The MTFS or the EMS: Which Way for Credible Monetary Policy?

Since the latter part of 1988, the primary policy objective has been to head off a rise to double digit inflation. To this end, interest rates have been raised from 7112 per cent to 14per cent, while the public sector is running a large fiscal surplus. Despite this apparently very tight policy stance, policy is deficient in a crucial respect: it lacks credibility. The all too public divisions within government have weakened the efficacy of monetary policy, especially in financial markets. The ongoing uncertainty over who is in charge of the conduct of policy - No. 10 or No. 11 - further undermines confidence. The most urgent priority must be to reassert clear priorities and guidelines. In this Viewpoint, we consider how best to restore the credibility of monetary policy. There are two main possibilities: first, to reassert the Medium Term Financial Strategy (MTFS) in an appropriate form; or to join the (Exchange Rate Mechanism of the) European Monetary System (EMS). We argue that it will be very hard to derive credibility benefits from a reassertion of the MTFS: because of the inflation record of the past decade and the twists and turns of past versions of the MTFS, a mere restatement will not resolve the uncertainties that result from known differences within the government. In particular, any restatement will rely on discretion and judgement in its implementation and this will weaken its beneficial effects on expectations. Instead we argue that entry into the EMS offers a tougher and more credible commitment for monetary policy. The Chancellor has been pushed to rule out UK entry until the second half of 1990 at the earliest, but the government should make a virtue of this by announcing a firm dale for entry next year. In the interim, it should encourage a debate about the appropriate rate for entry, a debate which will increasingly guide the foreign exchange market. The government should make it clear that in choosing this rate it will do so with the commitment to low inflation very much in mind, favouring a high exchange rate. Once in the EMS, the government should rule out the possibility of devaluing the pound in an EMS realignment. This provides a firm non- discretionary anchor for both monetary policy and inflation expectations. With this commitment, the principal gain from EMS entry will be establishing a regime of low inflation for the next decade: in this, choice of the exchange rate will be less crucial than the fact of entry.     

Assumptions–Central Forecast

We continue to make our best guesses about likely policy developments rather than assuming 'unchanged' policies. In the central forecast we assume that the broad thrust of policy is unchanged, i.e. we have made the technical assumption that the present government is returned in the next General Election. But, because an election must be held within the next 15 months, we also consider the medium-term prospects under alternative economic policies. (For details see p. 19.) In the central forecast. e herefore. we assume that policy will continue to be guided-though not completely determined-by an extended Medium- Term Financial Strategy (MTFS). For 1983-4 the MTFS requires the PSBR to be 23/4% per cent of GDP at market prices. Given official inflation and output forecasts, the Chancellor is therefore aiming for a 1983-4 PSBR of £8bn (Autumn Statement, p. 13). In the central forecast. however, we have assumed that the Budget of 15 March will give greater weight to the political objectives of cutting income tax and maintaining the attack on inflation, even if this implies slippage from the MTFS targets. Specifcally we have assumed that the standard rate of income tax will be cut by lp. that personal tax allowances will be raised by 12 per cent and that indirect taxes will be raised by only half the amount required for full revalorisation. This amounts to a total tax giveaway (compared with unchangedpolicy) of £1 1/2 and results in a PSBR of just over £9bn. 3.1 per cent of GDPat market prices.     

The London Business School with Gower Publishing

The economic recovery, which was gathering momentum in the second half of last year, was stopped in its tracks first by the US-led resurgence of interest rates last A utumn, and then by the harsh winter. There were some encouraging signs of recovery again this Spring, but the latest indicators, most notably from the recent CBl Survey, are disquieting. This time last year we took the view that a spontaneous recovery would occur as destock-ing came to an end. That forecast has proved correct on demand but over-optimistic on output - a very high proportion of the extra demand was met by imports. The scope for further spontaneous recovery is now limited and our growth forecast, especially for 1983, depends on the authorities taking some reflationary action.
It is now being debated how and when such reflation should take place - there is talk of an Autumn Budget. In effect the authorities have to decide a) whether there is scope for reflationary fiscal action within the PSBR guidelines of the Medium-Term Financial Strategy; b) if so, whether such action is more appropriately taken in the A utumn or next Spring; c) if in the meantime interest rates could be brought down while respecting the MTFS targets.     

