samchain/econo-pairs-v1 huggingface dataset:
Mervyn King: Uncertainty in macroeconomic policy making – art or science? Lecture by Mr Mervyn King, Governor of the Bank of England, at the Royal Society conference on “Handling Uncertainty in Science”, London, 22 March 2010. Accompanying slides to this speech can be found on the Bank of England’s website. David Aikman, Philip Barrett, Sujit Kapadia, Mervyn King, James Proudman, Tim Taylor, Iain de Weymarn and Tony Yates (Bank of England) contributed to this paper. * 1. *  *  Uncertainty and public policy  Most questions of public policy relate to uncertainties. Answers depend upon an ability to understand and evaluate those uncertainties. Yet many commentators and members of the public want to believe in certainties. They want to cut through the thickets of caveats and technical difficulties to the “bottom line”. We see this in economic policy, weather forecasting and the interpretation of secret intelligence. Five years ago, the Bank of England and the Met Office held an informal seminar to exchange ideas on how to communicate measures of uncertainty to the general public. Although we failed to persuade broadcasters to explore the issues of economic and weather forecasting in more depth, the bilateral relationship which developed between the Bank and Paul Hardaker, who moved from the Met Office to take over the Royal Meteorological Society, flourished. Today’s conference is a tribute to Paul’s persistence. It could hardly be more timely.

In particular, economic outcomes are sensitive to the way people behave under uncertainty, and to their beliefs about the past, present and future. Perceptions of uncertainty affect behaviour. If enough people are uncertain about their future job prospects and save more as a precaution, that may lead firms to cut employment, so increasing the chance that jobs are indeed lost. But uncertainty about whether it will rain today does not change the weather. Beliefs adapt over time in response to changes in the environment; and this in turn affect show economic systems behave. Because the surrounding environment can affect economic decision-making, there are probably few genuinely “deep” (and, therefore, stable) parameters  3  This particular example is fortuitous for earth science and biology, since it helps us date rocks and the fossils they contain and chart continental drift, based on the history of changes in the magnetic field of the earth. BIS Review 36/2010  3  or relationships in economics. In contrast, in many settings in the physical sciences there are stable “rules of the game” (e.g. the laws of gravity are as good an approximation one day as the next). The study of decision making under uncertainty has a distinguished ancestry in economics. Frank Knight (1921) wrote about the difference between risk (where frequencies could be used to calculate probabilities) and uncertainty (where there was no objective basis on which to derive probabilities).
Moreover, nor can we forget that an independent agency’s efficiency is not impervious to its surroundings. Accordingly, to preserve the independence and prevent overload of these institutions, it must be recognised that their performance also depends on actions taken in other economic policy areas.6 Monetary policy is an evident example of this, especially in a monetary union such as ours in which the single monetary policy coexists with each country’s own macroeconomic policies. Indeed, the governance of Economic and Monetary Union recognises the need for the single monetary policy to be accompanied by fiscal and structural policies consistent with economic stability. With this goal in mind, a wide range of coordination and supervision mechanisms have been put in place, such as the Stability and Growth Pact (SGP) and the Macroeconomic Imbalance Procedure. Such considerations are also applicable to other areas of activity of independent institutions, such as financial stability and banking supervision in the case of the Banco de España. Indeed, these considerations justify central banks’ frequent calls for an appropriate economic policy mix. And it is in this framework of assurance of economic stability that citizens and politicians should place declarations by the independent monetary authority on economic policy conduct in general. In this respect, as I indicated earlier, the functions of the Banco de España include advising the Government and producing reports and studies. The present crisis provides us with a good example. The robust monetary policy actions of the ECB, necessary as they were, would have been insufficient had it acted alone.

Legal independence is represented in the institution’s own legal personality, which is different from that any other State or General Government agency may have. As a result of this personality, the Banco de España has the autonomy to assume contractual rights and obligations with third parties and to take decisions under its remit, which are legally binding for those concerned. Functional independence means that, under the principles of observance of the law and the general interest that govern its conduct, the Banco de España has the instruments needed to perform its function and the autonomy to decide on the internal resources and processes it deploys to fulfil the objectives assigned to it. This autonomy extends to its internal organisation (divisions, departments and posts, with their tasks and procedures). As an exception, a matter to which I shall return, there is currently the possibility of government review of some of its decisions in the supervisory sphere. Personal independence means that senior management, the Council members and employees of the Banco de España can do their work “independently” in the exercise of the functions entrusted to the institution. Here, independence means that in the decisions taken and in the attendant actions, members of the institution must be free from external interference and be guided exclusively by rigour and professional competence.
To achieve this, they engaged in “quantitative easing” and “credit easing” policies by expanding and changing the composition of their balance sheets. The goal of these measures was to mitigate the effects of the economic slump and stabilise financial markets in the face of high uncertainty (charts 8 and 9). One may wonder – and many people do – whether these policies have gone too far. While the jury is still out on unconventional measures,4 there is no doubt that the policy of lowering short rates to virtually zero and keeping them there was fully justified. Had this policy been too expansionary, it would have translated into inflationary pressures. Yet, much to the contrary, inflation in most advanced economies has been subdued and is, in some cases, still falling even five years into the crisis. Finally, heightened uncertainty in global financial markets has increased the demand for safe assets like government bonds. At the same time, the supply of such safe assets has decreased as investors have increasingly questioned the relative security of assets that were previously considered safe, a fact that is reflected in the down-grading of several sovereign bonds. With an increased demand for and decreased supply of safe assets, their price has been bid up and their yield pushed down. The Swiss case These changes in the supply and demand for safe assets are of particular relevance in the case of Switzerland.

