Blimpish || a Tory

As the Spectator asks…  my BSc.-level prejudices on display.

1. Bank of England

a. Was inflation targeting the wrong measure? It worked in the 1990s, but was it rendered unreliable by the deflationary shock of globalisation?

Maybe.  Not sure.  There’s a danger of fighting last wars then, but there’s a danger that we change now and end up making the same mistake.  Ultimately, a broadly stable consumer price index is the generally accepted measure of sound money.  I don’t think output or employment should be an issue for monetary policy; monetary policy is about sound money.

Variations could be in scope or method, however.

In terms of scope, some people seem to be suggesting that the index should include asset prices, but asset prices should rise, at least through some association to general productivity.  Disaggregating that effect to ensure normal prices were stable would be very difficult, because asset prices are also subject to a lot of other factors.

In terms of method, the obvious alternative is to move to price-level targeting – saying the index will move 100 to 102 to 104 to 106 over four years, so that the value of the currency can be predicted in future.  But the problem here is – what to do when we go off the trend?  If the index went from 100 to 105 to 110, is the target going to be to engineer a deflation of 4 points in year 4?  Or, if it stays flat at 100, will it have to engineer a 6% inflation?  I think there are some big credibility issues here – over the extent of policymakers’ control, and also their willingness to correct where policy missed the target.  (This doesn’t mean it’s not worthwhile as a short-term expedient – for example, as a commitment measure against a deflationary spiral.  But I’m sceptical how it could work long-term.)

Other measures…  Well, you could go for exchange rate targeting (either bilaterally with the Euro or against the trade-weighted exchange); but the raw political economy tells us, as it did in ‘31 and ‘49 and ‘67 and ‘92, that domestic business and consumer interests will demand policy respond to their needs, precipitating a devaluation crisis – been there, tried that.

So, my guess is we’re stuck with an inflation target.  Unless you could persuade them to go for a commodity prices index; where you could use forward Sterling prices to ensure a continuing steady path for the price level, in principle.  But the mechanics are complex and there’s the question of how much commodity price bubbles could become an issue too.  (There’s also the issue over a 1973-scale oil price shock – in welfare terms, it may be better to allow some of that to feed through into prices; but to do that in this case would be to reduce credibility.  This would be analogous to devaluation crises under an exchange-rate fix; that the domestic economy’s needs come into conflict with the tradable-commodity-focused part, and win.)

b. Should it have paid attention to M3 or M4 supply of money, as the European Central Bank does? Should its remit have included asset prices?

Yes, and yes, but.

Yes, it should have paid more attention to broad money supply, but there’s no easy solution here – Goodhart’s law applies.  The experience of monetary targeting in the 1980s was not a success – the velocity of money is highly variable (as we are seeing now in spades), and that applies vertically (i.e. the relationship between broad money and narrow money) and horizontally (i.e. the velocity of different households and businesses in a changing economy).

Yes, its remit should have included asset prices, but only in the sense that these are another indicator.  Asset prices can shift in dramatic fashion for quite good, secular reasons.  Housing price increases over the past 20 years have been above trend – but maybe that’s because of shifting demographics (people living older, more migrants, more single people) and living preferences (more prosperity means more people choosing to live alone).  It’s easy to say in hindsight now that there was an asset price bubble and to take a guess on its scale…  But it isn’t so simple in practice.

I remember some years ago (long before all of this) Tim Congdon criticised the Bank not for its lack of attention to money and assets per se, but for its lack of any clear theoretical framework for inflation.  I think that’s fair as a starting point – and perhaps with that it could have a means of filtering money supply and asset price data – but none of it could make it fool-proof.

c. Did globalisation undermine its ability to control the supply of money in the economy – i.e. could banks borrow directly from the mountain of savings in China?

No, except for the self-imposed restriction of using short-term policy rates as the only way of changing the supply of money.  All that that means is that they’re making short-term liquidity (i.e. minimal risk lending) available above or below the market price; therefore affecting risk and return perceptions.  Given international financial integration, the consequences of small pricing errors become extremely large – and a small excess of liquidity amidst uncertainty over risk pricing can trigger a large bubble.

The solution to this doesn’t to me seem to be to intervene on long-term lending; getting the whole yield curve out of shape seems likely to make it worse.  Instead, direct quantitative measures seem more appropriate, as long as there’s a route to make the correction; hence me mentioning exchange-rate or commodity-price index arrangements, as they at least allow a direct sell of currency at a fixed future value – but they both have big issues over pricing rationality, and of political economy.  (I don’t think CPI futures – which could be another such mechanism – are practicable, because of the month-long gaps between price data.)

d. It had a very tight remit, and most MPC members are picked by the government. Does the bank need more independence? Would this have helped anything?

MPC members are picked by the Government, but that’s the British way – short of House of Lords approval committees, am not sure how else to do it?

True independence, as the Bundesbank had, only comes through genuine political commitment – in their case, procured through folk memory of hyperinflation.  I’m not sure how it can be achieved without that, especially given the ‘elective dictatorship’ problem we have in our constitution.  At most we can remove the MPC and allow the Bank Governor the autonomy to set rates (perhaps appointing his own committee), responsible to the Bank as a company.  That way, the ability of the Government to shape MPC composition is removed; but it still gets to appoint Governors.

