Insights from the inaugural Bank of England “Watchers’ Conference”
A new annual conference brings together leading academics, policymakers, and financial market practitioners to discuss and debate salient policy issues facing the Bank of England.
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These are tough times for central banks – none more so than the Bank of England. Over the past year, it has found itself caught in the crosshairs of both politicians and financial markets as it has grappled with a succession of crises, acute and chronic. From the highest inflation rates in a generation to September’s ‘LDI crisis’. Questions have been asked about the appropriateness of the Bank’s inflation targeting mandate to respond to the combined effects of the energy crisis, Covid-driven disruptions in supply chains and labour markets, and of course Brexit. It was with this inauspicious backdrop that we organised the first ever Bank of England Watchers’ Conference in November 2022. The event was co-sponsored by the Money Macro Finance Society and the Qatar Centre for Global Banking and Finance at King’s College London.
The purpose of the conference, which was inspired by the well-known ECB Watchers’ Conference and the US Monetary Policy Forum, was to bring together leading academics, policymakers, and financial market practitioners to discuss and debate salient policy issues facing the Bank of England at this juncture.
This will be an annual conference, and we welcome suggestions for topics to focus on in future years. These can be either monetary policy or financial stability in nature. We also welcome suggestions for commissioned research reports for presentation and discussion at the event.
For the inaugural conference, we were fortunate to have Sir Dave Ramsden (Deputy Governor for Markets, BoE) and Isabel Schnabel (ECB Executive Board) to give the keynote addresses – you can read their remarks here and here.
The lion’s share of the day was devoted to three panel discussions, which debated:
In what follows, we summarise the key points raised during these panel discussions and highlight areas of particular interest for research.
The first session of the conference focused on asset purchases as a tool of central bank policy. It was chaired by Clare Jones (FT) with three speakers: Huw Pill (Bank of England Chief of Economist), Lucrezia Reichlin (London Business School) and Gertjan Vlieghe (Element Capital, formerly MPC).
Vlieghe opened with a provocative rhetorical question: the initial estimate of the effectiveness of quantitative easing (QE) suggested that £200 billion of purchases would lower long-term bond yields by 100 basis points, so do we think that the cumulative £875 billion of purchases that has been delivered by the Bank of England over the QE era has reduced yields by 440 basis points? Clearly, not. The story, he argued, was more nuanced than just the profession revising down its estimate of the effectiveness of QE over the last decade.
Both Vlieghe and Pill subscribed to the idea that the transmission mechanism of QE is state-contingent: when markets are highly stressed or dislocated, asset purchases appear to have significant yield effects; but otherwise, the effects are much smaller. This prompted the reasonable challenge, raised by Vlieghe: if the positive impact of QE outside of times of financial stress was small, then was it possible that those benefits could be outweighed by the likely small costs?
There was considerable discussion about the conduct of large-scale asset purchases for financial stability purchases. Vlieghe noted a clear difference between the approach taken in 2020 and 2022: in the former episode, the Bank continued to buy huge amounts even once markets stabilised, whereas in the latter it bought as little as possible. Pill observed that whilst the change of approach might reflect lessons learned, it could simply be because the objectives of monetary policy and financial stability were no longer aligned in 2022, creating an obvious incentive for moderation.
There was an acknowledgement that further work needs to be done on the architecture of these financial stability interventions: around the lack of a symmetric target for the Financial Policy Committee (FPC), which would discourage excessive bond-buying (unlike the Monetary Policy Committee, or MPC); the lack of meaningful involvement of the MPC in the decision-making process; the failure to sterilise the interventions to avoid any impact on the monetary stance; and why asset purchases were necessary at all if the problem was liquidity – why couldn’t the Bank lend money instead?