This is not a question that can be answered by a clear set of facts that can inform a judgement of probabilities. And of course how the financial system responds to a shock is substantially dependent on the nature of the event. In assessing this question today, there are numerous factors to consider: •  The number of hedge funds, and their total assets under management, have increased dramatically since 1998, significantly more rapidly than total financial assets. Although they still represent a relatively small share of total financial assets, they play a significant role in some market segments. Total exposure of the major bank and non-bank financial intermediaries to hedge funds as a group may be larger today, but that exposure is probably more diversified than in 1998. Market participants seem to believe that average leverage in the hedge fund community, and the extent of leverage for the more highly leveraged hedge funds, is lower than in 1998, but clearly it is difficult to assess these issues with any precision. •  On balance, the quality of risk management by counterparties to hedge funds has, we believe, improved substantially since 1998. This is important, given the gaps revealed in market practice at that point. More on this later. •  Capital in banks and in the parts of the financial system affiliated with banks has increased significantly in absolute terms - that is, the major intermediaries are significantly larger than in 1998.
This trend began already in the mid-1990s, but it accelerated in the years preceding the crisis6 (see Figure 9). 4  Giavazzi, Francesco and Mishkin, Frederic: An evaluation of Swedish monetary policy between 1995 and 2005, Riksdag Committee on Finance, November 2006. 5  See for example Svante Öberg: Potential GDP, resource utilisation and monetary policy, Sveriges Riksbank, 7 October 2010. 6  Giavazzi and Mishkin (op. cit.) said that one reason why inflation had been low in the period 2002–2004 was that the Riksbank, since 2002, had begun to take house prices into account. However, in later papers Mishkin wrote that one lesson from the crisis is that that there are stronger reasons for monetary policy to counteract credit-driven asset price bubbles, see for example Mishkin, Frederic: Monetary Policy Strategy: Lessons from the Crisis, October 2010. BIS central bankers’ speeches  3  A comparison with a simple Taylor rule7 also indicates that the repo rate should have been significantly higher. A Taylor rule can indicate whether the level of the repo is reasonable. Based on inflation measured in terms of the CPIF or the HICP8 and the GDP gaps I presented earlier, the repo rate, according to the Taylor rule, should have been around 7 per cent in the third quarter of 2008. I now believe, as I said earlier, that the presented positive GDP gaps are exaggerated.

The conclusion that it could take quite significant interest rate rises to halt the accumulation of financial imbalances is also more in line with the Yellen camp’s view. It points to the limitations of the policy that the Borio camp argues should be given a greater influence, or possibly even be the main aim of monetary policy. Inflation targets are necessary However, as I have discussed, in this respect it is necessary to go a little deeper into the analysis. More specifically, the issue of whether it is really necessary to have a target for inflation at all needs to be addressed. Would it not be possible for monetary policy instead to focus on attempting to counteract the accumulation of financial imbalances and allow inflation to develop as it will? As I see it, this would not be an appropriate set-up. In my view, it is extremely important that there is an inflation target in which there is confidence, and that that target is set at a sufficient distance from zero. It is quite common that debaters who advocate a new type of monetary policy omit to discuss the problems that could arise if the central banks were to abandon their inflation targets. This is also the case in the Swedish debate. If the central banks were to abandon their inflation targets in the current situation, inflation would almost certainly fall and there would be a large risk that inflation and inflation expectations would become permanently stuck on a very low level.
A businessman who owes more than he owns should be honest about it, she says. “… But what do you want [the businessman] to do?” asks Tjælde. “ To lay all his cards on the table, and so ruin both himself and the others? … In that case we should see a thousand failures every year, and fortunes lost one after the other everywhere! No, you have a level head, Valborg, but your ideas are narrow.” And this play by Bjørnson was written in 1875. Three imbalances in the world economy The financial crisis triggered the largest decline in output in advanced economies since the Second World War. The financial crisis erupted after a period of substantial debt accumulation among households and banks, combined with a real estate boom in the US and in some European countries. There were numerous examples of creative accounting as practised by Bjørnson’s businessman, Tjælde. The bubble burst, but extensive government measures helped put banking systems more or less back on their feet. Interest rates are close to zero in advanced economies, and governments have increased purchases of goods and services and reduced taxes. Many emerging market economies are exhibiting vigorous growth. But imbalances are building up, making the recovery fragile. 1  Bjørnstjerne Bjørnson, Three Dramas. The Editor – The Bankrupt – The King. 2009. This eBook is for the use of anyone anywhere at no cost and with almost no restrictions whatsoever.

