The Bank of England's shifting target horizon

Andrew Haldane suggests inflation targets might be temporarily suspended; the targets are already flexible, it's the implementation that's flawed.

• Last year, the Bank of England tweaked the horizon over which they expect to meet their inflation target—but few noticed;

• This is constrained discretion in action;

• There is nothing much wrong with the UK monetary framework, but implementation needs a re-set.

Andrew Haldane, formerly of the Bank of England (BOE) and “rising star” of central banking, kicked off a new gig as contributing editor of the Financial Times this weekend. He has done so by suggesting that there may, at this time, be a case for temporarily suspending inflation targets.

Discretion constrained

Mr. Haldane argues that, after recent inflation performance, a temporary suspension of targets would be better than either overshooting further, which might “be a knock to central banks’ already depleted credibility,” or “shift[ing] up permanently the level of inflation targets, say to 3 per cent, reducing the scale of prospective inflation target misses.”

He goes on:

[A] preferred, option [for central banks today] would be to use the flexibility naturally built into inflation targeting. This could be done either by transparently lengthening the horizon over which inflation is returned to target, say, from one-to-two years to three-to-four. Or, more radically, given we cannot be sure exactly how long higher global prices will persist, by suspending inflation targets for a temporary period, with an accompanying promise to re-fix them at the earliest possible future date.

That is, Mr.Haldane emphasises using the constrained discretion built into inflation targeting as originally conceived, to improve the output-inflation trade-off, than kidding ourselves we can reasonably meet targets on time in the near future.

There is much to sympathise with here.

But the opportunity was missed by Mr. Haldane to illuminate precisely how the Bank of England, his previous employer, has already used her own constrained discretion in recent months—and what this tells us about the governance on the MPC.

But before telling that story, we note a curious anomaly between fiscal and monetary targets.

A fiscal precedent

As is well known, fiscal rules have “escape clauses” in the event of large shocks. But inflation targets apparently do not.

In the case of the EU’s infamous Stability and Growth Pact, a general escape clause is triggered in a severe economic downturn. Individual member states likewise can suspend domestic budget rules, as with Ireland’s Fiscal Responsibility Act. Even Germany’s irrational black zero is suspended during emergencies, most recently during the pandemic.

Yet, for central banks, even a temporary escape from an inflation target is not something monetary policymakers wish to acknowledge—presumably since this would be considered a dent to their credibility.

Never mind that the process of continually missing their target will itself dent their credibility!

But don’t inflation targeting frameworks embed such an escape clause already?

Inflation nutters

To be sure, deviations of inflation from target are already expected—central banks are not, we were once famously told, inflation nutters.

This is part of the constrained discretion that Mr. Haldane wishes to underline.

But there is more. The issue here is not simply temporary deviations target, but the discretion permitted in relation to the horizon over which inflation is returned to target in the event of outsized shocks.

In the United Kingdom such flexibility is already built into the monetary framework.

Indeed, the official remit for the Bank of England, which dates back to 1997, notes how in “exceptional circumstances, shocks to the economy may be exceptionally large or the effects of shocks may persist over an extended period, or both” in which case there is a trade-off between inflation and the variability of output that ought to be carefully considered in setting policy.

The Monetary Policy Committee (MPC) is therefore expected, under the remit, to promote an understanding of this trade-off and set “monetary policy to meet a forward-looking inflation target while giving due consideration to output volatility.”

Moreover, the MPC should “set out the horizon over which … it is appropriate to return inflation to the target.”

In other words, the Bank can already adjust the horizon over which they meet their target.

And, believe it or not, they did so last year.

But no-one, including Mr. Haldane it seems, appears to have noticed.

The Bank’s malleable target horizon

Everyone knows that in the event of a deviation of target by 1% in either direction the Governor of the Bank of England is expected to write a letter to the Chancellor covering the above considerations, promoting a public understanding of the path for inflation in light of the shocks hitting the economy.

How has the Bank of England used this communication device during the pandemic?

