On 8 June, the Bank of England and the Centre for Economic Policy Research jointly hosted a Monetary Policy Roundtable.

Astley, Mark

English

Research Papers in Economics

238 Quarterly Bulletin  2009 Q3
Introduction
On 8 June, the Bank of England and the Centre for Economic
Policy Research jointly hosted a Monetary Policy Roundtable.
This was the second in a regular series intended to provide a
forum for economists to discuss key issues affecting the design
and operation of monetary policy in the United Kingdom.(1)
Participants included a range of economists from private
sector financial institutions, academia and public sector
bodies.  There were four discussion topics:   
• monetary policy and the current conjuncture;
• quantitative easing;
• sterling and capital flows;  and
• lessons from monetary history for the current policy
challenges.
This note summarises the main points made by participants at
the Roundtable.  The event was conducted under the
‘Chatham House Rule’ and, as such, none of the opinions
expressed at the meeting are attributed to individuals.  The
views expressed in this summary do not represent the views of
the Bank of England, the Monetary Policy Committee (MPC) or
the Centre for Economic Policy Research.
Monetary policy and the current conjuncture
Short-term prospects for the UK economy were generally
perceived to have picked up in recent months.  Surveys
indicated that output had stabilised towards the end of the
second quarter.  Conditions in financial markets had improved,
with lower spreads and increased activity in markets for risky
assets.  There was also growing evidence that housing market
activity had been rising, albeit from low levels.  
The severity of the recession had been partly attributable to a
pronounced stock cycle.  Companies had cut their holdings of
stocks, in part due to pessimism about future sales, and in part
due to a need to conserve cash.  The pace of de-stocking was
likely to decline through 2009, which could potentially support
a sharp pickup in GDP growth.  But stockbuilding was
notoriously difficult to forecast, so the precise profile was
uncertain.
Looking further forward, there was a range of views on the
prospects for growth.  Some speakers argued that household
consumption spending had been excessive for a number of
years and the saving rate would need to rise significantly to
correct that.  Others pointed out that household consumption
had not grown at extreme rates in recent years.  And in
aggregate the private sector had been running a financial
surplus.  So there may not be large imbalances to unwind.
There was a general consensus that the prospect of a sharp
fiscal tightening would potentially dampen growth.  But it was
also noted that tighter fiscal policy could be consistent with a
continued weak sterling exchange rate, which would stimulate
some growth through net exports.  
There was little consensus on the likely path for inflation.
Some participants argued that there was a large margin of
spare capacity in the UK economy, which was likely to persist
for several years.  Given past experience in recessions, that
presented a significant risk that inflation would fall below the
MPC’s target and could potentially result in a period of mild
deflation.  Others thought that the chance of deflation was
low.  They emphasised the aggressive fiscal and monetary
policy responses and credibility of the inflation target, the
weak sterling exchange rate, recent increases in commodity
prices, and the relatively low levels of spare capacity implied
by service sector business surveys.  It was noted that inflation
expectations implicit in the price of index-linked bonds were
consistent with inflation remaining close to target, although
others took little comfort from that.
The MPC’s action to introduce a programme of large-scale
asset purchases was viewed to have reduced the threat of
deflation.  Some speakers, however, felt that any MPC
statements on how this programme might be wound up could
reduce the stimulus to growth and inflation.  Others perceived
a risk that the programme strayed too close to fiscal policy
issues and so might lead to concerns that the MPC was not
independent of the government.  
Returning to growth prospects, overall it was judged that the
rapid policy responses across the globe had almost certainly
averted the risk of a global depression as severe as in the
1930s.  Some participants thought that there could be a period
of protracted weakness for the UK economy, given the
combination of high debt levels and the potential for deflation.
Others were sceptical, reiterating that the chance of deflation
in the United Kingdom was small.
Monetary Policy Roundtable
(1) Roundtables are held twice a year:  a full-day event in the first half of the year and a
half-day event in the second half of the year.  The next Roundtable is scheduled for
December 2009.Report Monetary Policy Roundtable 239
Quantitative easing
This session covered three subjects:  how the MPC’s
programme of asset purchases (sometimes known as
quantitative easing) could stimulate the economy;  issues in
implementing quantitative easing;  and challenges for
monetary policy strategy.
Four theoretical explanations of how quantitative easing could
stimulate the economy were highlighted.  First, it could raise
expectations of future inflation.  There is some statistical
evidence that this channel was the most effective part of the
Japanese approach to combating deflation.  It was argued that
the credibility of the Bank’s inflation target meant that there
was perhaps less to be gained from this mechanism.  Second,
central banks purchasing assets that are imperfect substitutes
for money can change the composition of balance sheets,
thereby pushing up asset prices and reducing borrowing costs.
Views differed on the theoretical and empirical evidence on
the effectiveness of this channel.  Third, increasing banks’
liquidity may encourage them to lend more.  Fourth, direct
operations in corporate credit markets could reduce the cost
of borrowing in those markets.  But some argued that thinking
in terms of these channels overcomplicated the issue, as
increasing the growth rate of household and corporate
deposits was a necessary and sufficient condition for economic
recovery;  measures such as M4 had been correlated with
nominal GDP growth over many decades.
There were three issues about the implementation of
quantitative easing.  First, how should the MPC decide on the
amount of assets to purchase?  The Committee’s approach of
estimating the shortfall in nominal income, and then using a
range of models to map that into asset purchases, was
discussed.  Second, which assets should the MPC purchase?
Participants who felt that the composition of the Bank’s
balance sheet was the most important channel advocated
purchasing assets that were poor substitutes for cash such as
corporate bonds.  Other speakers thought that purchasing gilts
from the non-bank private sector would be sufficient to
increase broad money growth, without incurring credit risk.
Third, how could the success of the policy be measured?
