By Tony Yates
The Bank of England’s monetary policy committee decided not to cut interest rates, despite most forecasting said that it would. However, there was an innovation in monetary policy communication. Although it would not cut rates today, the minutes revealed that most MPC members expected to vote for more stimulus at their August meeting. This was a very clear departure from the old practice, under the previous governor, of, as Mervyn King used to put it “playing one ball at a time”. This part of the decision is welcome. Many both inside and outside the Bank of England have been explaining the benefits of this kind of forward communication. If a committee has a sense of what it intends to do in the future, it should communicate that as clearly as it can to those who are affected by its decisions. Policymakers that I spoke to usually objected to this logic on the grounds that it was too difficult for the committee to vote formally on an interest rate path. Additionally, there was a danger of a forecast being taken as a promise, and therefore of the committee suffering reputational damage when it did not keep the apparent promise. To some extent, these difficulties seem to have been swept aside by this little detail of the July 2016 minutes.
Monetary policy works not just via current rates but via expectations of future rates.
However, the July decision by the majority (one dissented) begs the question: if the committee thought it would loosen at its next meeting, why not loosen now? The reasoning seems to have been the following: although the committee recognised that monetary policy was too tight, it did not know exactly how much loosening was needed, and it would not know with enough precision until the staff had gone through the process of compiling the August inflation report forecast. There was, therefore, a possibility that the committee might loosen now, and then have to loosen by more in August, or even undo some of the loosening. The majority must have judged that the risk of looking incompetent by tinkering with the instruments each month in this way outweighed the benefits of moving promptly.
The dissenter, Jan Vlieghe, took what I interpret to be a more nuanced view. The logic may have been something like this. It was clear that interest rates would have to be cut down to a new lower floor, and more easing would need to be imparted by asset purchases. It was highly unlikely that a 25 basis point cut to rates would need to be reversed. Even if this were so, it is pretty costless to reverse interest rate changes. Zigzagging asset purchases could be much more costly and make a mess of debt management.
Why the others could not go along with this is not clear. Perhaps the others don’t agree that the new floor is 25 basis points. If the new floor was judged to be zero, then cutting that far in advance of an inflation forecast would raise the chance of having to reverse courseperhaps they think that the shock and awe effect would be diminished by imparting stimulus with one tool in one month, and another tool in another month.
Today, text of a 30th of June speech by Andrew Haldane was released, in which he calls for a “prompt” and “muscular” loosening. For my money, the loosening won’t be as prompt as it could have been. Although I can see the logic of waiting, I’m sceptical that much will be got by way of precision about exactly how much loosening will be needed from doing another inflation forecast. And it remains to be seen whether, however much unconventional monetary policy is undertaken, this is effective enough to amount to something that could be described as ‘muscular’.
Tony Yates is the professor of Economics at the University of Birmingham and teaches International Macro.