Friday, December 7, 2007

A cut with no im-pact (2)

Egg refuses to pass on rate cut to borrowers

"Egg will cut its SVR from 6.94 per cent to 6.79 per cent from January 1. A borrower with a £150,000 interest-only mortgage pegged at the lender's SVR will save £18.75 on their monthly repayments following the rate cut." C'mon this is hardly news!! I post more comments on why the BoE has lost control in the comments.

Posted by confused76 @ 10:54 PM (956 views)
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9 thoughts on “A cut with no im-pact (2)

  • Market fears that Bank has ‘lost control’
    http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2007/12/07/cnbank107.xml

    The rate cut gift that failed to dispel fear
    Lowering interest rates early has not restored confidence in a money market that is beyond control, writes Edmund Conwaythat failed to dispel fear
    http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2007/12/07/cnrate107.xml

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  • That’s because all of their customers are guinea pigs.

    Oh hang on …

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  • fahrenheit451 says:

    Re: Confused76, Telegraph: “A swathe of economists predicted borrowing costs could now drop to as low as 4.5pc or below by the end of 2008.”
    I would like to think that we are now seeing a re-adjustment where the margins for mortgages, etc are being re-evaluated. But to think that the financial markets are growing up (after a couple of centuries) is probably naive. Every new intake of recruits, perpetuate the same mistakes all over again.

    I am still predicting a drop to 5.25%, followed by a rise to 6%. Provided that some form of common sense appears, but its all going to be skewed by the impending General Election. Unless GBH learns from Houdini, there is very little he can do, and the silver surfers with their knobbled pensions are probably going to be the final straw. And with the dollar being manipulated out of existence, sanity is going to be in short supply. The much vaunted pegging with the petro-dollar is just the beginning.

    I would like to see how the Far Eastern influence works out over the next 4 or 5 years.

    =====
    Sorry about the absence just re-built the systems here (just got spiked and it took down several workstations), but I still think we have an unwanted guest (or two), but they are being very clever (they are no ordinary visitor either).

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  • Sorry about the absence just re-built the systems here (just got spiked and it took down several workstations), but I still think we have an unwanted guest (or two), but they are being very clever (they are no ordinary visitor either).

    I noticed the site was unavailable for a short while – was that coinciding with the rate cut announcement – or was that just heavy traffic?

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  • “…even though the Bank has now embarked on a major series of interest rate cuts for the first time in almost eight years”. so says the Telegraph. Has it?

    I thought this was a one off item…. fine tuning, balanced etc…?

    Is this (rate cutting exercise) becoming a currency rout?

    The Telegraph went on to say, “The sense of fear in the City was compounded by the severity of the Bank’s brief accompanying statement, which said: “Conditions in financial markets have deteriorated and a tightening in the supply of credit to households and businesses is in train, posing downside risks to the outlook for both output and inflation further ahead.” Oh dear, this could get akward..!

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  • @ F451 “I am still predicting a drop to 5.25%, followed by a rise to 6%”
    I would hope so but IMHO we will understand about future changes this coming week when details of the BoE vote are released

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  • C76, I remembered the name Rogoff, and found this article, the text had been blanked out in the html version. I hope you find interesting, and helps answer some questions, the info fairly recent and crucially before the start of the “credit crunch”.

    This is the html version of the file http://www.econ.ed.ac.uk/papers/Edinburgh.ppt.
    G o o g l e automatically generates html versions of documents as we crawl the web.
    To link to or bookmark this page, use the following url: http://www.google.com/search?q=cache:1nav9WPSosAJ:www.econ.ed.ac.uk/papers/Edinburgh.ppt+rogoff+central+bank+independence&hl=en&ct=clnk&cd=5&gl=uk
    Google is neither affiliated with the authors of this page nor responsible for its content.

    These search terms have been highlighted: 
    rogoff 
    central 
    bank 
    independence 

     
    How Robust is the New Conventional Wisdom in Monetary Policy? 
     
    The surprising fragility of the theoretical foundations of inflation targeting and central bank independence  
    Willem H. Buiter 
    Professor of European Political Economy, European Institute,
    London School of Economics and Political Science 
    Presented at the 2007 Chief Economists’ Workshop: Policy challenges to monetary theory at the Bank of England, Wednesday 18 April 2007
     
     
     
     
     
    2  
     
    Question: is the inflation-targeting operationally independent central bank ‘global best practice’? 
     