Economic Viewpoint Bringing Counter-Inflation Policy Back on Course

There is no doubt that the monetary limit for the first year of the Government's Medium-Term Financial Strategy will be grossly exceeded, The reported figure for sterling M3 is likely to show a growth of 16 per cent to 18 per cent for the financial year compared with the upper limit of 11 per cent. This is a setback for the government's counter-inflationary policy but not a disaster. The likely overshoot can be largely (but not completely) explained by the removal of the Bank of England's Supplementary Special Deposits Scheme (the corset). Its significance is best understood if we re-examine monetary history since June 1978. (when the corset was imposed). A reasonable interpretation is that the money supply has effectively been growing at an annual rate of 15 to 16 per cent for the past three years (Details are shown in Table 4 on p. 12.) In retrospect it can be said that last year's monetary policy (but not that of the previous two years) was defensible in the light of the shock to prices caused by the oil price rise and the increase in VAT. We did in fact argue in Economic Outlook of June/July 1979 (“Price Shocks and the Economy”) that if the UK'S past record of monetary control had been better we would advocate a relaxation of monetary policy to accommodate these shocks. In the event monetary policy was relaxed (albeit unintentionally) and the squeeze on the real money supply was less severe than appeared at the time. However, there must be a steady reduction in monetary growth from now onwards if the government is to maintain its current progress in reducing inflation. We believe that such a policy is feasible and will be successful However the government must stick to the fiscal policy set out in the Medium Term Financial Strategy (MTFS). Our preliminary estimates suggest that, if Current public expenditure plans are fulfilled, there may be little or no scope for a reduction in personal taxation in 1981-82. Further ahead, the danger point, on past experience, will be 1983 when the economy should be on a strong path of recovery and inflation should be well below current rates. That is the point at which upward pressures on the money supply are likely to reappear and will have to be resisted     

Tightening the Fiscal and Monetary Controls

The Medium-Term Financial Strategy (MTFS) is a new departure in post-war policy-making. As David Smith's Briefing Paper shows the ideas behind it are well rooted in historical experience, but nevertheless it was inevitable that there would be a major element of trial and error in the early years of its use. The experience of 1980-81 however has produced some alarming results. The monetary limits have been drastically exceeded and the PSBR is likely to be far above the original target. There are two possible explanations. Either the control system is gravely defective or the government has deliberately followed the kind of short-term discretionary policies (and has indulged in the kind of ad hoc interventionism) which the strategy was expressly designed to avoid. We believe that both explanations are true. It is also probable that they reinforced each other. The first year of the strategy was likely to be the year of greatest strain. It involved a highly ambitious attempt to reduce inflation at a time when cost pressures from wages and higher energy prices were particularly strong. The strains rapidly revealed the defects in the control system. Since the government was alarmed at the short-term consequences of its policies, it chose to make a virtue of necessity and in effect suspended its commitment to the control of sterling M3. It is possible to look back at 1980 and to say that, in the event, the government's loss of control over its policies was justified as statesmanlike flexibility. But there always appear to be good reasons for sacrificing long-term objectives for short-term expediency. The MTFS was intended to avoid the chronic tendency to accept the easy option. It is essential that in 1981 the commitment to the MTFS should be re-established and that it should be reinforced, as appears to be necessary, by a system of indicators and controls to ensure that the errors of 1980 are not repeated. Otherwise there is a serious risk that the hard-won gains in the fight against inflation will be lost in the economic upturn. In the first part of this Viewpoint we examine what happened to fiscal and monetary policy in 1980 and discuss the general lines that policy should follow in 1981-82. We conclude that in order to get fiscal policy back on course the authorities should aim for a PSBR of £10 bn in 1981-82. In the second part we discuss in more detail the reasons why monetary policy went so badly astray in 1980, focusing particularly on the role of the Bank of England. We argue that just as ‘dirty floating’ (i.e. the pursuit of exchange rate objectives) may threaten the monetary targets, so ‘dirty monetarism’ (i.e. the pursuit of interest rate objectives) may prove an even greater threat. We conclude that the discretionary activities of the Bank of England contributed to the excessive monetary growth in 1980, and that it is necessary to ensure that in future the Bank should conduct its policy on a non-discretionary basis.     

Assumptions

We continue to make our best guesses about likely policy developments rather than assuming 'unchanged' policies. In particular we assume that the Budget in the spring of 1983 will give greater weight to the political objective of cutting income tax than to maintaining the fiscal and monetary limits set by the Medium-Term Financial Strategy (MTFS). We therefore expect the PSBR, after falling below the planned level in the current financial year, to rise above the target jigure in the 1983-4 and 1984-5 financial years. We expect sterling M3 growth to mirror this and to be siightly below the upper end of its target range for the current financial year, slightly above in the following two financial years. The MTFS does not cover the period beyond 1984-5. We assume that the broad objective of reducing the PSBR is continued in 1985-6 and 1986-7. despite the expected overshooting of targets in earlier years.     

Public versus private provision of liquidity: Is there a trade-off?

