For most of the last 20 years, central banking was increasingly a soloist affair: one instrument (interest rates), one target (inflation). Since that didn’t prevent a series of asset price bubbles and gigantic leverage nearly destroying the world economy, fashions have shifted to employing a veritable orchestra of instruments including a “macroprudential controls” section – capital requirements, collateral rules, dynamic loan loss provisioning and so forth. The IMF released a paper today which confirms the intellectual shift.
All very well, but putting this new approach into operation is going to be highly complex, not least because of the potential for normal monetary policy and the new macroprudential roles to get mixed up – one of the reasons that monetary policy and financial supervision were separated in the first place. Central banks are going to have to learn how to be independent of themselves.
Sir Alan Budd, interim chairman of the Office for Budget Responsibility, was on the money this morning in highlighting what a difficult job his successor faces. He said:
“No one in their right mind would take on a job in which your success is judged by your success in fiscal forecasts”.
The OBR is not alone in this plight. Members of the Monetary Policy Committee take interest rate decisions which are predicated on the Bank of England’s forecasts. But in having a decision as well as a forecast, the MPC is always able to claim that it took the right decision based on the information available at the time, which takes the focus away from its often poor forecasts.
So much for the communication surrounding errors. The origination of forecast errors is more important. And the OBR’s greater, though far from perfect, transparency shows that its Budget forecast hinges on very thin and quite weird stuff. Read more
An interesting research paper from the Federal Reserve staff has drawn my attention to a speech Fed deputy chair Don Kohn made last October about why the Fed has not promised to keep rates low enough for long enough to allow a bit of inflation in the future (such as by setting a price level target).
To be sure, we have not followed the theoretical prescription of promising to keep rates low enough for long enough to create a period of above-normal inflation. The arguments in favor of such a policy hinge on a clear understanding on the part of the public that the central bank will tolerate increased inflation only temporarily–say, for a few years once the economy has recovered–before returning to the original inflation target in the long term. In standard theoretical model environments, long-run inflation expectations are perfectly anchored. In reality, however, the anchoring of inflation expectations has been a hard-won achievement of monetary policy over the past few decades, and we should not take this stability for granted. Models are by their nature only a stylized representation of reality, and a policy of achieving “temporarily” higher inflation over the medium term would run the risk of altering inflation expectations beyond the horizon that is desirable. Were that to happen, the costs of bringing expectations back to their current anchored state might be quite high. Read more
As expected, the Bank of Canada has just raised its overnight lending rate to 0.75 per cent, its bank rate to 1 per cent and its deposit rate to 0.5 per cent. Growth forecasts were reduced, however, and the bank now expects the economy to return to full capacity at the end of 2011, two quarters later than anticipated in April:
“The Bank expects the economic recovery in Canada to be more gradual than it had projected in its April MPR, with growth of 3.5 per cent in 2010, 2.9 per cent in 2011, and 2.2 per cent in 2012. This revision reflects a slightly weaker profile for global economic growth and more modest consumption growth in Canada. The Bank anticipates that business investment and net exports will make a relatively larger contribution to growth.” Read more
Inflation data, due out next week, will steer the next interest rate decision from the Reserve Bank of Australia, minutes show. “The important question for the Board at its next meeting would be whether the new [price] information materially changed the medium-term outlook for inflation,” reads the statement. “Pending this information, the Board judged it appropriate to hold the cash rate unchanged.”
International concerns continue to offset a pretty healthy domestic picture, the minutes show. Policymakers welcomed a moderation in the Asian recovery, but were watching closely to see the scale and speed of the slowdown. And the board discussed at length the issues in Europe, noting that “the coming month would see important announcements about the health of the European banking sector, which had the potential to have a significant impact on financial markets and global confidence.” Read more