     
    Answer:
    As regards inflation targeting: either ‘yes, but …’ or ‘not really, but if only…’
    As regards operational independence: either ‘yes, but only if…’ or ‘no, unless…’
     
     
     
     
     
    3  
    Both relatively recent phenomena:
    Inflation targeting
    New Zealand 1989
    Canada 1991
    UK 1992
    Sweden 1993
    Euroland 1999 (the inflation target that dare not speak its name)
    USA 2006/07??
    Operational independence
    Old-style: Buba & Fed
    New-style
    New Zealand 1989
    UK 1997
    Japan 1997
    ECB 1999
     
     
     
     
     
    4  
    Inflation targeting 
    Operational expression of pursuit of price stability
    Does not have ‘deep microfoundations’ or conventional welfare economics foundations
    Has political mandate-based legitimacy
    for lexicographic/hierarchical inflation targeting in UK, Euroland, NZ, Japan
    for flexible inflation targeting (on steroids) in US
     
     
     
     
     
    5  
    4. Distributional consequences of imperfect indexation by markets or political institutions 
    3d. Absence of the long-run natural rate property.  
    3c. Static relative price distortions caused by nominal wage and/or price rigidities 
    3b. Intertemporal relative price distortions due to anticipated or unanticipated inflation & imperfect indexation by markets and political institutions. 
    3a. Menu costs of  anticipated & unanticipated inflation 
    3. Efficiency costs when the pecuniary opportunity cost of holding cash is independent of the rate of inflation or demand for cash is independent of its opportunity cost 
    2b. Distortions in the relative price of cash goods and credit goods 
    2a. Shoe-leather costs of active cash management 
    2. Efficiency costs through impact of anticipated inflation on opportunity cost of holding cash 
    1. Inflation as moral failure/sin (Bundesbank) 
    Table 1
    A taxonomy of the costs of inflation
     
     
     
     
     
    6  
    Optimal monetary policy 
    Shoe-leather costs and Bailey-Friedman optimal quantity of money rule
     
    Deflation is optimal 
      Menu costs (if attached primarily to changes in money wages)
     
     
    Deflation is optimal 
    Indexation failures in private contracts &
       instruments or public contracts 
    Better indexation is optimal
     
     
     
     
     
    7  
    Invalid New-Keynesian argument for price stability (based on Calvo-Woodford Phillips curve): it avoids relative price distortions between constrained & unconstrained price setters
    Argument only works if there are wage & price setters who never raise their money wages & prices, regardless of the economy-wide rate of inflation.
    Such Old-Keynesian wine in New-Keynesian bottles implies the existence of a stable, exploitable long-run unemployment-inflation trade-off.
     
     
     
     
     
    8  
    Calvo-Woodford New-Keynesian Phillips Curve 
       
    (1) 
     
     
     