Opinion was divided here, with different weights attached to
well-functioning markets, financial market prices, intermediate
indicators such as money growth, and inflation projections
relative to target. 
On monetary policy strategy issues, there was a discussion of
the Bank’s exit strategy from quantitative easing.  Views
differed on whether it mattered if asset purchases were
reversed before any increase in Bank Rate.  There was a general
consensus that the macroeconomic impact and correct timing
of tighter policy was crucial, but hard to judge.  It was also
argued that the MPC could raise inflation expectations by
committing to maintain low interest rates for a period of time.
But there were a number of drawbacks with such
commitments. 
Sterling and capital flows
This session discussed the significant depreciation of the
sterling exchange rate during the financial crisis.  Speakers
focused on the role of short-term factors, changes to the
equilibrium exchange rate and the credibility of the inflation
target.  
One view was that periods of sterling’s depreciation could be
linked to expectations of future UK interest rates falling by
more than their foreign equivalents, but this link could be
obscured by periodic re-ratings of sterling.  Some speakers
thought that this factor was unable to account for the scale of
sterling’s depreciation and noted that the information content
of interest rate differentials was affected by the foreign
exchange ‘carry trade’.  Links between sterling and equity
markets were also discussed.
Several reasons were advanced for why the financial crisis
could have caused sterling’s equilibrium value to fall, including:
by causing UK consumers and firms to become less optimistic
about the United Kingdom’s future relative economic
performance, which would reduce UK demand for non-traded
goods relative to traded goods;  by reducing the previously
strong contribution of financial services to the current account;
and by adversely affecting the United Kingdom’s net foreign
asset position, given losses on ‘sub-prime’ assets.  One
approach to examining such issues, given the time lags in the
official data, was to examine proxies for capital account flows
such as international merger and acquisition transactions.  But
there were complications in interpreting these data.  
Another approach was to use models to examine the impact of
alternative assumptions about macroeconomic variables such
as the sustainable current account position.  Conclusions
differed here.  One view was that a substantial sterling
depreciation could be accounted for using reasonable
assumptions, although the fall would be smaller once 
supply-side adjustments were taken into account.  Another
view was that, once wealth effects from asset stocks were
considered, a large proportion of sterling’s depreciation
remained unexplained.  It was also argued that the crisis might
have no effect on sterling’s equilibrium exchange rate if it
represented a permanent decline in wealth.  A final view was
that the crisis should cause sterling to appreciate since,
relative to other countries, it had a larger effect on UK national
income but a smaller effect on UK output.  
There was also a discussion of whether sterling’s depreciation
reflected a decline in the credibility of the inflation target,
perhaps linked to the deterioration of the UK fiscal position.
One view was that this was not an important story, given the240 Quarterly Bulletin  2009 Q3
structure of UK public sector debt.  Other speakers referenced
the rise in financial market measures of UK sovereign debt
default, although it was noted that they had declined from
their peaks.
It was stressed that conclusions about exchange rates needed
to be consistent at an international level.  The role of emerging
market economies, as well as the industrialised countries, was
discussed.
Lessons from monetary history for the current
policy challenges
Discussion in this session centred on the lessons that could be
learnt from the Great Depression and the more recent
experience in Japan.  
The Great Depression of 1929–33 was the most catastrophic
event in American economic history and has been the 
most-intensively researched topic in economic history.  But
there was still disagreement over its causes and the reasons for
the eventual recovery.  One view was that the Great
Depression reflected the failure of the US Federal Reserve to
take appropriate actions, thereby not preventing a sharp
contraction in the money supply.  And it was argued that,
rather than a fiscal stimulus, the main reason for the eventual
recovery in the US economy was the monetary expansion
which occurred alongside the United States leaving the gold
standard.  The dollar’s depreciation raised inflation
expectations and reduced real interest rates.  Improved
confidence in the banking system, reflecting insolvent banks
being closed, also contributed.  Lessons from this experience
were that the banking system needed to be provided with
adequate liquidity and that such liquidity should be removed
when the crisis ends.
The discussion of the Japanese experience since 1990 focused
on the role of balance sheet problems.  These were a result of
high corporate debt accumulation, followed by asset price
falls.  And they forced Japanese businesses to pay down 
debt even when interest rates were around zero.  It was
suggested that these debt repayments remained in the
banking system due to weak household borrowing, putting
downward pressure on the economy.  In such a recession, the
economy does not enter self-sustaining growth until private
sector balance sheets are repaired.  One lesson was that
government borrowing can be helpful in such situations:
between 1998 and 2007 the Japanese Government borrowed
more and spent the excess savings of the private sector to
sustain economic activity.  And there were argued to be
similarities with the US Great Depression experience:  US
money supply growth after 1933 was also made possible by
increased government borrowing. 
Another view was that one of the lessons from history is that
the big crises cannot be avoided by monetary policy
intervention.  Rather, severe balance sheet recessions following
the collapse of asset price bubbles are best avoided by
regulation.  
Several arguments were advanced for why central banks
should worry about asset price bubbles:  misallocation of
capital during the bubble period;  overheating in the economy
due to wealth effects, which could raise inflationary pressures;
and a sudden collapse of asset prices may amplify a recession.
This might suggest that monetary policy should try to lean
against asset price bubbles, as some participants argued.  But
there were also reasons why a central bank should not
intervene, including the difficulty involved in knowing the
extent of the asset price overvaluation and the negative
impact on the economy more generally from raising interest
rates to tackle the asset price bubble.

Monetary Policy Roundtable

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Monetary Policy Roundtable

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