31 October 2012

BoE/Bean: Central banking in boom and slump

In the JSG Wilson Lecture at the University of Hull, Charlie Bean considers how policy was set during his tenure at the Bank of England, and considers what lessons have been learnt from the financial crisis.

Charlie Bean attributes the financial crisis to various factors. He suggests that households, businesses and especially financial institutions had increasingly underestimated the risks they were exposed to, resulting in a debt-fuelled search for yield. This was exacerbated by “pay packages that encouraged high-risk trading strategies; and informational deficiencies stemming from the underlying complexity of new financial instruments” among other things. 

He then explains a key new reform – to establish the Financial Policy Committee (FPC) with the responsibility of overseeing the stability of the financial system. As a member of the FPC, he describes its objectives and potentially what tools it will have once the Financials Services Act has passed into law. He also sets out some general principles on how the FPC might carry out its responsibilities.

He discusses the MPC policy of Quantitative Easing (QE). He explains how the policy works by pushing down on longer term interest rates, and sees little evidence that its effect on yields has diminished over time. But he does question “the degree of traction these lower yields have on demand at the present juncture”.  

He then discusses some of the alternative policy suggestions that have been made by various commentators. He notes that these can usually be “split into two legs: a fiscal leg, involving some bond-financed public expenditure and which ought to be subject to the control of the Chancellor and the Treasury; followed by a second monetary, or financing, leg in which the Bank buys the corresponding quantity of government debt on the secondary market and is just conventional quantitative easing". He notes that if an attempt is made to pass it directly to households through, say, a temporary income tax cut, one might expect “the vast majority of such a temporary windfall to be saved rather than spent” and so it “is not the obvious way to try to boost demand, unless one can direct the additional income to credit-constrained consumers who are more likely to spend it”.

He also discusses cancelling the gilts in the Asset Purchase Facility (APF) which he thinks “is not as good an idea as it sounds”. He notes that this would “deprive the Bank of the assets it needs to sell back to the market in order to suck the bank reserves out when the time comes to unwind the policy. It would also deprive the Bank of the wherewithal to pay the interest on the reserves in the mean time."

News release

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