It has become a running joke within the think tank that all I do is talk and talk about the Bank of England. Truth be told, I do like talking about central banking, and much to the dismay of my fellow colleagues, I am about to comment on the Bank of England once again.
Well, kind of. I have been rather critical of the Bank in the past, and I promise it will be quite different this time. In what one could call character development, I have become quite sympathetic to the good people working there; I do actually want to work there someday.
Explaining my sympathy towards the Bank will require some building, so let’s start laying down the metaphorical bricks. Macroeconomists have long been searching for their ‘holy grail,’ something sacred, a so-called magic bullet that responds to and solves recessions while keeping inflation well under control.
Some economists have claimed that we have found this holy grail since the central problem of macroeconomics, depression prevention, has been solved. However, I remain sceptical. Macroeconomic policy has had a turbulent history. In the wake of the Second World War, full employment targets were the norm. After a period of awful 70s stagflation, Milton Friedman exposed the inflation-accelerating nature of full employment policies, and they were replaced by money growth targeting. Yet, even this focus on money growth was short-lived, and ever since the introduction of central bank independence in 1997, policymakers have sworn allegiance to inflation-targeting.
Hindsight is 20/20, the saying goes. In retrospect, it is quite easy to view the failures of past macroeconomic policy approaches and speculate that a holy grail may, sadly, not exist. And why would it? While one can distinguish between good and bad policymaking, economic change - which itself is propelled by policymakers - can drive any good decision into the dirt.
Yet, for a long time, it did look like central bankers found their holy grail of policymaking. Through my own calculations, since the Bank’s independence and subsequent inflation-targeting focus, inflation has averaged within the Bank’s symmetrical target at 2.4%. If one were to look at these averages, it would be obvious to conclude that inflation targeting has been a resounding success up to the recent uptick in inflation. How could the Bank allow inflation to reach over 11% if it had the correct policy approach?
To answer this, it is first useful to consider whether the meeting of targets serves as a good proxy for measuring the soundness of policy. When shocks arrive, they derail targets and, by implication, expose errors within our current policy and highlight the need for change. This is a costly yet necessary component, and fortunately, it is rather overt. Anyone looking at COVID-era inflation can tell that something did indeed go wrong.
However, shocks that derail policy targets do not necessarily mean that the current consensus is useless or wholly incorrect. Healthy people who do not smoke, drink, or eat unhealthily still succumb to various cancers and illnesses, but this does not mean that they did anything ‘incorrect.’ Sometimes, we are just awfully unlucky.
Yet, the reverse is also true. You may make many blunders in a game of chess, but if your opponent is equally bad or even worse, you will win the game, potentially believing that you may be related to Magnus Carlsen. This sounds quite delusional, but it does happen, and it is precisely what has happened in the world of central banking. For years, policymakers have operated within Mervyn King’s ‘nice decade,’ where they have been used to favourable disinflationary conditions that had cemented inflation targeting - and the modelling accompanying it - in their minds, as a pretty perfect policy. Even the Global Financial Crisis, which, while disruptive to GDP, had not moved inflation beyond the central bankers’ grasp.
Measuring policy against targets can fool us into thinking that we have finally found this holy grail. Here, I have found sympathy towards Bank economists. One can quite easily see how decades of success lead to a very human problem of arrogance. Again, inflation targeting has had a jolly history. Two decades of hitting your inflation target, on average, is pretty damn good. Why on earth, as an expert, would you listen to critical schmucks like myself? Mainstream economics can become quite ignorant, and it's easy to see why.
Policymakers must keep an open mind. The central question to central banking shouldn't be: ‘how do we find the holy grail of policymaking?’ Instead, it should be, ‘if we found the holy grail, how can we test this without collateral damage?’
I suggest that the solution is to allow heterodox views to permeate the mainstream. Here, ideas that do not have full empirical or academic backing can be fully explored and considered. Policymakers need to recognise that just because targets are being met, that does not mean that the current approach of the time is totally better than another when times are good.
When you consider various strands of economic thought, you pay attention to a wider array of targets and data. This means that when times are bad, you see a proportional increase in lessons learned. Policymakers need to give up on their search for the holy grail. It does not exist. The best way forward for economics is one that maximises the lessons we learn when things do go wrong.