Why the MPC needs experts

There’s no doubt that Jonathan Haskel is an excellent appointment to the MPC. What we should be asking is rather: isn’t he over-qualified?

What I mean is that not much hangs upon interest rate decisions. The Bank’s own work estimates that a quarter-point rise reduces output only by around 0.15%. Granted, it’s possible that the economy might now be more sensitive than this to rate changes now. But even so, the cost of interest rate mistakes are small.

Put it this way. For a monetary policy error to have had the same cost as fiscal austerity or Brexit, interest rates would have had to rise to well over 10%. It doesn’t require somebody of Haskel’s intellect to see that that would be a stupid idea.

I suspect that the ratio of intellectual input to the stakes of the decision is greater for monetary policy than it is for any other decision in public life.

Which poses the question: why does the MPC need someone of Haskel’s expertise?

The question gains force from two considerations. One is that a lot of the job of setting interest rates requires you to interpret noisy high-frequency data and, arguably, to have market feel. Academic economists don’t have a comparative advantage here. The other is opportunity cost. If Haskel is thinking about whether to change rates by a quarter-point or not, he’s not doing other work, where he might well do more good.

There is an answer here. It starts from the fact that the MPC lacks direct democratic legitimacy. Of course, the inflation target is set by governments (and there’s been surprisingly little political debate about it) but the MPC itself is unelected.

And yet it has some power over us. Even the most modest rate rise destroys some jobs; that’s how it reduces inflation. And on the other hand, the lack of a rate rise means millions of savers forego some interest income. What legitimacy does it have to take such decisions? Governments have a licence to wreck the economy because that’s what voters want. The MPC has no such justification.

Which is why it needs experts. The job of MPC members is not merely to make interest rate decisions. It is to give legitimacy to the MPC by having the ability to explain monetary policy thinking to a sceptical audience of other economists, and to appear to the public as wise technocrats. Paul Tucker calls this “legitimacy through credibility”.

It was for this reason that Ben Broadbent’s remark about the “menopausal” economy attracted such attention. Technocrats acquire legitimacy by being grey and sober; ill-judged language detracts from this.

A decent trading-floor economist might well be able to take interest rate decisions as well as Haskel. But he wouldn’t have the authority with outsiders that Haskel has, nor – no doubt – the ability to construct genuinely interesting economic arguments.

Which brings us to a problem. Even the most genuine expertise, such as Haskel has, is not the only potential source of legitimacy. It’s also the case sometimes that people want decision-makers to be representative of those whose lives they affect – hence the complaints that the MPC is too male (and we might add, too white and too posh).

Now, I’m honestly unsure how much force these complaints have. What is clear, though, is that unelected policy-makers need some form of legitimacy; this is true not just of the MPC but of judges, quangos and so on. Expertise is one source of such legitimacy - maybe in most cases the best – but it’s not necessarily the only one. Unelected policy-makers should be chosen not just by their ability to take decisions, but by whether they enhance the authority of their office.

Comments

[e]

What if credible expert judgement wasn't only required to stand before their peers and explain, but also before the public who are affected? For example, be required to broadcast quarterly briefing with less jargon but not dumbed down. Over time democracy and fairness might feel better served. Perhaps, if any number of fields were involved, the lay observer/voters might get a better feel for how politicians, and commentators alike, can be inclined to interpret the expert to particular advantage; that more often its the interpretation that's stale and white, not necessarily the expert.

[Nanikore]

Three of the MPC members (including the Governor) are ex-Goldman Sachs. Is that the sort of legitimacy we want?

NK.

[Bill Posters]

Since when is expertise an overarching requirement to be on the MPC?

Andrew 'Death' Sentance was on the the MPC for four long years plus.

They are setting rates on the MPC. I want someone on there who knows what it's like to be seriously in hock. Someone with a big mortgage juggling impressive credit card balances. Someone who has been repossessed and maybe has a couple of ccj's against them.

[James Peach]

Bill that is the single most insane thing I have ever heard.

[derrida derider]

"a lot of the job of setting interest rates requires you to interpret noisy high-frequency data and, arguably, to have market feel"
"A decent trading-floor economist might well be able to take interest rate decisions as well as Haskel."

As a Marxist you should see what is wrong with this. Interest rate decisions may only weakly affect GDP (though that's arguable), but they have strong effects on the distribution of that GDP. It's basically why the old rich have always encouraged the worship of market sentiment and "hard money".

Perhaps read your Kalecki again.

[derrida derider]

And Bill Posters has pushed his point way too far, but it basically is the same point I just made. He aint insane, just angry.

[Robert Mitchell]

Central banks do more harm than good mucking about with interest rates. The Fed raised rates up to 2008, arguably triggering a default wave that set traders panicking to devalue the collateral value of Mortgage-backed Securities.

Today, the Fed pays interest on excess reserves to disincentivize banks from undercutting the policy rate. The unintended effect is likely a huge distortion in currency swap markets, where the law of covered interest parity has been in violation for a decade. Banks prefer to get the Fed's interest so dollar swaps now command a premium over borrowing dollars at published rates. If you want a free lunch, borrow dollars and then swap them into Euros and you will get back more dollars than you have to pay back. Economists are generally at a loss to explain the persistence of arbitrage opportunities in currency swap markets; one explanation proposed that the Fed's interest on excess reserves play a role in why big banks are not lending dollars below currency swap rates.

The existence of persistent arbitrage in the huge currency swap markets invalidates fair pricing formulas that rely on the assumption of no arbitrage. If central banks are contributing to the long-term arbitrage conditions, they are making prices arbitrary: free lunches exist, negative prices are possible, pricing is not bounded by textbook fair pricing equations.

[Ralph Musgrave]

Robert Mitchell (just above) is right to question the merits of interest rate adjustments. Milton Friedman and Warren Mosler (founder of Modern Monetary Theory) advocated a permanent zero interest rate. I've actually just published a paper supporting that "Friedman/Mosler" idea:

http://ralphanomics.blogspot.com/2018/06/the-merits-of-permanent-zero-interest.html

[Ralph Musgrave]

I'm on the scrounge.....The journal I'm submitting the paper to asks authors to suggest people who might review submissions. Anyone like to review my paper? It's about 5,000 words.

[Blissex]

«I want someone on there who knows what it's like to be seriously in hock. Someone with a big mortgage juggling impressive credit card balances. Someone who has been repossessed and maybe has a couple of ccj's against them.»

Bob Diamond? Any other CEO of one of the many massively bankrupt megabank?
Except that they sleep well, because the Fed and the BoE bend over to supply them with "liquidity" at near zero "friends of friends" discount rates.