An imaginary meeting of the Monetary Policy Committee of the Bank of England

IMG_0039 Boys at Crosse KeysGood morning MPC members. I have not heard anything from Janet so it looks as though our decision to leave things unchanged has been made for this month. However rather than play another game of monopoly for a couple of hours, and I know I promised you could play the English version today but, I suggest that we try something new. I would like each of you to consider that you are totally independent of any constraint and can talk freely about what you think the MPC should do. You have one paragraph each and we will start on my right.

  1. I know that our forward guidance unemployment target for raising interest rates has been breached, but I still feel that with low productivity there is still some way to go before we have closed the output gap. In addition to this the threat of a deflation in prices gives us some scope to kick start growth by reducing Bank rate from 0.5 to 0.25. It is only a small change but a significant indicator of our commitment to supporting growth in the economy.
  2. I know that the Treasury has its hands tied when it comes to expansionary fiscal policy but in my opinion it is irresponsible of them to think there is output gap to close using demand management policies and even more unrealistic to think that we at the Bank can do it. Our responsibility is to see that interest rates are in line with sustainable growth, not a short term fix, and certainly not just reinforcing bubbles. Now is the time to start the 25 basis point moves upward to rebalance savings and loan rates and redirect resources, away from bubbles, towards the real economy.
  3. We cannot raise rates on our own if Janet and Mario are going to leave rates low. If we act alone then the sterling exchange rate will rise dramatically and along with it our export prices.  With cheaper import prices our already unsustainable current balance deficit of £96b on the balance of payments will go through the roof.  We must leave interest rates as they are.
  4. Surely interest rates are not our main concern, it is the fact that we are slipping towards deflation. As scholars of history, we all know the potential damage a bout of deflation can have on an economy. The last time we dealt with the threat of deflation, after the 2007 crisis, we successfully introduced quantitative easing and no matter what anyone says, it avoided deflation. Time to do it again.  We probably only need a small injection of £25b to bring inflation back on target and if there is an unexpected pick-up in banks’ lending then we can always reverse the process with a bit of quantitative tightening.
  5. How can we introduce any QE given the fact that the sterling exchange rate has fallen by about 15% in the last six months. Any additional QE is likely to further damage the rate. Just look at what has happened in the Eurozone.  Admittedly it will reduce the price of exports and that may benefit us on the current account; while a rise in the price of imports may also help us to import some much needed inflation.
  6. We know that most political commentators and indeed a lot of economists do not understand QE and therefore its bad press causes unexpected consequences in currency and stock markets, but have we forgotten there is another way to expand monetary demand and that is to use open market operations. Without anyone knowing we can buy back more government debt and release cash into the economy.  This should be sufficient to halt the slide into deflation.
  7. Listening to what has been said and noting the concern we have for the impact of our decisions on the exchange rate, I think I have the solution. We have made note of the fact that a rise in Bank rate will put upward pressure on the exchange rate and that more QE will put downward pressure on the exchange rate.  Why don’t we do both and eliminate any damaging consequences for the exchange rate.  A higher Bank rate will help rebalance the economy and generate savings at the right level to satisfy loan demand and QE will remove the threat of deflation and move us back towards target inflation.
  8. In my opinion with one more adjustment we will have the ideal monetary policy. We seem to be reducing the impact of interest rate policy on managing aggregate monetary demand and in order to regain control over monetary demand, I suggest we reintroduce a cash to assets ratio for all the banks.  I have investigated this and at present and mentioning no names the lowest cash to asset ratio held by our main banks is just above 6% so why don’t we say that all banks must hold a 5.5% cash to asset ratio.  This will give a little incentive to expand bank lending and not cause any bank to need to reduce their loan book.  From here on that will give us more control over the volume of money circulating in the economy and this, in turn, will strengthen our control over the one thing that we can manage precisely i.e. the rate of inflation.

Thank you MPC members – a very useful and inspirational meeting.  So we have our unanimous decision: we will leave base rate at 0.5% and QE at £375b and keep our fingers crossed.

John Hearn 13/4/2015

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