The basis for calculating income tax was expanded, rates were reduced and corporate and personal income taxation was better integrated. Distortions were remedied, bringing business and economic returns more closely into line in the case of business investment. More neutral tax rules reduced the scope for companies and industries to obtain special tax advantages. The reform contributed to solid economic growth in the 1990s and a substantial increase in government tax revenues even with appreciably lower tax rates. BIS Review 15/2010  9  But the wave of reform ebbed out before the work was completed. There is now a striking contrast in the quality of various components of our tax system. There are major weaknesses in the taxation of wealth and property. First, income and the value of various types of capital are taxed differently. The return on and value of financial capital and business capital are fully taxed. Rental income is fully taxed, while owner-occupied dwellings are exempt from a corresponding tax. Mortgage interest is tax deductible while capital gains on dwellings and the benefit of home ownership are not taxed. Housing is taxed as an asset, but not at its market value. The table shows the distortionary effects of the tax system. Housing investment is considerably more profitable than repaying debt or investing in a business. This is the case for those who pay wealth tax and for those who are not liable to wealth tax. Second, property is taxed differently across municipalities.
This is, above all else, a matter of human health and welfare. The front line of combatting the challenges of Covid-19 comprises the extraordinary efforts of NHS health professionals, Public Health Officials and volunteers across the country, as well as the exceptional support by the FCO to UK citizens abroad. We are fortunate in this country to have the infrastructure, expertise and dedication in public health that we do. The Bank of England’s role is to help UK businesses and households manage through an economic shock that could prove large but will ultimately be temporary. The Bank will take all necessary steps to support the UK economy and financial system, consistent with our statutory responsibilities. Our policy arsenal includes monetary policy instruments, special liquidity facilities, and macroprudential tools. We are also coordinating with HM Treasury to ensure that any initiatives are complementary and that they will collectively have maximum impact, consistent with our independent responsibilities. And lines of communication are wide open with our international colleagues at the G7, G20 and the IMF. While there will be differences in the exact timing and form, the collective impact of our efforts will be both powerful and timely. The Bank are monitoring the situation closely across all our functions and ensuring all necessary contingency plans are in place in the private financial sector and at the Bank of England itself.

In 1998, the early days of the Great Moderation, GDP-at-risk was benign – that is, even in a tail outcome the level of GDP was expected to be higher three years out. Through the next decade, though central case GDP grew steadily, risks were gradually building. By 2007 a fifth percentile draw was expected to leave GDP 3.5% lower three years out. As the crisis hit, GDP-at-risk shrunk rapidly as risks crystallised. Since then, risks have been relatively stable reflecting post-crisis balance sheet repair, the implementation of comprehensive macroprudential frameworks, and relatively subdued economic activity (Chart 6). Chart 6: Risks grew during the Great Moderation but are now standard 2007  Latest  Probability density  1997  0.14 0.12 0.10 0.08  Risks increasing  0.06 0.04 0.02 0.00  -10  -8  -6  -4  -2  0  2  4  6  8  Cumulative GDP growth over 3 years (%)  10  12  14  [Chart 6 uses same data as Chart 5. For each distribution, shaded area denotes the tail; the line marks the 5th percentile]. 14  All speeches are available online at www.bankofengland.co.uk/news/speeches  14  2. Impact on growth The second set of differences between macroprudential and monetary policy concern the interaction between their objectives and growth in the short and long terms. Both monetary and macroprudential objectives apply at all times.
BIS central bankers’ speeches  13  Table 1: Estimated wage Phillips curves including measures of expected inflation Nominal wage growth(a) (1) (2) Wage growth (t-1)(a) Productivity growth(a) Unemployment gap Labour share (t-1) 2-year household inflation expectations (t-1)(b)  -0.31*** (0.09) 0.36*** (0.11) -2.22*** (0.36) -0.52*** (0.14) 1.13*** (0.35)  5-year breakeven inflation rate (t-1)(c) Interaction with inflation targeting dummy Constant  Observations R-squared  -0.35*** (0.09) 0.31*** (0.10) -2.23*** (0.36) -0.33** (0.17)  -0.14 (0.29) 0.02 (0.02)  1.02*** (0.28) -0.04 (0.29) 0.03* (0.02)  105 0.50  101 0.50  Sources: Barclays Basix; Bloomberg; Bank calculations. Notes: Estimated using quarterly data between 1987 Q1 and 2014 Q4. (a) Annualised quarter-on-quarter growth. (b) Excludes the period between 2012 Q2 and 2013 Q1 due to effects of the CPAC review on RPI-linked financial instruments. (c) Barclays Basix 2-year head household expectations. It is possible to simulate the effects of lower inflation expectations on the MPC’s February Inflation Report projections using the estimated wage relationships from Table 1, together with the Bank’s general equilibrium forecasting model. Chart 25 shows the effect on wages and inflation. Wage growth ends up around 0.3 percentage points lower at the twoyear horizon, while inflation is around 0.4 percentage points lower, than in the MPC’s central projections. Taking seriously recent falls in inflation expectations would add to the scale and duration of potential downside risks to UK inflation in the period ahead.