In terms of remit – tightness can mean focus.  But I do think responsibility for bank supervision should be returned to the Bank.

e. Did it notice the asset bubble, and why didn’t it want to act?

I don’t know – go back and read all of the Inflation Reports.

My guess is that it noticed it in the way we all did – uncertainly.  We all felt there was a bubble there, but we had good reason to hope that asset prices were a reflection of changed times.  Just because house prices go up a lot, it doesn’t mean it’s a problem – you have to be able to disaggregate the secular changes from the bubble-driven ones, and that’s not an easy thing to do.

The fear they had of acting is – what if we get this wrong?  What if asset values are inflating for good reasons – after all, record levels have to be set to become record levels.  If we choke it off, we could trigger a needless recession…

And here’s probably the biggest source of the problem – just as the postwar era (1945-1976), so too the post-Cold War era (1992-now), our tolerance of recession and unemployment is so low that no policymaker dare risk it.  The memories of the 1979-1981 and the 1990-1992 recessions loom large for voters and policymakers (especially Labour politicians, for whom those recessions often define their political being.)

f. How important was its claim that consumer spending (which sustained the UK economy in the dips) was not the result of the housing bubble?

It was very important in terms of justifying taking no corrective action – because, for the same growth-loving mentioned above, the fear of there being a housing bubble could be ignored in the name of ‘rational’ consumption levels.  This does again show through into the bluntness of the interest rate tool in a world with walls of money – jacking up rates to counteract stagnant pools of liquidity would be very painful, but there was no other way of withdrawing excess money.

2. The Treasury

a. How did its approach to debt, and the accountancy of debt, change after 1997?

I’m no expert here, but it’s important to bear in mind that the PFI innovation happened during the Major years, as an attempt to finance much-needed capital spending amidst a general effort to slash the deficit.  That isn’t to justify it, but to say that it shouldn’t simply be put on Gordon.

b. Was HM Treasury right to incorporate some of the innovations of the City, such as securitisation (e.g. International Finance Facility) and off balance-sheet financing (PFI)?

Well, yes, as a general principle – the problem is whether individual innovations were good.  PFI is a good thing, but the financial commitments should be recorded.

c. Should it quantify other liabilities, such as public sector pensions?

The accounting conventions (and possibly reporting arrangements too) need work, no doubt.  PFI commitments should be recorded, as should debt obligations under effective Government guarantee.

Public sector pensions – hmm, no, but also yes.  Pension liabilities are an ongoing cost of running the Government, and as long as the UK is a going concern, they’ll be paid – and so they shouldn’t be accounted for as debt.  But the problem is that where there has been a significant expansion of public sector payroll, the liabilities will grow – it seems to me that we should be accounting for the equivalent of an unfunded deficit for a pension scheme; perhaps, a measure of the NPV of future pension liabilities above the % GDP level now being spent (and therefore, already funded).

It’s probably also true that Government should measure its asset base better too, so that we can actually get a view on its Balance Sheet rather than its simple debt level.

3. What went wrong in the City

a. Did it have a reputation as the Peckham of the globalised world – i.e. were dirty tricks happening in London that weren’t in New York or Frankfurt?

I didn’t know that about Peckham.  I must visit.

New York didn’t get away quite so lightly, of course – more of ‘our’ investment banks are still standing.

Other than that, and the fact that US regulation encouraged corporate location in London, I don’t know about this one.

b. Should the Bank of England have kept its regulatory role, or would it have been better to have a functioning FSA?

As mentioned above, I think the Bank should have lead responsibility for banking supervision – which is different from regulation as such.  The Bank should have the power to impose reserve requirements for prudential (not monetary policy – no corsets, please) reasons; this could have been a mechanism to slow the housing bubble, by diminishing aggression.  But it needs to be handled by an agency like the Bank, as part of the City, because there really is no science – people saying about the need for counter-cyclical reserve requirements neglect the fact that we’ve never once been able to accurately predict the cycle; but at least some power might be able to avoid the worst excesses.

c. Was the problem light-touch regulation or wrong-touch regulation?

Both, and neither.

The neither bit is most important.  Capitalist energies can be ruinous to a nation if they aren’t constrained and channelled into productive, non-coercive, non-poltical behaviour.  That’s why the rule of law is important, and that’s why we have regulation, but that’s also too why we have responsibility too.

My view here is that the third of those constraints has disappeared, between the collapse of authority and the fading of institutions from the 1960s through to the 1980s (from Jenkins to Thatcher).  By the time of the 1990s and 2000s, we have a society where good is measured only by achieving private goals – of which money is a surefire part – and nobody is allowed to judge me.

