Pricing in Carney

Here is a paper I did with my colleague Anders Vestergård Fischer on the Bank of England and what to expect from the new BoE governor Mark Carney – obviously with a special focus on NGDP level targeting.

Our conclusion is that the markets are not in any way priced for NGDP targeting in the UK yet.

Don’t ever tell me again that monetary policy does not work! Chuck Norris visits Japan

I continue to be completely puzzled that somebody would think that central banks somehow have run out of ammunition and that monetary policy is impotent. The developments in the global financial markets since August-September last year clearly tell you that monetary policy is extremely potent – also when interest rates are at the Zero Lower Bound.

Just take a look at this story from Japan today:

Japanese shares rose, with the Nikkei 225 Stock Average heading for the highest close since September 2008, as the yen fell after Bank of Japan Governor Masaaki Shirakawa said he will step down ahead of schedule.

…The Nikkei 225 gained 3 percent to 11,377.53 as of 12:38 p.m. in Tokyo, heading for the highest close since Sept. 29, 2008, two weeks after the collapse of Lehman Brothers Holdings Inc. Volume today was 48 percent above the 30-day average. The broader Topix Index advanced 2.8 percent to 966.03, with eight stocks rising for each that fell.

…The Topix has surged 34 percent since elections were announced on Nov. 14 on optimism a new government will push for aggressive stimulus. The gauge is trading at 1.14 times book value, compared with 2.1 for the Standard & Poor’s 500 Index and 1.45 for the Stoxx Europe 600 Index.

(Update: Nikkei is actually up 4%!)

And from another story:

The yen slid to its weakest level in almost three years against the dollar and euro on speculation Japan’s government will hasten the selection of a new central bank chief to take further steps to end deflation.

Japan’s currency added to yesterday’s biggest drop versus the euro in more than a week after Bank of Japan Governor Masaaki Shirakawa said he will step down on March 19, almost three weeks before his term is due to end. Demand for the 17- nation euro was supported on prospects the European Central Bank will refrain from easing monetary policy tomorrow. The Australian dollar slid after data showed the nation’s retail sales unexpectedly fell in December.

Financial markets are the best indicators of the monetary policy stance we have – a surging Japanese stock market and much weaker yen is a very strong indication that Japanese monetary conditions are getting decisively easier. Easier monetary conditions mean higher Japanese nominal GDP – just wait and see.

The market action in the Japanese markets this morning is yet another extremely clear demonstration of the Chuck Norris effect – that monetary policy does not only work through “printing money”, but also through expectations. As Scott Sumner likes to say – monetary policy works with long and variable leads. Said in another way a new Bank of Japan governor has not even been appointed but he is already easing monetary conditions in Japan as Mark Carney is in the UK.

And to all you Keynesian fiscalists out there I challenge you to find me one single example of “optimism” about “fiscal stimulus” having moved any major stock market by 4% in a day!

What we are seeing now in the US, Japan and likely soon in the UK is the kind of Rooseveltian Resolve that brought the US economy out of the Great Depression in 1933 after Roosevelt went off the gold standard and trust me – monetary policy does work! In the 1930s the “gold bloc” countries failed to understand that – today it is the ECB – but luckily for Europeans the US and Japan are leading the charge and is pulling us out of this crisis. That is what the global stock markets have been celebrating since August-September. It is really simple.

Chuck Norris and why Mark Carney is already easing UK monetary policy

These days we are getting a proper illustration of the Chuck Norris effect – that the central bank can ease monetary policy through sheer credibility without even printing more money. In fact in the case of Mark Carney he is now easing monetary policy in the UK even before he has become Bank of England governor. That is pretty impressive, but also good news for the UK economy. It is of course the expectation that Mark Carney as coming BoE governor will be in charge of introducing some form of NGDP level targeting.

This is from Bloomberg today:

“U.K. inflation expectations rose to the highest level in 21 months amid speculation Mark Carney will expand monetary policy and spur price rises when he takes over as Bank of England governor in July.

The so-called break-even rate increased for a fifth day before Carney testifies to U.K. lawmakers this week after telling the World Economic Forum’s annual meeting in Davos, Switzerland, last month that policy in developed countries isn’t “maxed out.” Ten-year bonds fell after an industry report showed U.K. services expanded in January, undermining demand for fixed-income assets. The pound weakened against the euro.”

Market expectations of inflation in my view are one of the best measures of changes in the monetary policy stance. When inflation expectations are inching up it is a very clear indication that monetary conditions are getting easier. That is what is happening in the UK at the moment.

Central banks essentially have two monetary policy instruments. First of all they can print money – increase the money base. Second they can guide expectations. The latter is often much more important and that is exactly what we are seeing in the UK markets these days.

Effectively Mark Carney is already in charge of UK monetary policy – the only thing he has to do is hint what he would like to see happen with UK monetary policy going forward.

Mr. Osborne: “There is a lot of innovative stuff happening around the world”

It is hard not getting just a bit excited about the discussions getting under way in the UK after the coming Bank of England governor Mark Carney basically has endorsed NGDP level targeting. So far the UK government has not given its view on the matter, but it is pretty clear that UK policy makers are aware of the issues. That is good news and today we got a “reply” from the UK government to Carney’s (near) endorsement of NGDP targeting in the form of comments from UK Chancellor George Osborne.

