.gif)
WoPEc - Working papers in economics - WUSTL January 2001 Paper in pdf form
-------------------------
Money is mysterious (Buchan, 1997), and banks are part of this mystery, including central banks. Text books list the functions of the modern central bank, the issuing of notes and coins, the lending of last resort, the overseeing of the commercial banks and financial institutions, the regulating of exchange rates and interest rates. The text books are written by academics, banking outsiders, making a plausible story out of a mystery. The bankers have no plausible story of their own. They know what to do this afternoon and tomorrow, but if asked why, their answer would consist partly of details making little coherent sense to the outsider, partly of rhetoric borrowed from the academics. The outsider’s view of the functions of the central bank vary from time to time, but there is no doubt which function is overwhelmingly dominant in public perceptions today. By public perceptions is meant not only the view of the man in the street, but the story which lies behind all public commentary on the central bank, of politicians, journalists, academics, and of the central bankers themselves. This publicly perceived dominant function is the announcement of the central bank’s interest rate - the base rate, the repo rate, the Federal Funds rate, as the case may be.
It would be difficult to exaggerate the weight given, by authorities and commentators alike, to this function. Paul Volcker himself states (Deane and Pringle, 1994) that “there can be no mistaking the key role that central banks play in a modern economy. That role is frequently related entirely, or almost so, to the importance of monetary policy - the decisions about the appropriate supply of money and credit or the direction and level of interest rates”. Numberless newspaper and journal articles have discussed the god-like mastery of Alan Greenspan, Volcker’s successor, in guiding the US economy, and how he has been indispensable in this function under four successive presidential administrations. The indicators affecting the timing of the next change of interest rate are endlessly analysed. It is always pointed out that such a change will take two or more years to work through, while in another part of the text it is implied that somehow it is a matter of great skill to decide whether the change should be made this week or next.
This adulatory treatment is extraordinarily uniform. People may differ in their appraisal of the central banker’s performance in steering the economy, but as regards the essential link between the performance and the economy, there are no publicly dissenting voices.
To illustrate this, some totally unexceptional remarks are quoted below from a leading article in the Financial Times of London (Dec 2001).
“Looking back, the Fed deserves more criticism and the ECB [European Central Bank] more praise. This is more than an academic, retrospective point. Appreciating where the world's two leading central banks went wrong and right in the past few years also provides an important guide to the future.”
Clearly the writer believes that he can make a judgement on past performance, and that this judgement is of importance.
“For the Fed, Alan Greenspan, its chairman, should come clean … where they were at fault … was in allowing the boom to take on the dimensions it reached at the tail end of the 1990s.”
Alan Greenspan is here being presented as being in total charge of the timing and rate of the “boom”, i.e., of the entire progress of national output. The writer goes on to detail Greenspan’s “four serious mistakes”, all to do with his timing of interest rate changes.
“The ECB has been consistently slow to react … what matters … is the quality and speed of its decisions.” However, “Mr Duisenberg, in his plodding way, has presided over a gradual accretion of competence for the ECB. … The reputation of both [the Fed and the ECB] depends on how skilfully they steer the world back to stability and growth in 2002.”
Again the unquestioning premise that if “the world” reverts to stability and growth, it will be due to the skilful and speedy “steering” of the Fed and the ECB.
We are so accustomed to reading the sort of material I have put in quotation marks above that we generally read it without subjecting it to normal scrutiny. Clearly, the words, taken literally, are palpable nonsense. We all know that the enormously complex technological and social factors which govern output growth are incapable of being described in terms of a simple cause and effect machine, that our understanding of them is so poor that the forecasts of academics and central bankers alike are hardly worth the paper they are written on. It can confidently be asserted that the writer of the words quoted does not himself really believe in the clear underlying implication of his words, that the economy is a simple engine which responds to skilful day-to-day steering by a handful of bankers.
This is confirmed when he (or perhaps another leader writer) goes on to discuss the performance of his home central bank, the Bank of England. If familiarity does not breed contempt, it introduces a breath of scepticism.
“How far the MPC [the Bank of England Monetary Policy Committee] itself is responsible for the happy coincidence of low and stable inflation with steady growth is open to question. Since its inception in 1997, the MPC has changed rates no fewer than 23 times. Yet all in the garden is not roses. Over the past four years, output of manufactures has risen a mere 0.2 per cent, while that of services has grown 15.1 per cent. The MPC could do nothing about this.”
