Central Banks have a big problem with the future

by Shaun Richards

A feature of 2019 so far has been a succession of U-Turns by central banks and by two of the world’s major central banks in particular. This has been most marked at the US Federal Reserve where it was not so long ago that some were suggesting we would see four interest-rate increases ( of 0.25%) this year on the road to what was called normalisation. Regular readers will recall that we were one of the few places that were troubled by the fact that we simply do not know what and where normal is anymore. But for our purposes today the main issue is that the US Federal Reserve looks set to cut later this month and perhaps one more time in 2019. Should that scenario come to pass then the previous concensus will have been wrong by a net 6 interest-rate changes. Seeing as interest-rates are so low these days that is quite an achievement.

This is on my mind because if we take the advice of Kylie Minogue and step back in time just under 7 years central banks were heavily influenced by this from Micheal Woodford and Jackson Hole.

The first of these is forward guidance — explicit statements by a central bank about the outlook for future policy, in addition to its announcements about the immediate policy actions that it is undertaking.

This was always going to be adopted as it flattered central banking egos and provided an alternative at a time when central bankers were afraid of being “maxxed out”. But as my opening paragraph pointed out it has been a complete failure in recent times in the United States where it began.

Europe

This has been something of a two stage failure process for Forward Guidance. The opening part got some intellectual backing last September from Benoit Coeure of the ECB.

Communicating our expectation that the ECB key interest rates would remain at their present levels at least through the summer of 2019 was therefore consistent with the “risk management” approach to monetary policy that the Governing Council has repeatedly applied in recent years,

This had two steps as it was perceived like this.

Yet, on my next slide you can see that, at some point in early 2018, markets expected the ECB to hike its deposit facility rate one month after the expected end of net asset purchases.

So that was a bit of a fail and it continued long after this speech. It was something I found hard to believe but the idea that the ECB would raise interest-rates in 2019 was like these lyrics from Hotel California.

And in the master’s chambers
They gathered for the feast
They stab it with their steely knives
But they just can’t kill the beast.

It seemed to exist in an evidence-free zone but somehow survived. But events recently took a dreadful turn for it and by implication ECB Forward Guidance.

In the absence of improvement, such that the sustained return of inflation to our aim is threatened, additional stimulus will be required……..This applies to all instruments of our monetary policy stance. Further cuts in policy interest rates and mitigating measures to contain any side effects remain part of our tools.

So the interest-rate rises had not only morphed into unchanged but now we were being forward guided to a cut. Could that be any worse? Apparently it can as the incoming ECB President switches to downplaying the size of the interest-rate cuts on the horizon.

*IMF SAYS THERE MAY ONLY BE LIMITED ROOM FOR ECB RATE CUTS ( @lemasabachthani )

But apparently forward guidance is another beast that our steely knives cannot kill.

We remain able to enhance our forward guidance by adjusting its bias and its conditionality to account for variations in the adjustment path of inflation.

Bank of England

Gertjan Vlieghe has given a speech on this subject and he is in the mood for change and I do not blame him but sadly it does not start well.

In particular, communicating more about the Monetary Policy Committee’s preferred future path of interest rates
would be easier to understand than our current approach.

Preferred? I would prefer England to win the cricket world cup final on Sunday but a balanced reality involves looking at the strengths of New Zealand. Also it is not often central bankers do humour and when they do it is mostly unintentional.

Global central banks have changed their outlook for policy significantly in recent months.

He has a go at placing a smokescreen over events as well.

and the UK outlook for monetary policy continues to be materially affected by Brexit uncertainty.

This is misleading in my view mostly because none of us know what will happen so we cannot allow for it. Even if you think there is an effect right now then it is too late to do anything about it because an interest-rate move takes around 18 months to fully impact.

It feels for a while that we are getting some honesty.

Before diving into the details of the argument I want to stress that a far bigger challenge to monetary policy is
that the future is uncertain, and my suggested communications improvement will not change that. Today’s
preferred path of interest rates will change tomorrow, if the economy turns out differently from what we
expected.

But sadly as so often with Gertjan he drops the ball at the crucial point.

But I am arguing that we can achieve a modest improvement in the understanding that
businesses, households and financial markets have of what our objectives are, and what we think we need
to do to meet those objectives.

Most people only vaguely know who they are at best, so they idea they will be hanging on their every word is laughable. Financial markets do, of course, but how much of the real economy gets missed out?

The next bit reminds me of this from Queen.

Is this the real life?
Is this just fantasy?

Here is Gertjan pedalling hard.

Moreover, the Swedish central bank reported that the quality of its own internal deliberations and discussions
with staff had improved, and that discussion of monetary policy by external observers had become “less
speculative”

Meanwhile if we go back to real life.

The Riksbank has become pretty much a laughing-stock.

Comment

As you can see Forward Guidance has been one of the failures of our times. On an internal level down keeps being the new up but also it is part of a framework where the environment keeps getting worse. What I mean by that is after all the policy accommodation economic growth now has a “speed limit” of 1.5% and 2019 is proving to be a difficult year for the world economy. It flatters central banking egos, gives markets a hare to chase and journalists something to copy and paste, but not so much for the real economy.

The piece de resistance to all this is provided by Gertjan who you may recall has been Forward Guiding us to interest-rate increases for a while now. He has another go.

This would justify further limited and gradual rate increases, such that we might reach 1.00% in a year’s time,
1.25% in two years’ time, and 1.75% in three years’ time, with large uncertainty bands around this central
path.

You may notice the use of the word “might” here. Whereas he seems a lot more sure about this road.

On balance I think it is more likely that I would move to cut Bank Rate towards the effective lower bound of close to 0% in the event of a no deal scenario.

Just for clarity the Bank of England now thinks this is at 0.1% after assuring us for quite a long period ( Governor Carney repeated it more than once) that it was 0.5%.

So if we just look at Gertjan’s career at the Bank of England he looks ro be pointing us towards a situation where he has twice “Forward Guided” us to interest-rate increases and then cut them! I await your thoughts on how useful you think he will have been in such a scenario?

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