All bound up? Monetary policy in recovery and beyond

1. All bound up? Monetary policy in recovery and beyond AngusArmstrong, NIESR KateBarker,economistandformerMPCmember Martin Wolf, Chief Economics Commentator at the FT PhilipAldrick, Economics Editor at theTimes Matt Whittaker, Resolution Foundation #zerobounds / @resfoundation

2. Renewed Interest The role of monetary policy in crisis and beyond MattWhittaker January 2016 @mattwhittakerRF 2

3. 3 MONETARY POLICY ENTERED NEW TERRITORY POST-CRISIS

4. 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 4

5. 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? 5 One (and that related toJapan) Zero

6. 6 WE MAY BE CLOSER TO THE NEXT DOWNTURN THAN WE ARE TO THE LAST

7. 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 7

8. Post-war, the probability is a little lower, but still high over a 10-year horizon 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 8

9. Post-globalisation, there’s an 84% probability within 10 years 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 9

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

11. 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 11

12. 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 12

13. 13 LOWER HEADROOM AND THE EFFECTIVENESS OF POLICY

14. The monetary transmission mechanism operates through a number of channels 14

15. The monetary transmission mechanism operates through a number of channels 15 We focus on one element of this – mortgage repayments

16. 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 borrowers 16

17. 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

18. 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 18

19. 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 19

20. 20 IF NOT NOW, SOON

21. 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 21

22. 22 LIVING WITH LOWER RATES

23. By their nature, many of the alternatives are unconventional and uncomfortable 23 More QE • Probably helped in 2009, but questions over its longer-term efficacy Negative 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 outcomes Structural reform • Strategies for growth and investment might tackle structural decline of rates at source

24. Renewed Interest The role of monetary policy in crisis and beyond MattWhittaker January 2016 @mattwhittakerRF 24

26. National Institute of Economic and Social Research Comments on ‘Renewed Interest’ by Matthew Whittaker Dr Angus Armstrong, NIESR Resolution Foundation, 28th January, 2016

27. National Institute of Economic and Social Research Section 6: Policy options MW 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.

28. National Institute of Economic and Social Research Section 6: Policy options Negative 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: o Get rid of cash and impose negative rate on central bank reserves (Buiter, 2004) o Introduce 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)

29. National Institute of Economic and Social Research Section 6: Policy options Even more unconventional monetary policies? • More Quantitative Easing? o Keynes (1933) “trying to get fat by buying a larger belt” o Probably had a positive influence through long rates • Monetary financing o Coordinated buying of Govt debt directly with no commitment to reverse purchases • Helicopter drops o Directly supplying money to private sector

30. National Institute of Economic and Social Research Section 6: Policy options What might happen / where are the risks? • US probably less risk to fiscal policy or even monetary financing because of universal use of dollar o If 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 o UK 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

ResolutionFoundation

All bound up? Monetary policy in recovery and beyond