A key issue – raised by Reichlin in particular – was the unintended consequence of post-crisis regulatory reforms, making financial markets less resilient, which has then compelled central banks to intervene periodically on financial stability grounds. Two inter-related concerns were highlighted: first, the pull-back of market-making capacity by the banks; and second, the transfer of risk beyond the regulatory perimeter into the shadow banking sector. Pill outlined some stylised central bank responses: the central bank could act as a ‘central counterparty of last resort’, matching orders, and not taking any risk on balance sheet, or it could act as a ‘market maker of last resort’, at which point the central bank is taking risk onto its balance sheet via the inventory that the market maker holds.
With regards to the neutral setting of the balance sheet, Reichlin advanced a possible argument for running a relatively large balance sheet for precautionary purposes, given the unpredictable demand for reserves. But she acknowledged that the larger the central bank’s balance sheet, the larger is its fiscal footprint. Vlieghe argued that the size of the balance sheet was not a particular problem – one can operate with a large or small central bank balance sheet – and that the concept of neutrality was more appropriate to changes in the size and composition of the balance sheet: if either adjusts rapidly, then that is likely to have non-neutral macroeconomic consequences. Pill observed that large balance sheets almost inevitably come with pressure to get involved in distributional issues. The Bank’s job, he argued, is to focus on the risk-free curve and leave it to others to get involved in allocative decisions.
Finally, there was pushback against changes to the remuneration of the reserves that have been created through QE. Pill emphasised that the Bank needs to have the capacity to set the price of money at the margin, but the infra-marginal question is really a fiscal question and not for the Bank. He also felt that it would be preferable to tax banks in a more transparent way if that was the direction of policy. Vlieghe added that to change the remuneration of reserves now could shake confidence in the UK’s macro-financial framework, given background concerns about fiscal dominance.
The session on inflation was chaired by Soumaya Keynes (The Economist) and received contributions from Charles Goodhart (LSE), Catherine Mann (MPC member, Bank of England) and Ben Nelson (BAMFunds).
The issues to discuss were: What has caused the rise in inflation? What have we learned about forecasting inflation? Will inflation expectations drift higher in these circumstances and what that would imply about the inflation outlook? How can we assess that risk of de-anchoring in real time and the appropriate monetary policy response? Can central banks credibly deliver this response if it implies a steep rise in unemployment?
Goodhart asserted that predictions that inflation would return to target in two years’ time were most likely to be wrong. There was currently a wage-price spiral underway in the UK private sector and pressure in the public sector for wage increases. Labour was scarce, and the natural rate of unemployment was going to rise. All this reflected the end of a beneficial deflationary era. He drew attention to a reversal of long-term trends that were driving inflation up globally. The first was the decline in the world population, particularly the decline in the working age population, in Europe and China; only Africa and possibly India had younger and growing populations. This resulted in a rising dependency ratio as there were many more ‘old’ people, and fewer ‘young’ people to support them. The second trend was a rise in medical costs, even before Covid, placing an immense burden on fiscal policy, with expenses rising exponentially. Covid has only made matters worse. While the rise of China has been a disinflationary force for the last two decades, the pandemic and demographic trends will be inflationary. There would be greater inequality between rich and poor with larger exposure of the poor to global shocks.
Goodhart’s dismal conclusion, delivered with a wry glance at other contributors, was that inflation is coming and this will lower real returns, lower growth, raise inequality and eventually threaten central bank independence.
Nelson began by showing us that CPI inflation was high by any measure (headline, core or median). Contextualising UK inflation compared to other countries, we saw that the UK had ‘European’ headline inflation (rising through 2022, while US inflation has already peaked) and ‘US’ core inflation (higher than the European average). Despite this, he showed evidence that inflation expectations had not de-anchored: five- to ten-year inflation expectations were less sensitive to realised inflation, oil shocks had smaller effects in the long term, while lagged expectations and short-run expectations of inflation were passing through at about the same rate as they did since 2005. However, the labour market was very tight, it was hard to fill vacancies, and wage pressure was high given low unemployment. This was being made worse by higher level of inactivity in the UK versus the US and more people registering as long-term sick.