Clearly, we are in the presence not of scientific or objective description, but of a practised rhetoric which is tailored to suit what is known to be an uncritical audience. The MPC is portrayed, not as lacking steering skill, but as being in part impotent. But this is sceptical tone is not the usual one. A few days before, a columnist in the same newspaper reflected the conventional attitude:
“The Federal Reserve has proved itself the modern economic policy counterpart to the US Air Force … it lowered interest rates for the 11th time this year - extending a campaign of unprecedented intensity intended to save the US economy from a slump … only the most curmudgeonly could fail to marvel at the flexibility and dispatch the central bank has shown in responding to the first signs of slowdown a year ago and to the potential economic catastrophe posed by the terrorist attacks three months ago.”
And again (Financial Times, Nov 2001),
“The decisions by both the ECB and the Bank of England to cut rates by half a percentage point yesterday, rather than the quarter-points expected by the markets, demonstrated that avoiding recession - or mitigating its effects - is now the priority for policymakers.”
And,
“ ‘This is an incredibly powerful statement by the MPC’, says Richard Jeffrey of Charterhouse Economics. ‘They are saying that the reductions in rates they had made before this would not be sufficient to sustain the pace of growth next year.’”
These quotations imply that central bank decisions on base rate, if made skilfully, steer the economy in an intended direction, away from recession towards growth.
If academic opinion is more nuanced, there is certainly no evidence in newspapers and magazines that there is a marked desire to put the public record straight.
A view as sceptical as one could wish is given by Barro, safely buried in his text-book (Macro Economics p472):
“Over the longer term, the Fed moves the discount rate to match changes in market interest rates. Hence, most of the movements in the discount rate are reactions to changes in the economy, rather than vice versa. But the timing and sometimes the amount of a shift in the discount rate are at the Fed’s discretion. It is possible that some of these changes are a useful signal about the future behaviour of the monetary base. No one has yet shown, however, that changes in the discount rate can actually help to predict the future quantity of the monetary base or other economic variables.
“From the standpoint of controlling the monetary base, the existence of the discount window adds nothing to open-market operations. Thus the argument for the Fed’s lending to depositary institutions comes down to the desirability of subsidising selected financial institutions, presumably, mainly institutions that are in trouble. So far, no one has come up with good arguments to justify this policy.”
But, when Barro later spent some time on secondment to the Bank of England, a report on his work there (1995, also summarised in an article in the Financial Times) was devoid of scepticism. On the contrary, he wrote that his results gave evidence “more than enough to justify the Bank of England’s keen interest in price stability” There was no echo here of the remark on p201 of his book with reference to the Weimar hyper-inflation:
“Over the period from 1921 to 1923, the rates of inflation ranged from near zero to over 500% per month! Further, the available data suggest that relatively small changes occurred in aggregate real variables such as total output and employment.”
A similar reticence is shown by Paul Volcker in his preface to “The Central Banks” (Deane and Pringle, 1994), where he implies that his normal tone was one “affirming the glories of central banking”, but near or after retirement, “I found myself reminding my fellow conferees that history provided little support for the simple proposition that the creation of a central bank, in and of itself, would provide much assurance against inflation. Nor was there much evidence that we could look towards any simple rule book to determine when to ease or when to tighten”
However, my aim here is not only to add weight to muttered asides deflating the general story that central bank interest rates play a unique role in actually steering or determining output growth, but to show that the central bank’s decisions on base rate do not even determine what they are supposed directly to determine, namely commercial short term interest rates. It is, in fact, to add substance to Barro’s contention in his text book that “most of the movements in the discount rate are reactions to changes in the economy, rather than vice versa”, and indeed to go further in suggesting that they are pure and simple echoes of market-determined changes in interest rates which are already fact when the central bank decision is taken.