     
    (2) 
    (3) 
    (4) 
    (strict Calvo-Woodford New-Keynesian: α=0, 0<β<1)           9           (5)  New-Keynesian Calvo-Woodford Phillips curve is the Old-Keynesian Phillips Curve, which has an exploitable inflation-unemployment trade-off across deterministic steady states! (Note: Calvo recognises this flaw and has corrected it in recent work which chooses    optimally).           10       (6)  (7)  (8)  The log-linear approximation at the deterministic steady state of the Woodford (2003) New-Keynesian model can be written as follows: equation (1) and           11   When is zero inflation optimal in this model?  Either     Constrained price setters keep nominal prices constant:   The natural level of output equals the efficient level of output:           12   Invalid New-Keynesian argument against price stability when there (a) is an exploitable long-run inflation-unemployment trade-off and (b) the natural rate of unemployment is higher than the optimum rate of unemployment because of real distortions. Based on the same Calvo-Woodford New-Keynesian Phillips curve. Optimum inflation rate between zero (which would minimise relative price distortions) and the positive inflation rate that would set the actual unemployment rate equal to the optimum level. Phelps, Friedman & Lucas have laboured in vain & have to return their Nobel Prizes.           13   Constitutional/legal mandate-based justifications for inflation targeting  Bank of England: price stability and subject to… ECB: price stability and without prejudice to… BoJ: price stability Fed: maximum employment, price stability and moderate long-term interest rates           14   Flexible inflation targeting  Central bank’s objective function has trade-off between price stability (squared deviation of inflation from target) and output gap stability (squared deviation of output from potential output). Problems No welfare economics foundations Not compatible with mandate of central banks whose primary objective is price stability, with anything else only subject to/without prejudice to achievement of primary objective           15   Flexible inflation targeting        (9)  (10)  Fed’s triple mandate should be           16   When price stability is primary target, correct operational objective is lexicographic or hierarchical inflation targeting, not flexible inflation targeting Flexible IT in practice often assigns monetary authority objective function with trade-off between inflation volatility and output volatility:     (11)  Should instead be:  (12)           17   Flexible inflation targeting  In addition to the non-lexicographic problem this adds: Assumption of no ‘inflation target bias’ Assumption of no ‘output gap bias’ Assumption that monetary policy cannot affect covariance between actual and potential output  Result: flexible inflation targeting becomes soft inflation targeting. Risk of upward drift in inflation rate (New Zealand, Australia, US).           18   Central bank operational independence  Freedom or ability of central bank (the Agent) to pursue its objectives as it sees fit, without interference or pressure from third parties (including the Principal(s)) Reasons for this particular delegation of authority are unclear. Standard story that this solves a commitment problem resulting in an inflation bias is unconvincing (Lohmann (2003) audience costs). In what follows, this delegation relationship is taken as given. Focus is on how to minimize the negative side effects. Note: neither Principal-Agent relationship, nor Fiduciary (Trustee – Beneficiary) relationship.           19   Unavoidable problems with operationally independent central bank: How to incentivise the Agent (central bank) to act in the interest of the Principal (government, citizens), assumed to be given by the central bank’s official mandate How to achieve political legitimacy for this delegation of authority to a substantively unaccountable body of unelected technocrats           20   “No One Likes Us – We Don’t Care”  Why do so many central banks & central bankers sound like Millwall FC fans? Good reason: William McChesney Martin’s punch bowl Bad reasons: Substantively unaccountable nature of central bank power Arrogance with which too often this power is exercised Mandate and mission creep           21   Central bank operational independence is not easily achieved  Requires Political independence (don’t take or seek instructions) Technical independence (does the central bank have the tools to do the job?) Financial independence & security from external raids on its financial resources Security of tenure and of terms of employment Independent body (court) to settle disputes           22   W: Financial net worth or equity  R: Foreign exchange reserves  N: Other financial liabilities     L: Private debt  M: Base money     D: Treasury debt  Liabilities     Assets  Table 2 Central Bank Conventional Financial Balance Sheet  Example: is the inflation target independently financeable by the central bank?           23       Comprehensive net worth or equity  T: Present discounted value of taxes paid to Treasury  E: Present discounted value of cost of running central bank  S: Present discounted value of seigniorage profits       (interest saved on non-interest-bearing monetary liabilities).  R: Foreign exchange reserves  N: Other financial  liabilities  L: Private debt   M: Base money  D: Treasury debt   Liabilities  Assets  Table 3 Central Bank Comprehensive Balance Sheet or Intertemporal Budget Constraint           24   ECB has achieved the highest degree of operational independence of any central bank Political independence Functional independence Financial independence Security of tenure Independent judicial review in case of disputes ECB also has operational target independence Just one potential chink in the armour, related to technical independence. Exchange rate policy is a joint responsibility of ECB and Council of Ministers.  What are ‘exchange rate orientations’, and who decides whether they are consistent with price stability? ECB is entirely correct that only ECB decides on exchange rate.  Anything else would drive coach & horses through operational independence.           25   Formal vs. Substantive Accountability  Formal accountability: reporting obligations (ex-post). Requires openness & transparency. Permits monitoring of Agent by Principal(s) Substantive accountability: Pay-off relevant consequences may follow after the reporting, explanation & justification.     Principals exercises judgement (imposes penalties or grants rewards) .           