To what extent is public debt private liquidity? Much policy advice given in the aftermath of the financial crisis rests on the assumption that increasing public debt relaxes borrowing constraints of private households. This is the case for ad-hoc debt limits, which are exogenous to public policy. Instead, if debt limits are fully endogenous, as e.g. in the case of the natural borrowing limit, public debt has no impact. We assume that borrowing limits arise because of limited contract enforceability and are therefore determined as equilibrium outcomes. Using an incomplete markets economy in which households are subject to uninsurable earnings shocks, we show that public debt provides some liquidity, but less so than it would if constraints were imposed ad-hoc. We show that generating borrowing constraints as an equilibrium outcome substantially alters the answers to other important questions, such as for the welfare effects of government debt or its impact on real economic activity.     

4 Years to Abolish Unemployment

Arguments for the reduction in unemployment in the UK have ranged from reflation to cuts in taxes (or benefits). Professor Tom Kronsjö (right), of the University of Birmingham, argues that return from work over benefits must be substantially increased if unemployment is to fall. His analysis is provocative, but his figures should stimulate thought and debate.     

[2] Assumptions

We have attempted in this forecast to make our best guesses about the likely development of policy over the coming years rather than to assume 'unchanged policy'. We assume that, at least until 1984, the broad framework of policy will be that provided by the Mediwn-Term Financial Strategy, which provides a target for the growth of the money supply (ł M3) and a path for the PSBR.
The forecast suggests that one objective of the MTFS, which was to reduce the PSBR as a percentage of GDP at market prices, remains feasible. However, we do not now expect the 1983–4 PSBR guideline of 2 per cent to be achieved until 1984–5, and we expect the growth of sterling M3 to remain outside the target range right through the forecast period, even though real interest rates remain positive.     

Can the government create a vibrant cluster? Understanding the impact of cluster policy on the development of a cluster

Research has debated to what extent policy measures can facilitate or contribute to the development of clusters. This article contributes to this debate by questioning how the government can create a cluster that is self-organizing and vibrant but also maintain sufficient influence to continue using the cluster as a policy instrument. Taking the perspective of cluster members, the article investigates how members perceive the ambiguous role of the government in a government-supported cluster. It analyses to what extent cluster members value a government-supported cluster and whether they perceive the government as one that facilitates or hinders them in self-organizing the cluster. Empirical evidence is derived from a case study of a French cluster established as a result of a cluster policy initiative and which has recently been required to fulfil a new set of objectives by the same government. The findings suggest that government-supported clusters can self-organize if members are given the opportunity, but with the consequence that it becomes difficult for the government to fully control such clusters. To continue steering the cluster’s development, the government would have to leverage the technology gatekeepers’ power by designing policies that allow gatekeepers to translate government objectives into meaningful objectives for themselves.     

Voting on road congestion policy

This paper studies the political economy of urban traffic policy. A city council and a regional government (representing city and suburbs) decide respectively on parking fees and a road toll. Both charges are below the optimum when median voters in city and suburbs prefer cars to public transport sufficiently more than the average. Even if the city government would set an optimal road toll, the regional government blocks it when the median suburban voter prefers cars strongly enough. Letting the city control parking and road pricing may therefore increase chances of adoption of the latter. However, if the city controls parking and the region road pricing, the combined charges are higher than if the city controlled them both. Hence, when voters want all charges below the optimum, the involvement of two governments may be desirable. We also find that earmarking road pricing revenues for public transport is welfare-enhancing, compared to lump-sum redistribution, only if they are topped up by extra funds granted to the city by a higher level of government.     

THE AUTUMN STATEMENT

The Treasury's forecast, published with the Autumn Statement, has been widely heralded as showing a surprisingly cheerful picture for next year as far as both output and inflation are concerned. In fact it is close to the forecast which we produced in October. Here we compare the two forecasts and then consider how our forecast is affected when we adopt the Treasury assumptions on asset sales and the exchange rate. We find that the Treasury is more optimistic than we are on investment and that holding the exchange rate - which is needed to produce the official inflation forecast - requires rather higher interest rates than we assumed in October and this widens the gap between our forecast for GDP and the Treasury's forecast.
We also consider how the government should respond to lower North Sea oil revenues. Taking a permanent income approach, we suggest that the PSBR should be allowed to rise by £2bn on this basis. The same approach, however, suggests that an extra £71/2bn of asset sales should be used to cut the PSBR not taxes. On balance therefore this analysis indicates that next year's PSBR target should be lowered by £1/2bn from the £71/2 bn contained in the 1985 MTFS.     

