MNI INTERVIEW: Put Fiscal Coordination In BOE Remit - NIESR

The Bank of England's remit should be reformed to enable more fiscal coordination when Bank Rate approaches the effective lower bound, as the Treasury bears any losses from quantitative easing, National Institute of Economic and Social Research director David Aikman told MNI, 

"When you're at the zero lower bound, you need to have more active fiscal policy," he said in an interview, adding that "it’s a problem with our framework if it's not mature enough to have that sort of coordination discussion.”

The BOE’s remit, which is set to be revised alongside the Nov 26 Budget, only includes loose wording indicating that the Monetary Policy Committee should work with the government to ensure "appropriate governance arrangements" when the Bank uses unconventional policy instruments.

"A bigger change is needed. And we [should] have a protocol where, when the Bank runs out of ammunition ... there needs to be a handover to HM Treasury to support demand in the economy," Aikman said, adding that clearer guidelines are required both for when bond purchases are deployed to drive down the yield curve and stimulate the economy and also for when more targeted operations are deployed to ensure financial stability, as occurred in the wake of the budget presented for former Prime Minister Liz Truss.

"Maybe it's too much to expect that they're going to have a new protocol around each of them [the types of QE] in this remit letter but it could hint that there's going to be a review of this,” he said.

"Now's the time to plan these things," he added. (See MNI INTERVIEW:  BOE To Cut Long Gilt Sales - Ex-MPC's Saunders)

"Financial stability rests on an assumption the Bank of England will step in, and when there's market dysfunction, correct it. That shouldn't carry the same fiscal costs as the first type of QE,” he said.

The variety of QE used to stimulate the economy "like a bazooka, where you buy lots of government bonds" has large losses baked in, said Aikman, who was "not sure we've had a neutral, independent assessment of whether the costs are less than the benefits."

"It's been a problem relying so much on QE [which is] relatively ineffective, and it's allowed these losses to transpire through huge balance sheet expansion," he said.

RATE RULES

The Bank published rate paths for two alternative economic scenarios for the first time at its November meeting, and Aikman described this as “steps in the direction of trying to communicate the reaction function” of how interest rates will be set. (See MNI INTERVIEW: BOE Needs To Update Forecasts For New Scenarios)

“Whether that is really communicating the reaction function, I’m not so sure, but it’s going in the right direction, and it’s showing that the Bank is developing the right tool kits," even though the range of the rate paths implied by the different scenarios was narrow, he said.

"The scenarios they have chosen so far are perhaps more useful for them internally at the Bank of England. It’s allowing them, instead of having nine different paragraphs that are all kind of talking about different things, to condition or group their views a little bit. Whether that’s always going to be a good thing is not clear, because you could get more entrenched positions as a result.”

The Bank's scenarios included rate paths differing by fewer than 50 basis points. When asked if the Bank should publish a greater variety of scenarios considering more remote risks, such as a potential correction in the price of U.S. equities, Aikman questioned “the benefits … of publishing a scenario where the stock market collapses and the MPC cuts interest rates in response."

“I think if they were to do something that’s really far in the tails, it will be harder to get people to pay attention to it, however "back in 2021 when inflation took off, ‘we may have to increase rates quite sharply if we keep getting these shocks’, would have been a helpful thing to say."