This is from the Daily Telegraph:

The Chancellor said he was “glad” that Mark Carney, the next Governor of the Bank, had raised the prospect of ending central banks’ inflation targets to concentrate more on gross domestic product.

Mr Osborne described the suggestion (NGDP level targeting) as “innovative” and said he was pleased Mr Carney was discussing such ideas.

“There is a debate about the future of monetary policy — not exclusively in the UK, but in many countries. There is a lot of innovative stuff happening around the world,” he said.

“There is a debate going on. I am glad that the future central bank governor of the UK is part of that debate.”

Asked if he was considering making the change suggested by Mr Carney, Mr Osborne said: “There is a debate going on. Any decisions, any future decisions are a matter for government.”

He added: “I have no plans to change the framework. There is a debate going on. I think it’s right there is a debate.”

Mr Osborne said he had had “lots of discussions” with Mr Carney about monetary policy before appointing the Canadian to the Bank of England. But he declined to confirm they had discussed the inflation target, sating the conversations were “private”.

Although he signalled he was open to changing the target, he said that the current inflation target has “served us well” and he would have to be persuaded to changing it.

…A similar debate about nominal GDP targets has been underway for some time, Mr Osborne noted, adding: “It would be a good thing for academia to lead the debate and government to follow.”

This is certainly uplifting. Osborne signals that he don’t necessarily think that NGDP level targeting is a bad idea (it is a great idea!). Obviously for those of us who think NGDP targeting is a great idea it is natural to cheer and scream on Mr. Osborne to get to work on changing the BoE’s mandate immediately. However, for once I will be cautious. I think it makes very good sense for Mr. Osborne to encourage discussion about this issue. Changing a countries monetary regime is an extremely serious matter. Yes, I strongly believe that an NGDP level targeting regime would be preferable to the UK compared to today’s regime, but I also think that the “institutional infrastructure” needs to be sorted out before completely changing the regime.

That said as far as I understand the legal framework (and I am certainly no specialist on this) the Chancellor actually can change the BoE’s mandate simply by sending a letter to the Bank of England governor. So with the stroke of his pen Mr. Osborne could make the  UK first country in the world that had an NGDP targeting regime. I would compare such a policy move to the decision in 1931 that took the UK of the gold standard. That saved the country from deflation and depression. Mr. Osborne could write himself in to the economic history books by showing the same kind of resolve as the UK government did in 1931.

Mr. Osborne deserves a lot of credit for encouraging debate

While I do not agree that the UK’s inflation targeting regime has “served the UK well” I would also say that the UK could have had much worse regimes – just think of monetary policy in the UK in the 1970s or the failed experiment with pegging the pound with with the ERM in the early 1990s.  The is no doubt that an inflation targeting regime is preferable to both alternatives – discretionary inflationary madness or a misaligned fixed exchange rate regime.

However, the inflation targeting regime in the UK likely added to fueling the UK housing bubble (sorry Scott – there was a UK housing bubble) and it has certainly made the crisis much deeper since 2008. An NGDP level targeting regime would have meant that UK monetary policy would have been tighter in the “boom year” just prior to 2008, but also easier over the past four years (but maybe with much less QE!). That would have led to more conservative fiscal policies, more prudent lending policies from the commercial banks and a small housing bubble prior to 2008 and most defiantly much stronger public finances and less unemployment after 2008. Who would seriously oppose such a monetary policy regime?

So I certainly think that an NGDP level targeting regime would have served the UK better than the inflation targeting regime. But Osborne is right – there need to be a debate about this and think the Mr. Osborne deserves a lot of credit for calling for such a debate instead of just declaring that nothing can ever be changed. That is wonderfully refreshing compared to the horrors of the (lack of) debate about monetary policy in Continental Europe (the euro zone…)

 

Mark Carney comes close to endorsing NGDP level targeting

Here is Mark Carney present governor of Bank of Canada and the next governor of Bank of England:

If yet further stimulus were required, the policy framework itself would likely have to be changed.19 For example, adopting a nominal GDP (NGDP)-level target could in many respects be more powerful than employing thresholds under flexible inflation targeting. This is because doing so would add “history dependence” to monetary policy. Under NGDP targeting, bygones are not bygones and the central bank is compelled to make up for past misses on the path of nominal GDP (Chart 4).

Bank of Canada research shows that, under normal circumstances, the gains from better exploiting the expectations channel through a history-dependent framework are likely to be modest, and may be further diluted if key conditions are not met.  Most notably, people must generally understand what the central bank is doing – an admittedly high bar.20

However, when policy rates are stuck at the zero lower bound, there could be a more favourable case for NGDP targeting. The exceptional nature of the situation, and the magnitude of the gaps involved, could make such a policy more credible and easier to understand.21

Of course, the benefits of such a regime change would have to be weighed carefully against the effectiveness of other unconventional monetary policy measures under the proven, flexible inflation-targeting framework.

I stole this from Nick Rowe. Thanks for the very good news Nick – it seems like Carney will try to move Bank of England in the right direction and there is no doubt that a number of Cabinet members in Cameron’s government has sympathy for NGDP targeting.

The Bank of England showed the way in 1931 – could it do it again in 2013? I certainly hope so – now we just need an official endorsement of NGDP level targeting from the UK government. George Osborne what are you waiting for?

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Scott Sumner also comments on the good news – as do Britmouse.

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