The general rhetoric on the operation of the central bank is that the change in base rate changes commercial short-term interest rates and hence stimulates borrowing for both spending and investment. Thus, at the very least, there should be historical evidence that changes in base rate lead changes in commercial or market rates. I will show that this evidence is generally lacking. Note that to prove my case, I am not required to show that the market short-term rate leads the base rate, although it will become apparent that that is the most convenient way to proceed. I am required only to show that the base rate does not plausibly lead the short-term rate, and this will be shown incontrovertibly
For short-term commercial rates, I use the 3-month market rate. The data I have to hand cover a period beginning in January 1995, and ending at the time of writing, January 2002. They relate to the US dollar, the UK pound, and what I will call the Euro. The latter begins by being simply the Deutsche Mark, but later (1st January 1999) becomes the currency linked “indissolubly” to ten other currencies of the “Eurozone”. The data was logged, for another purpose, at nominally weekly intervals, and at dates of base rate changes, from data which appears in tables printed daily by the Financial Times. The table currently being used gives “Libor” rates, but it cannot be guaranteed that the data presented has always come from consistent sources. In my view, its reliability is easily adequate for my purpose, but it will be a simple matter for anyone with access to more reliable data bases to repeat the analysis.
The basis for the work is nine graphs, three for each zone, each of the latter partitioning the period, for ease of presentation, into three parts.
It was hoped, of course, to apply some mathematical procedure to the time-series data for the base rate and for the 3-month rate, to produce numerical “confidence limits” for the truth of a “hypothesis” that set A leads set B by so many weeks or days, or for a “null hypothesis” that neither leads the other. However, it became clear on examination that even this simple relationship of two parameters is too quirky to be captured by simple algebra. There is nothing for it but to look and see.
Each graph covers 1000 days, or about 3 years. The total period is about 2500 days or 7 years. The data represented by straight lines is the central bank base rate. The more variable curve is the 3-month rate. Each dot along its length signifies a tabulated point. Since my data has some “holidays” or holes, it is useful to keep the dots in view in any stretch of the curve deemed to be of particular interest. The third plot on each graph, shown as a discontinuous line shifted regularly downwards relative to the 3-month curve, will be referred to later, and should be ignored at this point (for the UK graphs, it is so close to the 3-month curve as to be barely distinguishable).
The vertical scale is in “basis points” or one-hundredths of a percentage point, and is the same on all nine graphs. The graphs are produced from a Microsoft Excel spreadsheet, using a Visual Basic “macro”. The macro also places the arrows and annotations. The coding is available from me to anyone who wishes it.
The method followed was to white out the base rate lines, and determine by eye the major turning points of the 3-month curve. Since Excel prints on the screen the co-ordinates of any point located by the cursor, it is easy to log those turning points. The base rate lines were then brought back, and the decision points of the central bankers were compared with the 3-month turning points.
A commentary will now be given on each graph.
It can be seen by hindsight that, at around 290 days, the 3-month UK rate, after a period of quasi-stability, begins a 100 day descent of about 100 basis points. And then, again with the aid of hindsight, after another more stable interval, it begins to rise at about 600 days, and continues to the end of the period shown, i.e., to 1000 days.
Now let us examine the central bankers’ decision history in some detail. The first move downwards is made 51 days after the turning point identified on the 3-month curve. At the moment of decision, the bankers can see the 30-point fall of the 3-month rate, but since they have seen a similar fall at around 110-140 days without reacting, it cannot be said with any conviction that the bankers are being “led” by the 3-month rate. On the other hand, it can be said with total conviction that the 3-month rate is not being led by the base rate, since not only does it begin to fall 51 days before, but it pays no particular attention to the bank’s belated signal, even going against it for a few days. It may be said to react a little, lagging by a few days, to the bank’s second signal, but then it over-reacts by plunging downwards, leaving the bank to catch up 20 days later at about 420 days. It may be said that the upwards turning point indicated at 600 days is very much a matter of hindsight, and could not have been evident to the bankers at their decision point 69 days later, but even here, it is seen that the more decisive upswing of the 3-month rate starts 5 days before the bank’s decision, and is very much more marked. After five months of relative stability, the market which determines the 3-month rate marches steadily upwards by 100 points, paying no particular attention to bank decisions, which lag by 10 to 20 days. A further point to notice is the very marked cross-over which occurs. The 3-month curve appears to be leading the base rate level, not only in the timing of its upward or downward changes, but in its relative level, in the sense that it is generally below the base rate line when it may be imagined to signalling “down”, and above when it may be imagined to be signalling “up”. The picture is of a tractor, which has to get on the other side of the dragged object to reverse direction.