If real wages were rigid downwards, as seems to be the case, then inflation expectations were biased upwards. Where did this leave the standard ‘risk management’ approach to monetary policy proposed by Evans et al. (2015) and Adam and Billi (2007) that places emphasis on the constraint placed on inflation stabilisation by the effective lower bound? The traditional argument is that in the presence of the effective lower bound, we should keep monetary policy looser for longer. But this is an incomplete description of the policy problem in a high inflation environment. Real rigidities also impose important constraints. If they are asymmetric, it implies higher cost-push risk, which suggests policymakers should tighten by more. Nelson argued that the two risks need to be balanced. The second seemed more relevant now.
Mann highlighted the new inflation vocabulary and its policy challenges. First on the list was external shocks. These were terms-of-trade shocks that drive inflation (e.g. energy and global goods) and monetary policy cannot offset them. They were not domestic and may be transient. Next on the list was ratchet. Since inflation had risen, the base effects will not allow it to continue to rise but will cause it to dissipate as prices stabilise. This was mostly about statistical measures, and monetary policy can’t deal with this either. Third was embeddedness. Since services and core goods prices were higher, we can expect second-round effects to make inflation persistent. This was domestically generated inflation to which monetary policy could and should respond. Fourth was spillovers – as a small open economy, global shocks transmit to UK inflation. The dollar-sterling exchange rate plays a part in this, raising import prices, especially for commodities. As inflation remained above target, we start to think about persistence in various measures of underlying inflation. Expectations in the medium term about inflation in the future were well above target, pulled up by a positively skewed distribution of inflation expectations. Lastly, there was a policy challenge, with stickiness downwards and a shift in the Phillips curve, raising the cost of lowering inflation. Therefore, we should not let inflation run out of control. Mann concluded by noting that the projection of inflation showed inflation returning to target, but risks were still skewed to the upside.
The final session of the conference focused on the remit and accountability of the Bank. The panel was chaired by Chris Giles (FT) and featured Ed Balls (Harvard and KCL), Vicky Pryce (CEBR), Lord Andrew Tyrie (House of Lords) and Sushil Wadhwani (PGIM Wadhwani) as speakers.
The questions we posed the panel, some of which had been overtaken by events, were: Is there merit in moving away from an inflation target? Is there enough clarity on the FPC remit? Are capital markets sensitive to changes in institutional arrangements? Has the Bank become overburdened? What should be done to make policymakers more accountable?
The panel began by discussing the September LDI/gilt market crisis. Balls argued that after the 1992 crisis, which saw the pound sterling forced to exit the Exchange Rate Mechanism, a new Treasury orthodoxy had been formed centred around the inflation target, central bank independence, fiscal rules, independent audit and more recently the Office for Budgetary Responsibility. This framework allowed for credible discretion in response to shocks. Prime Minister Truss and Chancellor Kwarteng had undermined this consensus. We found out why, as a small open economy, we needed this transparent framework! Chancellor Hunt had since re-established this macro-fiscal framework and this had restabilised the markets. The episode reinforced the need for credibility in our institutions by showing what happens when they are removed.
Tyrie argued that the episode had strengthened the Bank of England’s independence and had left the Bank in a very strong – perhaps dangerously strong – position. This needed attention from Parliamentary committees. There was growing and deep dissatisfaction with the performance of financial regulators, including the Bank of England. Specifically, there was concern that the Bank was vulnerable to groupthink and its communications resembled a snowstorm of information rather than what the public and those charged with holding the Bank to account actually need to know. For instance, the letter of indemnity for QE had still not been published. The Bank Executive had also become increasingly powerful, but did not have the requisite transparency safeguards of the MPC.
Wadhwani made the case that unfunded tax cuts had played a small role during the September crisis; the undermining of our institutions had been far more important. The mooted change in the Bank’s target to a nominal GDP target during the Truss premiership was extremely worrying. While Wadhwani saw merit in handing the Bank power to set its own price stability mandate, this was strongly rebuffed by Tyrie and Balls.
