Thinking aloud, about the future of money and monetary policy

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Andy Haldane is the chief economist at the Bank of England (BoE). He has the reputation of being a thoughtful central banker. This was certainly borne out in a recent speech (“How low can you go?”) he gave on the future of money and monetary policy. In fact thoughtful doesn’t really do justice to Mr Haldane’s speech. He went on a central bank policy walkabout and gave the burgers of Portadown, Northern Ireland, what must have been a cracking Friday night out.


Mr Haldane’s theory # 1 on the future of monetary policy

His basic premise is as follows: the global financial crisis led central banks to reduce policy rates to their effective floor (i.e. zero). This in turn meant central banks had to pursue ‘unconventional’ monetary policy in the form of quantitative easing (QE), faced as they were with the zero lower bound (ZLB) – the inability to set negative cash rates on currency. By ‘currency’ he means cash – as in cash in a sock under your bed – some central banks having of course set negative rates on bank reserves.

So far, QE has resulted in central banks making asset purchases totalling USD 5 trillion. While QE has, according to Mr Haldane, had the ‘desired effect’ (namely, “a timely and powerful effect in stimulating demand and inflation”), it has not created an environment in which policy rates will be hiked as they were in the past.

Andy Haldane postulates that, if global interest rates remain persistently low (and not just a Jonah Lomu-like freak occurrence) due to deep-rooted structural issues, then central bankers may not be able to pack away their unconventional policies and go back to their usual routine. Instead they may find themselves repeatedly bumping up against the ZLB.

Need to cope with low ‘monetary policy headroom’

If that is going to be the case, he argues, central banks need to find a way, in a regime of permanently low real rates, of coping with low ‘monetary policy headroom’. In other words, if real rates are at zero and inflation at 2%, how do you loosen rates by 3% – the average seen in a typical loosening cycle when a recession came along (and they come along once every three to ten years according to Andy Haldane’s calculations)?

By the way…

Mr Haldane quotes some data from BoE research on the factors behind the 450 basis point (bp) fall in real rates since the 1980s. His breakdown of these ‘not-likely-to-reverse-quickly’ factors is as follows:

– Lower trend growth (100bp)
– Worsening demographic trends (90bp)
– Low investment rates due to falling prices for capital goods (50bp)
– Rising inequality (45bp)
– Savings gluts in emerging markets (25bp)

How to slacken the ZLB constraint on a durable basis

This is central-bank speak for “whaddya do to avoid finding yourself with a recession on the horizon, policy rates at zero and QE not a policy option?” Mr Haldane sees three potential solutions (he’s thinking aloud here, as there are clearly some practical issues relating to these solutions):

– Raising inflation targets from 2% to 4% would provide wriggle room. BUT, as Andy Haldane points out, if you do manage to get the inflationary cat out of the bag, how can you be sure you’ll get it back in again?

– Render unconventional monetary policy conventional – that is, if interest rates are parked at the ZLB then QE should be a permanent part of a central bank’s toolkit. BUT, there’s much more uncertainty about the impact of QE as a means for implementing monetary policy than for interest rates. In addition, QE as a permanent policy tool would potentially lead to an unfortunate blurring of the boundaries between fiscal and monetary policy. If a central bank purchases, permanently and on a large scale, government and/or private sector assets, then those would arguably be quasi-fiscal acts. And (here’s the second BUT) the cross-border spill-over effect from the impact on the exchange rate could create issues for the longer-term stability of the global financial system.

– The ZLB constraint could be removed by abolishing paper currency – (I did tell you he was a thinking central banker). This would enable policy-makers to levy a negative interest rate on currency (so no more cash under the mattress). The ‘distributed payment technology’ embodied in Bitcoin, has, according to Mr Haldane, real potential. So, for him and his colleagues, one of the big questions is whether a variant of Bitcoin could work as a central bank-issued currency. Would the public accept it ? Privacy, security, logistics, etc. etc. These questions are so tricky that a core part of the BoE’s current research agenda is apparently on central-bank issued digital currencies.

Meanwhile, back at the ranch…

Having thought aloud with great verve on the future of monetary policy, Mr Haldane ended his speech by revealing his thinking on the factors shaping monetary policy right now (he’s obviously referring to UK monetary policy but in our globalized world the implications for the rest of us are, I think, clear).

Greece and China have dominated most of the debates on the global economy in recent months. Andy Haldane doesn’t see them as independent events but as “part of a connected sequence of financial disturbances that have hit the global economic and financial system over the last decade.”

A triple whammy ?

Or, in central-bank speak, a trilogy, caused by a large slug of global liquidity rotating through the international financial system. As it moves through the system it inflates – and then deflates – capital flows, credit, asset prices and growth in the regions.

This is the pattern that Mr Haldane sees as having played out in Parts One and Two of the trilogy, namely the Anglo-Saxon crisis of 2008/09 and the eurozone crisis of 2011/12.

Now, in his view, we may be in the early stages of Part Three, the “Emerging Market” crisis. Mr Haldane concludes that its simply too soon to tell what the impact of the slowdown in emerging market economies will be on the world economy. But he’s not optimistic. Overall he sees the balance of risks to UK growth and inflation over a two-year horizon as being very clearly skewed to the downside.

Looser rather than tighter monetary policy in the UK?

On that basis, the case for raising UK interest rates is not yet made. And if the downside risks do materialise, Andy Haldane anticipates a need to loosen rather than tighten UK monetary policy. That’s not a consensus view – other members of the BoE’s monetary policy committee have, a bit like those at the Fed, been suggesting UK policy rates would rise in 2015. We shall see…

Source for the above image of the Bank of England in London: Angelina Dimitrova /
Andrew C. Craig

Head of Financial Market Analysis & Publications

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