The above commentary tries to be fair, but it may be, perhaps unavoidably, tendentious in parts. The important point however, is that it would be almost impossible on the basis of the presented evidence to make a case, however tendentious, that the base rate is the master of the market rate. It could be argued that the bankers, and the participants in the 3-month market are reading the same signs, and that the market agents are lighter on their feet. Even this view would concede that the bank is following a course of inevitability rather than one of “skilful steering”. I cannot know, as an outsider, how the 3-month market operates in detail, but I imagine that, as in any market, blind factors of supply and demand operate predominantly, rather that forecasting, deliberation, discretion, and decisions.
On this graph occurs the only case where the 3-month rate unambiguously lags the base rate in making a change of direction. The 3-month rate seems to ignore completely the bank’s signal at around 1360 days (October 1998) and then responds 27 days late. Thereafter the rates descend rather rapidly and in unison for 200 days, dropping 250 basis points. If this 200 day sequence was all that was available, the thesis that the bank plays a leading role would be incapable of being disproved. That is not to say, of course, that it would be capable of being proved either. The louder voices, that is, the establishment, would settle the matter.
The picture here is rather like that of the first graph, but in reverse. First, it should be pointed out that the first, upward trending part of the graph is marred by extensive “holidays”, and perhaps by one point which looks as if it might be the result of a typing error. Nevertheless, the general commentary here would be very like that for the first graph, namely clear leads in time for the 3-month curve, first upwards then downwards, and a marked and sustained cross-over in the relative levels which takes place as one trend gives way to the other. This time, it could be claimed that if only the second part of this graph were available, it would be impossible to maintain that the bank is playing any role whatever, except that of officially rubber-stamping the result delivered by the market.
The 3-month rate in the first US graph shows no turning points, unless the change from descent to stability can be called a turning point. The 3-month rate starts the best part of a percentage point above the base rate, and tracks steadily downwards for nearly 400 days, seemingly paying no heed to either the level or the zero slope of the base rate. Finally, with the 3-month rate still showing no sign (without the aid of hindsight) of stabilising, the base rate drops, seemingly to keep up, whereupon the 3-month rate, instead of responding to this signal, promptly stabilises. Overall, not much can be speculated on the basis of this graph, except that there is no evidence of the central bank influencing anything during this period. It may be noted that the 3-month rate spends only a negligible time below the base rate.
After a period of stability lasting nearly 2 years, the 3-month rate signals a decisive (with the aid of hindsight) shift upwards at around 1130 days. A stable gap of 60 basis points is thus opened up relative to the base rate, which persists for 150 days, each rate seemingly ignoring the other. The 3-month rate then decisively signals “down”, and this is followed 47 days later by two 25-point steps downwards by the base rate, as if to maintain the 60 point gap. At about 1540 days, the 3-month rate reverses direction, and begins a steady rise upwards. After a lag of 139 days, with the gap standing at 75 points, the base rate reacts, and, since the 3-month rate continues to rise quite steeply, the gap opens to a maximum of 150 points ….
… A succession of five rises in base rate barely keeps pace, and before the last rise, which is of 50 points, the gap is still more than 100 points. As more time passes thereafter, the bankers can see that the 3-month rate has stabilised, still at 60 points or more above their own level. However, at 2150 days, the 3-month rate begins to plunge, the base rate following only after a lag of one month. Thereafter, the picture is of each rate chasing the other downward, but it is fair to say on the basis of attentive examination, that at the moment of each Fed cut, the bankers could see, without benefit of hindsight, that the 3-month rate was in more or less steady fall up to each moment of decision.
The downturn signalled by the 3-month (Deutsche Mark) rate at around 40 days and continued thereafter had been in sight for up to 50 days when the Bundesbank responded. Thereafter, there was a fairly continuous reduction in the central bank base rate over a period of 180 days, which, over the second part of this period at least, was clearly led by the 3-month rate. The base rate step downwards at 590 days can be seen, by hindsight, to have been anticipated by the 3-month rate 50 days before. This would not have been evident at the time of decision.