26   Highly operationally central banks like the ECB have zero substantive accountability; operational independence means no substantive accountability; e.g. incompetence does not mean getting fired, getting demoted getting a pay cut getting sued (probably). This applies with almost equal force to the Bank of England           27   ECB also one of least formally accountable central banks because of minimalist interpretation of reporting obligations (individual votes not in public domain; no minutes etc.) When there is no substantive accountability, enhanced formal accountability can help incentivise central bankers to give their best efforts. With better information on individual performance & competence, incentives can be enhanced two ways: The pride & embarrassment channel Post-central bank term of office employment prospects Selection of appropriate agents (Rogoff (1985), Besley (2005)). Special problems of group monetary policy decision making: Shirking (more serious problem the larger the group) Pathologies of group decision making (‘group think’, aggravated confirmation bias)           28   Limiting the domain of unaccountability  Lack of accountability is less apt to undermine the legitimacy of the institution & thus to threaten its independence if (a) there are clear performance benefits (‘output legitimacy’) (b) the domain of unaccountability is as restricted as possible.   It is as regards (b) that many central banks have made & continue to make serious mistakes, that may undermine their future independence.           29   Central banks should ‘stick to their knitting’  No participation as central bank in public debates about Fiscal sustainability Social security Structural reform Eurozone enlargement Anything beyond monetary policy, narrowly defined. These areas are outside the mandate of central banks and outside their areas of competence Central banks have right/duty to explain their reaction functions, that is, their contingent responses to developments in economy that are relevant to their price stability mandate, including fiscal developments Central banks should speak out when their operational independence is under threat.           30   To preserve operationally independent monetary policy making, the operationally independent central bank should, where possible, be turned into an operationally independent minimalist monetary authority  Main qualification: applies only to countries with well-development financial institutions and markets, not to emerging markets and developing countries with limited institutional capacity           31   Operationally independent central banks should be denied any of the following functions (for which a much lower degree of operational independence than that enjoyed by the ECB & BoE are appropriate): Supervision & regulation of banks, other financial institutions and financial markets Ownership, control & management of interbank clearing & settlement systems (ECB should divest itself of TARGET2;  New TARGET2 owner/manager should have guaranteed access to ECB liquidity) Ownership, control & management of financial securities clearing & settlement systems (ECB should not play an active role in proposed TARGET2-Securities; TARGET2-Securities owner/manger should have guaranteed access to ECB liquidity) An active role in prevention and mitigation of financial instability.           32   Question: Does the monetary authority have a natural role in the prevention and mitigation of financial instability? Answer: no, not in well-developed mature financial systems           33   Whatever institution(s) is (are) responsible for financial stability, a minimalist view of financial instability is essential Public policy-relevant financial instability: prevent or mitigate 3 kinds of pathologies: Disorderly markets.  Extremely rare; job for the lender of last resort, not for the monetary authority. Extreme credit booms and busts and asset market bubbles.     These are more common, but there is little if anything monetary policy can do about them. Credit policy, open mouth operations and fiscal measures are indicated. Defaults and bankruptcies that have material negative systemic externalities.  Very rare. A job for the lender of last resort and the Treasury, not the monetary authority. ECB favours a definition of financial instability that includes virtually any inefficiency in the intermediation process. It also lobbies for a supervision/regulation role for itself in the Eurozone. Extreme example of ‘mandate & mission creep’           34   Effective public policy towards financial instability requires cooperation and coordination of LOLR (short-term deep pockets), Treasury (owner of long-term non-inflationary deep pockets) & Regulator-Supervisor (information and knowledge).  Monetary authority need not be part of Financial Stability Squad (FSS), even though it has highly liquid short-term deep pockets provided by ability to issue legal tender at will.  Liquid deep pockets do not make central bank active LOLR: Regulator-Supervisor could be active LOLR, as long as it had overdraft facility with central bank, guaranteed by Treasury. Role of central bank/monetary authority in LOLR process could be entirely passive MoU between UK Treasury, FSA and BoE has one signatory too many.           35   Conclusion  Flexible inflation targeting risks setting back monetary policy to pre-1989 days & soft inflation targeting.  Lexicographic inflation targeting is the solution. The Calvo-Woodford New-Keynesian Phillips curve risks setting back monetary theory and policy 40 years. The solution is to forget it. Operationally independent central banks are substantively unaccountable and therefore invariably suffer from legitimacy problems. This problem can be mitigated by reducing scope of responsibilities and powers of operationally independent monetary authority to narrowest possible interpretation of pursuit of price stability. Unless central banks like ECB agree to ‘stick to their knitting’ and to desist from mandate and mission creep, they risk losing their operational independence even where it makes sense: in the single-minded pursuit of price stability.

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  • dohousescrashinthewoods says:

    Unwanted guest? “no ordinary visitor”?

    Surely our friendly government, with no objection to free speech, and their security services, appropriately restrained by the rule of law, couldn’t be having a sniff? Either that or general Russian/Chinese/US illegal use of any resources they can get their hands on to further their interests.

    I know some clever people in the IT security world if that’s any help.

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  • I’m sure its nothing too hot for farenheit451. Most intruders are ankle-biters looking for easy ways in – I work in infosecurity too.

    Someone certainly has issues with this site, which doesn’t surprise.

    That rate cut hasn’t really made a jot of difference to anything really now has it?

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