As an addendum to the previous post, it is often argued that central banks are all the same, and that behind apparently different mandates they all follow the same model. This is wrong. Adam Posen, a member of the Bank of England Monetary Policy Committee has just given a speech in which he looks at the data, balances the risks and comes out clearly in favour of additional monetary stimulus. Compare, for instance, the following two paragraphs from that speech with yesterday’s ECB statement.
In every major country, actual output has fallen so much versus where trend growth would have put us, and trend growth has not been above potential for long enough as yet, that there remains a significant gap between what the economy could be producing at full employment and it currently produces. Thus, policymakers should not settle for weak growth out of misplaced fear of inflation. If price stability is at risk over the medium-term, meaning over the two- to three-year time-horizon for the MPC’s decisions, it is on the downside.
There are, however, some very serious risks if we make policy errors by tightening prematurely, or even if we loosen insufficiently. Those risks are not primarily the potential for a double-dip recession or even of temporary measured deflation. While bad, those situations would still be within the range of short-term cyclical developments, and could be weighed against simple inflationary pressures from monetary policy trying to stimulate too much. The risks that I believe we face now are the far more serious ones of sustained low growth turning into a self-fulfilling prophecy, and/or inducing a political reaction that could undermine our long-run stability and prosperity. Inaction by central banks could ratify decisions both by businesses to lastingly shrink the economy’s productive capacity, and by investors to avoid risk and prefer cash. Those tendencies are already present, and insufficient monetary response is likely to worsen them. The combination of those risks with the potential attainable gains motivates my call for additional monetary policy stimulus.
There Is An Alternative (TIAA) to the ECB!
I might add that I am by no means an uncritical fan of Posen, who in my view badly misinterpreted the reasons for Germany’s until-recent economic stagnation. For an early statement of the ways in which monetary policy can create dangerous self-fulfilling prophecies, as argued above by Posen, see here. That piece was directed at the ECB’s failure to jolt Europe out of sluggish growth in the mid-2000s, but, unfortunately, remains topical.