
Top central bankers say bigger monetary policy moves are more effective at anchoring inflation expectations and tackling economic uncertainty than smaller ones.
Catherine Mann, a member of the Bank of England’s monetary policy committee, told attendees of the Reserve Bank's (RBNZ’s) policy conference that gradual rate moves were becoming old-fashioned.
Mann voted to cut the United Kingdom’s benchmark interest rate by 50 basis points in February but was overruled by other members, who preferred a 25 basis point reduction to 4.5%.
“The Monetary Policy Committee collectively judged that a gradual and careful approach to the further withdrawal of monetary policy restraint was appropriate,” she said.
“Gradualism, as the preferred monetary policy strategy, was promulgated at a time when financial flows were small and markets stable. Gradual moves in the policy rate were seen to prevent monetary policy from creating excess volatility in financial markets, which would hamper transmission”.
But nowadays the financial markets themselves were the main drivers of volatility, particularly due to cross-border spillovers. International factors had overwhelmed policy decisions and driven outcomes in the short end of the yield curve.
“The founding premise for a gradualist approach to monetary policy is no longer valid. Hence, 50 basis points to cut through the turbulence,” she said.
“Monetary policy has to navigate through the choppy financial markets, the shock-ridden economies, and these stick and drifting [inflation] expectations. So larger cuts, as the one I voted for at the meeting, cut through this turbulence to more effectively communicate the stance of policy and to influence the economy”.
She called this an “activist monetary policy strategy” which was defined by large moves in policy rates and longer holds at desired levels.
Least regrets?
This style of strategy seems similar to the RBNZ policy choices throughout the pandemic. It quickly loosened monetary policy when the lockdowns first hit, and then tightened once inflation left the target range.
Now the Monetary Policy Committee has decided rates should be neutral, and it has been cutting in 50 basis point steps to get there.
The Reserve Bank has adjusted the Official Cash Rate 17 times since 2020, mostly in double or triple steps. Traditional 25-basis-point moves accounted for less than a third of these changes.
In contrast, nearly 90% of policy moves in the five years before the pandemic followed the 25-bps standard.
Critics would say it was exactly this strategy of large moves and overly long holds, which led to the mediocre economic outcomes New Zealand has experienced. Inflation is back in the target range but it took a serious recession to get there.
Paul Conway, chief economist at the RBNZ, said the “least-regrets approach” used by the bank during the covid response was closer to an activist strategy than a gradualist one.
“It wasn't incredibly different from other central banks, but we did go a bit higher, and we got there a bit more quickly. What I'm hearing is that may well have been an optimal response to the shock and the inflation that we were experiencing at the time,” he said, after the speech.
However, several conference attendees seemed skeptical of Mann’s activist strategy during a question and answer session.
Senior Fellow at Motu, Arthur Grimes and Treasury’s Dominick Stephens both asked about the negative externalities of more dramatic policy moves. For example, the RBNZ’s strong response sent house prices soaring and caused a “huge destabilisation of the economy”.
Mann’s response was that asset prices aren’t in most central bank remits and therefore shouldn’t be a priority in policy settings.
Another questioner challenged her idea that larger policy moves could be used as a way to counteract uncertainty. In a dark room, shouldn’t you take small steps, they asked?
“Part of the reason why the room is dark, or the fog hasn't lifted, is because monetary policy hasn't taken a decisive stance,” Mann replied.
8 Comments
Chicken or egg?......they have no idea.
Mann's comment about asset prices not being a central bank concern is a bit disingeneous methinks... especially in the New Zealand context?
No, absolutely not a central part of their current remit (or, at least, their interpretation of it) ...
But maybe that's the problem?!
I can see a major issue here. You have a bunch of central bankers and technocrats sitting around for self-reflection and backslapping when the majority of the popn has no idea what they're talking about. And to a large extent, you also have politicians and commercial bankers who also don't understand or partially understand.
It's one big circle jerk with scant attention paid to their own institutions and dogma creating the problems for which they think they're solving.
Exactly - in some respects CBs have become self licking ice cream cones. Made themselves important to be the hero’s who create financial stability by creating the financial instability they are fighting.
CBs have become self licking ice cream cones.
Wonderfully expressed and so apt.
No offence to Paul Conway, but I find it hilarious that he's harped on about productivity for much of his career while working for orgns that appear on the surface to be furthest removed from what he preaches.
I've said it before : Conway is the RBNZs Lord Farquaad
"Some of you may die but that's a price I'm willing to pay"
spoiler alert!
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