Mervyn Maradona

Posted by Tracy Allowayon Jun 23 11:56.

The Bank of England governor is a rule-breaker, just like Argentinian football star Diego Maradona.

So says Malcolm Barr over at JPMorgan:

One of Mervyn King’s most memorable analogies in explaining the conduct of monetary policy was his reference to Diego Maradona’s two goals against England in the semi final of 1986 World Cup. King recalls that the first goal, where Maradona blatantly handled the ball into the net, was a clear example of rule-breaking to achieve an objective. A monetary authority could in theory exploit low inflation expectations to boost growth temporarily, but it could not get away with it repeatedly. But unlike the old “mystery and mystique” form of central banking, modern approaches with a clear remit for an independent central bank are designed to prevent such action.

The second goal saw Maradona dribble over half the length of the pitch before scoring, proceeding largely in a straight line while defenders anticipated a move to either side. King argued that a well understood central bank was often able to achieve its objectives with relatively little policy movement – like Maradona moving in a straight line – because its potential moves are anticipated by markets. The impact of those moves in market rates lowers the need for policy itself to move when the central bank’s objectives are well understood.

In discussions about monetary policy, King’s reference to the second of Maradona’s goals is often recalled. And in the current context, it may appear particularly appropriate. After a hawkish turn in MPC rhetoric earlier this year, policy was ultimately not tightened. But expectations of higher rates had built in the meantime, term rates in markets rose, and that plausibly had some impact on activity and inflation expectations. The mention of possible support for additional QE in the June MPC minutes could be seen in the same light: activity data have been weaker than expected, while wage growth and measures of inflation are contained. The flattening of the term structure and easing the exchange rate encouraged by more dovish rhetoric may prove helpful to achieving a profile for growth closer to the MPC’s expectations, even if further QE does not occur.

We would argue that analogies drawing on the second of Maradona’s goals ascribe rather more coherency to the committee as a whole than is currently appropriate. As the MPC has acknowledged, the spread of views is wider than usual. Among what we have labelled the three triads on the MPC, the dataflow is changing the relative volume of the rhetoric coming from the triads at the dovish and hawkish ends of the committee. Meanwhile the middle ground triad whose votes will drive policy outturns (Miles, Bean and Broadbent) continue to extend the period of “wait and see”. Rather than leading the market via some collectively agreed strategy in its rhetoric, the path of rates implied by markets has appeared a convenient compromise among the MPC’s disparate views when the Inflation Report forecasts have been constructed. Both the last two Inflation Reports appeared designed to rubber stamp expectations where they were, rather than leading them.

Indeed, we find ourselves wondering whether the flirtation with further QE is beginning to look more like Maradona’s first goal than his second … the MPC’s tolerance for inflation risk has risen post the financial crisis. On unchanged policy, the mean two year ahead forecast for inflation in May was the highest on record at 2.54%. In February it was 2.48%. We find it difficult to believe the pre-crisis MPC would have shown such forecasts for consecutive inflation reports without tightening (and it indeed it never did so). Recent commentary from King and Fisher has also had a rather revisionist tone in suggesting that the MPC collectively decided to “see through” high inflation. They neglect to mention that such “seeing through” was predicated on inflation forecasts that had shown returning to near 2% at the two year horizon by now, and that has not occurred.

The MPC’s remit does afford them flexibility in achieving their inflation goal. The focus on the inflation forecast two years hence has always been part of the MPC’s “sketching in” of the rules of the game – designed to show that the MPC was not playing fast and loose within that flexibility. But the way the MPC responds to its own inflation forecasts is moving in a more tolerant direction. To extend Mervyn’s Maradona analogy, this is not as blatant as the MPC handling the ball into the net. But it is certainly lingering in an offside position, hoping not to be flagged if the ball comes its way.

So … ‘stead ‘Hand of God — Hand of Gov’na? (We’ll get our coats).

Related links:
Reasons for a UK QE2 – FT Alphaville
A football revolution – FT magazine

This entry was posted by Tracy Alloway on Thursday, June 23rd, 2011 at 11:56 and is filed under Capital markets, People. Tagged with , , , , , , , , .

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