逆向物流系统构建博弈分析

基于经济博弈论的基本思想,在考虑消费者影响的情况下,分析政府和企业在逆向物流系统构建中的博弈关系并建立模型,接着分别从企业角度和政府角度分析相关纳什均衡解的指导意义,最后指出只有企业履行其社会责任并开展逆向物流活动、政府出台相应激励政策并严格管制、消费者积极参与才能推动逆向物流系统的构建及发展。     

Optimal fiscal policy with robust control

This paper analyzes how consumer uncertainty affects optimal fiscal policy in the Lucas and Stokey (1983) framework. The consumers, lacking confidence in their knowledge of the stochastic environment, endogenously tilt their subjective probability model away from an approximating probability model. The government, though, is confident that the approximating probability model characterizes the stochastic environment. This confidence dichotomy reveals a range of possible objective functions for an altruistic government. I assume that the government maximizes the consumers' expected utility under the consumers' own subjective probability model. It is found that this government relies less heavily on labor taxes to absorb the fiscal shock than would be optimal if consumers were fully confident in their probability model. This policy helps mitigate the direct welfare cost associated with consumer uncertainty. I compare this policy to the one implemented by a government that maximizes the consumers' expected utility under the approximating probability model.     

No-trade-deal Brexit would lower GDP by 1ppt by 2022

• ▀ A no-trade-deal Brexit would result in UK GDP being 1ppt lower than our baseline forecast at the end of 2022. Increased trade frictions and a negative reaction from financial markets would more than offset looser policy settings.
• ▀ Even if an FTA is agreed, trade between the UK and EU will be subject to new customs and regulatory trade barriers. If a trade deal is not agreed, tariffs will also be levied on UK-EU trade, while non-tariff barriers are likely to be higher.
• ▀ A no-trade-deal outcome would almost certainly see the BoE undertake further quantitative easing. A further, temporary, loosening of fiscal policy would also be likely, with higher government investment an obvious option.

     

Forecast Summary

There is one overriding question which this issue of Economic Outlook seeks to address: to what extent will the tight monetary policy now in place produce a slowdown in consumer spending and take the savings ratio back up from last year's record lows? The answer, provided by the forecast, is that the savings ratio will rebound this year and our Macroeconomic Viewpoint argues that this will be sufficient, in combination with a rising budget surplus, to effect a reduction in inflation and the current account deficit over the medium term. But it does not achieve the government's target, set out in the MTFS, of a balanced budget - the public sector remains in chronic surplus. This objective requires national savings to be privatized and, in a special Microeconomic Viewpoint, we put the case for tax incentives to boost personal saving and enable the budget surplus to be reduced in a way which does not add to demand.     

基于成本差异的最佳贸易与产业政策选择

本文讨论了存在成本差异的第三国市场模型的最佳贸易与产业政策选择问题，讨论了社会成本和私人成本、本国和外国成本差异情况下的Cournot竞争和Bertrand竞争的情况。本文发现，在Cournot竞争下，政府首先行动时，当政府基金影子价格低于4／3时，政府对出口进行补贴，并且本国越有成本优势，补贴越高，补贴的利润转移效应越大；当政府基金影子价格高于4／3时，政府对出口征收出口税，且本国越有成本优势，征税越多。在Bertrand竞争下，当政府先行动时，对出口征收出口税；当政府后行动时，对出口进行补贴。当本国企业具有劣势时，事后补贴是最佳政蓑。     

Optimal fiscal and monetary policy with occasionally binding zero bound constraints

This paper studies optimal fiscal and monetary policy when the nominal interest rate is subject to the zero lower bound (ZLB) constraint in a stochastic New Keynesian economy. In the baseline model calibrated to match key features of the U.S. economy, it is optimal for the government to increase its spending when at the ZLB in the stochastic environment by about 60 percent more than it would in the deterministic environment. The presence of uncertainty creates a unique time-consistency problem if the steady state is inefficient. Although access to government spending policy increases welfare in the face of a large deflationary shock, it decreases welfare during normal times as the government reduces the nominal interest rate less aggressively before reaching the ZLB.     

Second Generation Models of Currency Crises

Until the beginning of the 1990s, currency crises were typically analyzed within the framework of a generation of models that assumed that the foreign exchange reserves of a country that was running a fixed exchange rate policy were falling (because the government was running a deficit on its budget that was financed by printing money). When the foreign exchange reserves reached a lower bound, a speculative attack on the fixed exchange rate was launched. Today, this theory is no longer the benchmark when explaining the occurrence of a currency crisis. Actually, a new generation of models that seeks to take explicitly into account the costs and benefits associated with the maintenance of a fixed exchange rate has emerged. This paper surveys these 'second generation models of currency crises'. This generation of models emphasizes that it is an endogenous decision if a government chooses to abandon a policy of fixed exchange rates. The survey pays special attention to the fact that the second generation of currency crises models often generates multiple equilibria for the rate of devaluation given one state of the economic fundamentals. A currency crisis can thus occur even if no secular trend in economic fundamentals can be identified, as in recent currency crises.