MNI INTERVIEW:Flat Rates Fit With Data Dependence-ExBoe's Bean

Policymakers can both make clear their preference for holding policy rates flat-for-longer and stick to the line that they are data dependent, former Bank of England Deputy Governor for Monetary Policy and LSE professor Charles Bean told MNI.

With central banks from the BOE to the Federal Reserve suggesting that they might hold rates at their peak for an extended period in a so-called “Table Mountain” approach, some including European Central Bank Executive Board Member Isabel Schnabel have pointed to a contradiction between committing to a flat rates stance whilst also promising policy will respond flexibly to incoming data.

But Bean drew a distinction between maintaining rates at a high level and previous promises to keep them low.

Low-for-long “is, if you like, committing to a period of excessive inflation in the future .. and is necessarily time-inconsistent as there is little incentive to go through with that bout of excessive future inflation once today’s lower-bound episode is past,” Bean said by email.

“The current situation is rather different. We are not talking about central banks committing to hold rates constant whatever happens. Rather it is about getting policy rates to the right general level early so that it can be held relatively flat with modest adjustments in the light of incoming data (‘Table Mountain’), rather than leaving it late and then having to move in big steps to catch up and in response to new information,” he said.

TABLE MOUNTAIN

The ECB on Thursday said it would keep rates at sufficiently restrictive levels for as long as necessary, and would also follow a data-dependent approach. BOE Governor Andrew Bailey also recently told lawmakers that the Bank had to make an “important judgement” over whether to hold rates at a relatively high level or push them up further and risk rapid reversal.

Monetary Policy Committee member Swati Dhingra, like Bean a professor at LSE, told lawmakers on Sept 6 that she preferred the Table Mountain approach, which would provide a smoother rate profile rather than the more jagged hike and reverse.

“With the latter strategy, because of the long and variable lags in the transmission mechanism, there is more chance of miscalibrating the necessary tightening and overshooting, so warranting an early reversal,” Bean said. “But with Table Mountain, upside news in the inflation outlook would still warrant tightening.”

A challenge facing MPC members is how to get the message to market participants that they are more likely to keep the policy rate on hold, getting them to flatten rate curves, while still being seen as ready to respond as data shift.

Policymakers are already indicating that the rate peak may well be close, with Bailey saying “we are much nearer now to the top of the cycle”, raising questions over how the MPC will alter its guidance accompanying its Sept 21 policy decision.

Bean, who was on the MPC from 2000 to 2014, said market participants need a proper understanding of the Bank’s reaction function, which would allow policymakers to hold rates pretty steady while markets do much of the work for them by adjusting rates curves. (See MNI INTERVIEW: Higher-For-Longer Rates Risk Volatility)

This, Bean noted, was the essence of former Governor Mervyn King’s “Maradona Theory” of interest rates, named after the legendary Argentinian football player who sliced through the England defense while running in a more-or-less straight line as opponents anticipated that he would shift one way or the other.