all bound up? monetary policy in recovery and beyond

All bound up?Monetary policy in recovery and beyond

Angus Armstrong, NIESRKate Barker, economist and former MPC member

Martin Wolf, Chief Economics Commentator at the FTPhilip Aldrick, Economics Editor at the Times

Matt Whittaker, Resolution Foundation

#zerobounds / @resfoundation

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Renewed InterestThe role of monetary policy in crisis and

beyond

Matt Whittaker

January 2016

@mattwhittakerRF

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MONETARY POLICY ENTERED NEW TERRITORY

POST-CRISIS

The 2008-09 cuts were not startling in their depth, but in their destination: ZLB

The base rate was cut by

4.5ppts between Oct

08 and Mar 09, broadly in line

with the average

loosening cycle post 1970 of

5ppts

But the move took the base

rate to its lowest ever level (since

1699), with the MPC

concluding that it couldn’t go

lower

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To provide further stimulus the MPC introduced QE, a policy not much discussed before 2008

Number of speeches mentioning QE or related issues 1997-2007?

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One (and that related to Japan)

Zero

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WE MAY BE CLOSER TO THE

NEXT DOWNTURN THAN WE ARE TO

THE LAST

Looking back over 300 years, we’re almost certain to face at least one recession a decade

Probability curves use the

frequency of recessions

during different historic periods to establish the random chance

of a recession occurring in a

single-year horizon, and

then roll those probabilities

forward over a 10-year horizon

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Post-war, the probability is a little lower, but still high over a 10-year horizon








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Post-globalisation, there’s an 84% probability within 10 years








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Post-globalisation, there’s an 84% probability within 10 years








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Market expectations imply a very gradual rise in base rate over this period

OIS rates are instruments

that settle on overnight

unsecured interest rates

and are the basis of the

five-year conditioning

path used by the Bank of

England in its Inflation

Report

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Pointing to a 2/3 chance of entering the next recession with a base rate of just 1.6%

This is no more than an illustration –

outcomes could look somewhat

different

But it highlights the relatively high

likelihood of re-

encountering the zero lower

bound in the coming years

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LOWER HEADROOM AND

THE EFFECTIVENESS

OF POLICY

The monetary transmission mechanism operates through a number of channels

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The monetary transmission mechanism operates through a number of channels

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We focus on one element of this – mortgage repayments

The 4.5ppt cut of 2008-09 helped to reduce aggregate mortgage payments by £24bn

This reflects not what actually

happened to aggregate

repayments, but what the

specific impact of rate changes

was

Actual payments were

affected by changes in the overall volume

of borrowing and the arrival

of new borrowers16

Though it also generated ‘losses’ for savers: £11bn on sight deposits alone

As with the mortgage

example, this reflects not

what actually happened, but

the isolated impact of rate

changes

Inclusion of time deposits

would significantly

increase these ‘losses’, but we

also ignore other loans

such as credit cards and overdrafts

17

In hypothetical recession of 2021 with base rate at 1.6%, mortgage ‘gains’ are cut significantly

In the 2021 scenario, total

mortgage debt is assumed to

have increased to £1.6tn and

mortgage rates have increased

by 0.6ppts

This doesn’t mean the

overall impact of conventional policy is cut by

one-third, but it gives a sense

of scale

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In hypothetical recession of 2021 with base rate at 1.6%, mortgage ‘gains’ are cut significantly

In the 2021 scenario, total

mortgage debt is assumed to

have increased to £1.6tn and

mortgage rates have increased

by 0.6ppts

This doesn’t mean the

overall impact of conventional policy is cut by

one-third, but it gives a sense

of scale

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IF NOT NOW, SOON

The zero lower bound is likely to loom more regularly in a world of secular decline in rates

Real ‘world’ interest rates

have been declining for some time –

well before the financial crisis –

driven by slow moving

demographics and secular savings and investment preferences

While some forces might

slow in the coming years,

there is little prospect of rates rising

rapidly

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LIVING WITH LOWER RATES

By their nature, many of the alternatives are unconventional and uncomfortable

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More QE• Probably helped in 2009, but questions over its longer-

term efficacyNegative interest rates• Already in place in parts of Europe, but raises exchange

rate concerns

Higher inflation targets• Supports higher equilibrium rates, but we’re struggling to

reach 2%More active fiscal policy• Mon/fisc balance affects efficiency and distributional

outcomesStructural reform• Strategies for growth and investment might tackle

structural decline of rates at source

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Renewed InterestThe role of monetary policy in crisis and

beyond

Matt Whittaker

January 2016

@mattwhittakerRF

National Institute of Economic and Social Research

Comments on ‘Renewed Interest’ by Matthew Whittaker

Dr Angus Armstrong, NIESR

Resolution Foundation, 28th January, 2016


Section 6: Policy optionsMW raises an important ‘contingency policy’ question

Changes to the Inflation Target?

•Inflation targeting is the latest in a long list of monetary regimes, E.g., Bretton Woods, Monetary Targeting

•What drives national inflation rates? For OECD countries around 70% seems to be common factors (ECB, 2005)*

Do inflation expectations really drive demand and inflation, or is it the other way around?

* Governor Carney ‘s speech to Jackson Hole (2015) reports lower correlations (based on a 47 country dataset) implying national central banks continue to determine the inflation rate.


Section 6: Policy optionsNegative interest rates?

•If the ‘market clearing’ real interest rate is substantively negative, then the ZLB becomes a limit on delivering this

•Two modern contenders for negative rates:oGet rid of cash and impose negative rate on central

bank reserves (Buiter, 2004)oIntroduce an exchange rate between paper money

and central bank reserves (Eisler, 1932 and Kimball, 2015)

Are we repeating the mistake of ignoring banking sector? Banks not be forced to raise lending rates (to protect profit margins)


Section 6: Policy optionsEven more unconventional monetary policies?

•More Quantitative Easing?oKeynes (1933) “trying to get fat by buying a larger

belt”oProbably had a positive influence through long rates

•Monetary financingo Coordinated buying of Govt debt directly with no

commitment to reverse purchases

•Helicopter dropsoDirectly supplying money to private sector


Section 6: Policy optionsWhat might happen / where are the risks?

•US probably less risk to fiscal policy or even monetary financing because of universal use of dollar

oIf there are credit doubts, Fed can issue dollars and the exchange rate can depreciate

•For other nations this is more difficult because international banks borrow in dollars – large depreciation may be a problem

oUK has fiscal space and banking system does not seem exposed to weaker sterling

•Elsewhere, is the answer to stop becoming so dependent on dollars? Will we see more capital controls?

all bound up? monetary policy in recovery and beyond

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