Mervyn King, former Governor of the Bank of England. Photo by Oli Scarff.
While the ECB print money, was ex-Governor Lord King calling for fiscal stimulus in the UK?
On Monday evening at the London School of Economics, Lord King, former Governor of the Bank of England, and Sir Alan Budd, former chief economist at HM Treasury and a founder member of the Monetary Policy Committee, had ‘a conversation about central banking’ with Professor Charles Goodhart in the chair. I am struck that it does not seem to have been reported in the press, but the conversation is of great interest and is available on a podcast.
A lot of fascinating ground was covered, with choice remarks on uncertainty, cost-benefit analysis (for Lord King, mostly ‘not worth the paper they are written on’), the teaching of academic economics in general (from 67:45 minutes) and New-Keynesian economics in particular (69:50 – I report this at the end of this post as of some importance to those interested in the theory).
But from the contemporary perspective, Lord King’s remarks on deflation and policy going forward were of most interest and surely were newsworthy. I report these verbatim (88:35).
At what level does deflation become a worry in developing countries for central banks and in the UK especially. What tools are left given interest rates are so low?
(Respect here to the questioner from Warwick University (Tass?) who tried to point to the fiscal elephant in the monetary room.)
I don’t think we should define the problem as one of deflation; it is a serious problem of weakness in demand. I think we should worry about that.
The question I’d put back to you is that we had the biggest monetary stimulus the world must have ever seen, and we still have not solved the problem of weak demand.
So the idea that monetary stimulus, after six years, just a little bit more, is the answer, does not seem to me [sensible?]. That does not say the right thing to do is put up interest rates today, where I would part company with the BIS [Bank for International Settlements] point of view. But it suggests the problem does require a much wider set of responses than merely ones in the monetary field.
But in the nineteenth century we saw periods when there was deflation overall that did not stop a growing economy.
The real problem in a way is after the great successes in monetary policy over the 1990s and early 2000s, everyone felt that every aspect of economic behaviour, certainly at the macroeconomic level, must therefore be the result of central bank action, instead of looking at the real equilibrium of the economy. And I think it’s time now to lift one’s eyes above the horizon and actually start looking at the wider factors that are determining the real path of output and demand. And look at those to see why demand is so weak.
Now I want to be very cautious about reading between the lines here, but these remarks seem profoundly important in the light of the present debate. Yesterday’s MPC minutes erred heavily on the ‘good-deflation’ side, with emphasis on the oil shock as primary cause and on the potential boost to global and UK growth, and the implication that UK demand is buoyant. (Though of course fragilities on the demand side could not be entirely absent, with the notable observation in paragraph 28 that with 40 per cent of pay settlements to be agreed in April when CPI inflation was likely to be around zero, “… there was a risk that any pickup in pay growth might be delayed” . )
Lord King instead was categorical about ‘a serious weakness in demand’.
This counters too the claims of Axel Weber, ex-Governor / President of the Bundesbank (Germany’s central bank), who is busy warning euro area quantitative easing may not work because there has been a failure to repair structural (i.e. supply-side) factors in the weaker euro area countries (i.e. the tired formula of blaming the victims of austerity).
The Treasury’s ‘good deflation’ narrative is almost inevitable, given to concede ‘bad deflation’ would be to concede weaknesses to the economy that is so central to the Tory economic strategy. (Though it is not so clear why the line is so unequivocally parroted by the vast majority of the media.) Moreover any such weakness then makes a live issue of expansionary fiscal policy, rather than the election narrative of austerity and cuts. Now I stress that Lord King did not quite go there (and sadly the chair did not give me the opportunity to ask my own question of clarification), but it’s hard to see, from both a theoretical and practical view, how ‘wider action’ would not involve expansionary fiscal policy.
Lord King’s is a weighty voice of experience: it surely merits attention.
… as do Lord King’s remarks on economic theory. While the jargon here will be off-putting, the sense of what he is saying is pretty straightforward.
The below is again a verbatim report of comments made on the theme of academic economics. They are not entirely straightforward, and I have not made any effort to edit. But in this case I think it is clear that Lord King is dismissing the relevance to current policy debate of the New-Keynesian model, and moreover rejects attempts by New-Keynesians to repair their model by adding in financial fractions. In English: the main model on which Bank of England (and Office for Budgetary responsibility, and probably all other central bank) decisions and forecasts are based is irreparably broken, and regarded as irrelevant to the problems of the world. Lord King points out that other models are used, but, on my understanding, none of these have the status or central position in the theory of monetary policy as presently conducted as the New Keynesian one. It is of some importance that the case for austerity is based on the same models.
At face value, we are canoeing down a certain creek (no demand), without a paddle (no theory). But there are other, better paddles (not least, Keynes). Anyway, over to Lord King:
What I worry about some of the macroeconomic literature is that some of the models that were crafted to help us understand about time inconsistency and about incentives and about the case for independence of central banks. A world in which output does literally follow along a simple path with a few random shocks on either side. There’s only one good in the world, and this is the nature of the model that has been used to draw conclusions about policy, how monetary policy should respond to the sort of challenges we face now. Now I don’t think it’s a criticism of the model to say that the model is not relevant to these problems and I think it is in large part.
And I think again there has been in macroeconomics a temptation to think there is a single model, a variant of the New-Keynesian model, which encapsulates all our wisdom and should be used to discuss every macroeconomic problem. And I think that is something we should learn is not the case. It’s not helped by thinking as well all we have to do is get little financial friction into the system, change a first order condition, and that’s the bit that’s missing, if only we had that friction in the model then we would have understood what would have happened to the crisis. I don’t think it’s like that.