that Americans drew from the war. Although the war had much to teach, Americans tended, I will argue below, to learn too much from the war, drawing strong conclusions from a war in which the US was actively engaged for only 19 months.
Competition policy Economic history
World War I, WWI, planning, rationing, New Deal, Great Depression, fiscal policy, monetary policy, stimulus, financial crisis, conscription, inflation, unemployment, price controls, Competition policy, antitrust, National Industrial Recovery Act