Burke said: “Men are qualified for civil liberty in exact proportion to their disposition to put moral chains upon their own appetites.”  And it seems, we took off all those moral chains and went for it.  But I don’t think more regulation would’ve been a lot of help – in fact, it was regulation which encouraged off-balance sheet vehicles.  Attempting to regulate means putting a wild animal in a cage – what we wanted was to domesticate, and that means getting the wild animal to adopt some self-restraints, and nobody even thought that that was necessary anymore.

But responsibility goes down the line, too.  Nobody forced anybody to get a 115% mortgage, or take on several years’ earnings’ worth of unsecured debt.  Nobody forced the Government to run a deficit among hogwild tax revenue growth.  We’ve forgotten it all, and if we could do one thing for the future, it would be to focus policy (not just banking policy) on restoring ideals of decency and responsibility.  I’m all for entrepreneurial success, but it has to accept its obligations to society; and this isn’t about paying dues to greenies and Lefties (screw ‘em, I say), but about accepting that some deals shouldn’t be done because they’re bad for business; that some risks aren’t worth the returns.

Regulation should support that, while also leaving spaces for risk.  I’m a supporter of narrow banking for the future – that our High Street banks should be heavily restricted from financial engineering of the sort they’ve been doing; focused on deposit-financed mortgages and personal loans.  ’Broad’ banking can be more heroic, but shouldn’t be guaranteed by Government, and should be accessed only by customers who accept (and are informed of) the attendant risks.  We should not seek to protect fools from their own folly, nor to stop adventurers taking risks; but we should make sure both fools and adventurers know it’s all on them.

One other thing worth mentioning – the issue about off-balance sheet vehicles relates to a wider point, that application of prudential financial regulation should be on a conduct-driven rather than organisational basis – we should regulate complex and large-scale financial vehicles of any sort, even where it’s not formally their main business.

d. Did the Treasury have an incentive to look the other way, given that it was pocketing 40% of all bonuses?

Yes, of course.  And didn’t we all?  I don’t see many people complaining about the extra spending those tax revenues afforded – even those of us on the Right were simply aggrieved that we weren’t cutting taxes, including for those earning the bonuses.

But I do think that Gordon Brown’s tenure as Chancellor destroyed one thing about the Treasury which might have saved us all – its traditional miserly resentment of proposals to either spend money or cut taxes, and lament Chancellors’ tendency to do the reverse and never balance the budget.  He changed it into a body with a focus on ‘investment’ (i.e. finding new ways of spending taxpayers’ money) and a seeming amnesia about fiscal rectitude.

4. Where was the parliamentary scrutiny?

a. What did the Treasury Select Committee miss? And is this because it is under-resourced, or the inevitable consquence of having government fix its membership?

Don’t know, really – what did we all miss?  I don’t think the Select Committees provide the scrutiny they need to, probably because of the cited reasons.

b. Should we give up on parliamentary scrutiny and use a quango, such as the Office of Budget Responsibility that George Osborne is proposing?

Yes and yes, but.

Parliamentary scrutiny won’t work because the majority have to back their ministry in the House of Commons; it’s a facet of the British system.  If we had an Upper House worthy of the name, it could have a non-spending approval process where it could rebuff a Budget, and it could be structured in such a way as to limit party influence.  But outside of that (sweeping) change, put not your trust in kings and princes.

As for a quango, well again, I think it will only work if it has some constitutional protection – if it’s a Parliamentary rather than a Government body.  I also think it would have to work differently if it is to have the effect we really want.  I would want it to report not just on debt and deficit trends, and be responsible for overall public accounting, but to do so with a full sense of the fiscal position, reporting each year on the intergenerational consequences of current taxation and spending policy commitments.  My view is that, subject to automatic stabilisers (admittedly difficult enough), we should aim to target a long-term debt/GDP ratio, and budget balances should be judged against the intergenerational trajectory for that purpose.

But, just as with all of this stuff, political context matters.  We need a political culture which values fiscal rectitude and a realisation that we have an obligation to posterity.  Without that, a quango or a group of backbenchers will be voices in the wilderness.

c. Which MPs were asking the right questions, and when? Why did they think they were so alone?

Oh, I don’t know.  Wasn’t keeping track.  And they all need to be tested to make sure they weren’t just stopped clocks before we declare them prophets.

5. Why did personal debt balloon in Britain? Was it a bling culture that needs to change, or just the inevitable consequence of excessively cheap money?

Oh, the same old reasons and then some more.  It couldn’t have happened without such a glut of capital in the world, driven from the other side of the world, and it wouldn’t have gotten quite so bad without the excess liquidity in the early 2000s.

But I do think most of it comes back to us.  The first conceit was that we’d solved the business cycle, that the only way is up.  The second conceit is that today’s consumption is all that matters, because that ever, onward growth path would make all things come good.

As for bling – I don’t think it’s just that.  I think we all think we’re owed are dreams; it’s the happiness, not just the pursuit of happiness, we think we’re entitled to.  We’ve become so far away from the experiences of evil – war, starvation, disease – that we think not getting two holidays in a year is a major hardship.  The absence of pleasure is now what we think of as pain.  And this isn’t (in case you think I think so) all for the bad; it’s allowed us all to do many good, fulfilling things as a society.  But it’s time now to get serious.