The panellists turned to discuss the role the Bank had played in the September debacle. Pryce felt that the Bank’s announcement that it would be embarking on quantitative tightening (QT) just before the mini budget was decidedly unhelpful. This was not to say that the Bank was primarily to blame for the events in September, but it certainly contributed. Balls agreed that the Bank’s actions had exacerbated the problems in September. These included: being behind the curve in raising Bank Rate in summer 2022 (although not before that); the decisions regarding QT the day before; the convention of not taking into account the latest information on fiscal policy in its monetary policy decision; the Governor’s statement on the Monday, which was contradicted by the Chief Economist a day later; the idea that decisions could be made on the normal timetable despite the crisis; and confusion about how long the liquidity support would last. Tyrie argued if policy had been tightened earlier, the September catastrophe would not have been as severe. It was turned into a catastrophe by the fact that policy was already too loose. This point was disputed by Wadhwani, who felt it implausible that policy could have been tightened sufficiently to have made a material difference given what was known at the time.
In response to a question from the Chair about why these Bankof England failures had not been raised by the Treasury Select Committee (TSC), Tyrie argued that the TSC now needed to be robust and should consider sending in some specialist advisors with the right to see any document at all in real time and with a mandate to report back to the Committee. This approach had been taken with the Financial Services Authority (FSA) after the financial crisis. He argued that Parliament, however, did not currently have the capability to hold the Bank to proper account and there needed to be a new repository of expertise, as we have with the National Audit Office, that could be charged with looking at the Bank and the financial regulators and picking off issues earlier – a body with a collective memory that could be built up over time.
In response to a question from the audience, Balls agreed that there needed to be a TSC investigation into what happened in September. There had undoubtedly been a hit to the UK’s international standing. Why, he asked, did the IMF decide to call the UK out? Perhaps it was a concern that, following the financial crisis and the pandemic, governments everyone had become a little too relaxed about their budget constraints. The UK was the canary in the coal mine.
The discussion turned to the post-crisis regulatory architecture and the role of the Financial Policy Committee (FPC), which has a responsibility for macroprudential oversight. Tyrie argued that one weakness of the FPC from the start was the convention that it would make decisions by consensus. We failed to learn a lesson from the early MPC, whose great strength was the difference in views it allowed to be expressed, which fostered a wider debate. But more broadly, there needed to be a public debate about reform of the FPC. This should include whether we need it in the first place. It may be better to have something closer to the US Fed’s Federal Open Market Committee, where monetary and financial policy decisions are taken by a body with the same membership. A key problem was that power to act had gravitated away from the Bank’s committees and towards the Bank’s executive. The opaqueness of this process would eventually weaken the Bank.
Balls argued that the current system was not an equilibrium. The MPC model worked because there was a clear objective that applied to everyone in the country. In its early days, Parliament deliberately chose independent members with strong voices to open the debate, with opinions and votes recorded. The FPC framework lacked this independent strength of voice – there were no votes and the debate was not observable. The FPC objective also lacked clarity. Only the Bank of England’s internal executive had members common to both committees, which disempowered the externals. It may be preferable to merge the committees into one, although this may come with the risk of losing focus on financial stability issues.
But the bigger issue was that the government should take on more ownership of the financial stability objective. The US Financial Stability Oversight Council approach, which brings the government and regulators together but is chaired by the finance minister, is an example of how to do this. The current approach piles all the risk on to the Bank if something goes wrong, which contrasts sharply with the monetary policy side where the government absorbs political risk by owning the inflation target. One could see evidence of this during the LDI crisis, where it was not clear where the buck stopped.
Wadhwani agreed, noting that he had long advocated for a single FPC–MPC structure. The September crisis provided a clear example of why this was needed. We could have had worse luck and gilt yields could have continued rising. The Bank could have found itself repeatedly needing to intervene, which would have been subversive for monetary policy. This was a lucky escape. We should have one body that internalises these issues, he argued.
This Bank of England Watchers’ conference is the first in a series. The next will be held in the autumn of 2023, focusing on topics that are central to the Bank’s policy agenda. For more information see the websites of the Money Macro Finance Society and the Qatar Centre for Global Banking and Finance at King’s College London.