Not very well, one could argue.

If we consult the latest exchange of letters last December between Governor Bailey and Chancellor Hunt, we are informed that (emphasis added hereafter):

The economy has been subject to a succession of very large shocks. Monetary policy will ensure that, as the adjustment to these shocks continues, CPI inflation will return to the 2% target sustainably in the medium term.

What should be make of this “medium-term” clause?

Well, the exchange of letters has become a quarterly ritual by now (available here.)

Let’s select some of these at random to see how the horizon to meet the Bank’s inflation target has shifted.

• Initially, in mid-2020, it was judged that “the Committee is setting monetary policy so that inflation returns sustainably to its target at a conventional horizon of around two years.”

• By Sept-2021 it was reiterated that their aim was “to set monetary policy so that inflation returns sustainably to its target at a conventional horizon of around two years. … the Committee, in judging the appropriate policy stance, will as always focus on the medium-term prospects for inflation rather than factors that are likely to be transient.”

• But then, at some point by Sept-2022, the two-year horizon was dropped in favour of a reference to the MPC meeting the target in the medium-term “in line with its remit.”

So the Bank has shifted from emphasising their traditional two-year horizon for meeting their target over the course 2022.

Instead of two years “conventional horizon” the Bank has subtly changed the horizon to “the medium-term”—something sufficiently vague that they cannot be held to account for achieving this.

Moreover, it is worth noting that this change of horizon happened all the while the Bank’s official inflation forecasts showed inflation falling below target in about 2 years—alongside an ever increasing risk of deflation.

It’s almost as if they don’t believe their own forecasts. No-one else does.

In other words…

The Bank of England, Mr. Haldane’s former employer, is already permitted to “transparently lengthen the horizon over which inflation is returned to target.”

And they have.

But their “medium-term” fudge is only a convenient placeholder for “we don’t know.”

Such slippery leadership from the Bank rather undermines the purpose of the constrained discretion written into the remit.

And rather than educate the public, Bailey and company have engaged in classic obfuscation-through-language characteristic of the analytically challenged but unaccountable macroeconomics profession of which the Bank is a prime example.

As noted on this substack previously, central banks have failed to comprehend and manage the post-pandemic monetary overhang. In Europe, this has been compounded by an energy shock similar to that experienced in the 1970s.

Providing clearer guidance on the horizon over which inflation will be brought back to target is a minimum requirement for our central banks at this time.

Slippery language is not enough.

Still, there is no need for an inflation target escape clause because the Bank already has the in-built flexibility within the remit to respond to today’s challenge. They only lack the know-how to deliver on it.

It’s a pity Mr. Haldane didn’t use the FT to educate his readers on these details.

The content in this piece is partly based on proprietary analysis that Exante Data does for institutional clients as part of its full macro strategy and flow analytics services. The content offered here differs significantly from Exante Data’s full service and is less technical as it aims to provide a more medium-term policy relevant perspective. The opinions and analytics expressed in this piece are those of the author alone and may not be those of Exante Data Inc. or Exante Advisors LLC. The content of this piece and the opinions expressed herein are independent of any work Exante Data Inc. or Exante Advisors LLC does and communicates to its clients.

Exante Advisors, LLC & Exante Data, Inc. Disclaimer

Exante Data delivers proprietary data and innovative analytics to investors globally. The vision of exante data is to improve markets strategy via new technologies. We provide reasoned answers to the most difficult markets questions, before the consensus.

This communication is provided for your informational purposes only. In making any investment decision, you must rely on your own examination of the securities and the terms of the offering.  The contents of this communication does not constitute legal, tax, investment or other advice, or a recommendation to purchase or sell any particular security.  Exante Advisors, LLC, Exante Data, Inc. and their affiliates (together, "Exante") do not warrant that information provided herein is correct, accurate, timely, error-free, or otherwise reliable. EXANTE HEREBY DISCLAIMS ANY WARRANTIES, EXPRESS OR IMPLIED.