Chart 16: IMF estimates of global price Phillips curve slopes Interquartile range  Median 2.0  1.5  1.0  0.5  0.0 1961 1967 1974 1980 1986 1993 1999 2006 Sources: IMF (2013). Chart 17 shows the results from this exercise. Wages and prices are both weaker throughout: at the two-year horizon, wage growth is 0.6 percentage points lower than in the February Inflation Report, while inflation is 0.2 percentage points lower. In other words, a flatter Phillips curve would generate a downside risk to the inflation outlook at the policy horizon. A final explanation for the wage puzzle is that weak wages are signalling that the output or unemployment gap is larger than currently estimated. There are a number of potential sources of such additional slack, including greater spare capacity in firms, a greater willingness among workers to increase their average hours, or a lower long-term rate of unemployment than is currently estimated by the Bank.10 How much additional slack? Imagine you asked yourself how much slack would be needed to resolve the wage puzzle of the past few years. Even with a very conservative estimate of the Phillips curve slope, the implied degree of slack could be somewhere close to 4%, materially above the MPC’s current central view of slack of around ½%.
As you are aware, the Comprehensive Assessment of major banks undertaken by the ECB marked the start of a trilateral relationship between banks, National Competent Authorities and the ECB in its role of supervisor of banks in the Euro area. The Single Supervisory Mechanism’s micro-prudential responsibilities will complement the existing ECB’s macro-prudential role in shaping the future of banking in the Euro area. Banking supervision, viewed as one of the tools at the disposal of the ECB, will help ensure financial stability which is needed to sustain macroeconomic growth. The demanding Asset Quality Review and stress tests coupled with an overall result that  BIS central bankers’ speeches  3  exceeded expectations set a positive mood in the market and should lead to easier access to bank funding for investment growth. Financial sector dimension of Malta’s competitiveness Turning to the Maltese context, it would be a pity if the low-cost credit conditions that are being offered by the ECB are not fully exploited in Malta. Broadly speaking, the overall participation in the TLTRO programme by core Maltese banks has been somewhat disappointing, with the participation of very few banks and with the actual take up being way short of the limits available. On the positive side, we have noted the introduction of a lending scheme that a domestic bank is funding from the ECB’s TLTROs. These TLTROs provide funds at very favourable terms – at a very low interest rate that is fixed for four years.

Some of the salient features of the Act, as can be read in the Consultative Paper prepared for this workshop are:   provisions to strengthen the legal basis, ownership and structure of Bank of Zambia as a modern central bank, as well as its primary objective;    provisions relating to adequate power and independence;    provisions relating to all aspects of the relationship between the Bank and Government structures;    institutional arrangements of the Bank including the appointment of governors, directors and auditors, internal budgets, reporting requirements, preservation of confidentiality and handling of possible offences;    adequate mechanisms for good governance and security of tenure for Governors;    measures to better manage and application of monetary policies, including the role of lender-of-last-resort, interest rate policies, exchange rate policies and Bank of Zambia’s involvement in money and foreign exchange markets;    creation of a Monetary Policy Committee; and    accountability to Government, Parliament and the Public. By tabling this draft Act before you the Stakeholders, the Bank of Zambia wants to maximise its consultative process by taking into account your views on this layman’s draft. We encourage constructive debate and assure you that your views will be taken into account before the draft is transmitted to our parent ministry, the Ministry of Finance and National Planning. The Ministry is responsible for initiating the legislative process that shall see this layman’s draft transformed into a Bill and tabled before Parliament for debate.