Ménage à trois

Comments from Fed member James Bullard suggest the Fed, like the BoE, could soon have a three-way split. (Assuming Hoenig continues to vote for rate rises). This is becoming like the old economist joke about hiring two economists and getting three different points of view. So why have such extreme differences in opinion on these committees emerged? Macro Maestro suggests its a case of:

1. Huge uncertainty about the outlook. Though growth has slowed in line with what most commentators were expecting earlier in the year, it's incredibly hard to work out whether this is just a 'soft spot' or something more sinister. (Macro Maestro suspects the latter.) The economic models used by policymakers failed to predict the recession, so they are understandably reluctant to use them to try to forecast recovery. As these models have broken down, any existing consensus has fragmented.

2. Quantitative Easing has made it difficult to judge how loose current monetary policy is and what effect it is having on the wider economy. Some policymaker believe monetary conditions are so expansionary they are risking asset-price bubbles and further financial instability (eg the Fed's Hoenig and the BoE's Sentance), while others argue policy isn't yet doing enough. In the past, it was sufficient just to draw a Taylor rule to figure out the stance of monetary policy, but now with rates at zero, such analysis has become largely redundant. Most Taylor rules would now point to negative nominal interest rates. While QE might be equivalent to negative nominal rates, there is no way to judge how far negative.

This all points to a further period of inactivity from the Fed and the BoE. Unless of course, these economies slip back into recession. Then these differences in opinion would evaporate and central bankers will once again be united in doing everything they can to get their economies moving again.. And this time they might need to try something extreme. (See my next post.)