MNI INTERVIEW: BOE Should Set Out Views On Policy Transmission

The Bank of England should follow in the footsteps of independent Monetary Policy Committee member Catherine Mann and come clean about how it thinks its policy changes are impacting the economy, David Aikman, a former Technical Head of Division at the BOE and now director of the Qatar Centre for Global Banking and Finance at King’s College London.

Aikman welcomed Mann's openness in her Feb 23 speech at the Resolution Foundation although he questioned the validity of her new Financial Conditions Index and questioned any assumption that the policy transmission mechanism has significantly shortened, both of which are building blocks for her case for further, swift policy tightening.

The MPC has tightened by 390 basis points in over a year and Mann argued that the transmission from policy changes to financial markets has been quick, and likely swifter than the 18-24 months typically assumed for policy to feed through in full to the real economy. Mann has been pushing for faster tightening than the MPC majority, but, while her colleagues may not fully agree with her analysis, the Bank's own views on transmission channels are typically kept in-house. (See MNI BOE WATCH: BOE Hikes By 50, "Watchful" On Inflation)

"I hope other MPC members do follow Catherine’s lead here. She should be commended for putting her view out so clearly, whether you agree with it or not – this is exactly where external members of the MPC can add value," Aikman said.

FINANCIAL CONDITIONS

Mann argues that forward looking financial markets have anticipated the apparently soon-to-be-reached peak in policy rates and that financial conditions have now begun to loosen, in part due to sterling depreciation and a falling equity risk premium. More dovish MPC members would say that much of the impact of previous tightening has yet to be seen, which is also Aikman's view.

"It’s clear from the most recent Monetary Policy Summary that they think we’re yet to feel the full effects of the monetary policy tightening over the past year. That’s my view too – I’m not convinced there has been a material shortening in the transmission mechanism," he said.

But, while Aikman considers the Bank to be right to steer away from publishing rolling assessments of policy multipliers, which would mechanically link changes in Bank Rate to likely changes in inflation, it should set out its view on policy transmission channels.

"I don’t think the Bank should publish a regular estimate of this policy multiplier ... That would unhelpfully take us down the road of viewing monetary policy as an engineering task, with predictable and mechanical effects. The world isn’t like that," Aikman said.

"But it should publish its collective understanding of the channels through which its monetary policy tools – Bank Rate and QE – affect the economy. The most recent description of this transmission mechanism is from 1999 and we don’t have one at all for QE," he said.

FINANCIAL CONDITIONS INDEX

Mann, in setting out how rate hikes are initially passed on through financial institutions, also published a new Financial Conditions Index which showed conditions had recently risen to near global financial crisis highs before easing back as the rate peak came into sight.

Aikman noted that Mann index added to an already large existing set of such indexes and it is not clear that it is an improvement.

"In working out how to value this measure, I would want to know whether it helps us better understand the transmission mechanism of Bank Rate to the real economy than existing measures. One immediate issue I have is that it suggests financial conditions in the UK were as tight recently as they were during the Global Financial Crisis when Lehman Brothers collapsed. That doesn’t pass the sniff test for me," he said.