The next base rate step, this time upwards, at 1000 days, was heralded by a 3-month rate steady rise beginning more than 100 days before. The 3-month rate reinforced its message for some time thereafter, before settling into what can be seen by hindsight to be stability. The base rate step-down at 1420 days does seem to be virtually simultaneous with the 3-month rate break, but, given that the 3-month rate seems at this period to have been systematically around 25 basis points higher than the base rate, the next step down at 1550 days could be said to be signalled rather clearly by the steady closure and reversal of this gap.
The evidence of the next phase is quite unequivocal. Over a period of 400 days, the 3-month rate rose almost monotonically upwards through 225 basis points, or 2.25 percentage points. It is unarguable that at the seven upward steps taken in succession by the central bankers, compelling and almost unvarying evidence was available to the central bank decision makers, from the 3-month data, that the market rate was soaring upwards. All they needed to do was keep up, with the mean slope of 3 or 4 basis points per week. At 2130 days, and almost without pausing, the 3-month rate turned and began to fall, and fell more or less fast all the way to the date of writing. Again, the fact that, in time-sequence terms, the base rate is lagging the 3-month rate by very considerable periods is clear from the graph.
In the commentary on the three UK graphs, it was remarked that in periods when the 3-month rate seemed to be leading the base rate upwards, it led from above, while during a downward trend, it tended to lead from below. This observation did not come so readily for the remaining six graphs, although, for the EUR graph at day1390, a closing of the gap to zero and a little beyond, while being only a vestigial crossover, was a hint in this direction. The question arises: of what significance is the general level of the 3-month rate relative to that of the base rate? I have chosen the 3-month rate simply because the central bank base rate is aimed in some not-well-defined way at influencing short-term rates, and the 3-month rate is the shortest tabulated short-term rate which is reasonably stable. There is no reason to suppose that they are closely related as to absolute level, and to the extent that they are, there is no reason to suppose that the relationship would be the same under different banking cultures.
Since I am interested in how the rate of change, or the shape, of one is related to the rate of change, or the shape, of the other, it is useful to bring the shapes arithmetically together, to eliminate the effect of absolute level. This has been done by moving the 3-month data up or down (denoted by a negative sign) by a sufficient number of basis points to minimise the sum of squares of the gaps between the 3-month curve and the base rate curve, separately for each zone, but over the entire period of 2500 days. The result was -1.5, -32.5, and -10 basis points for the UK, US and EUR zones respectively - that is about zero for the UK, a third of a percentage point down for the US, and a tenth of a percentage point down for the EUR zone. This at once shows why the crossover effect was seen at once for the UK, glimpsed for EUR, and not remarked on at all for the US.
On each graph, the “adjusted” 3-month rate is shown as a discontinuous curve, and without the small dots. If all the six graphs for the US and EUR zones are examined in some detail, it is seen that the adjusted curve tends throughout to lead the base rate curve, from above when increasing, from below when decreasing.
In "The evidence - part one" above, it was stressed that the method used relied essentially on judgment by eye - as follows:-
"It was hoped to apply some mathematical procedure to the time-series data for the base rate and for the 3-month rate, to produce numerical 'confidence limits' for the truth of a 'hypothesis' that set A leads set B by so many weeks or days, or for a 'null hypothesis' that neither leads the other. However, it became clear on examination that even this simple relationship of two parameters is too quirky to be captured by simple algebra. There is nothing for it but to look and see."
Later, it is noted that this was "not because academic treatments are in this case over-powerful, but because they are hopelessly simplistic and inadequate".
In the course of this update, a possible numerical method was explored further. The method tested was to compare:
(a) the change in the 3-month rate observed at the time of the bank rate change, measured from the time of the previous change, with
(b) the size and sign of the "current" bank rate change.
The probability of this yielding a method better than judgment by eye is debatable, since it effectively replaces the detailed path of the 3-month rate, which can be assessed by eye fairly easily, with a path which has two or three points for each period between bank rate changes, i.e., a path of straight-line segments which is indifferent to what small or wild changes may in reality be followed within the period of each segment. The idea was, however, that if there was a very high correlation of today’s bank rate change with one definable and observable previous commercial money-market change, this would be close to a numerical proof that the central bank interest rates are led by the market. Such a proof may be more convincing than one which appeals, however plausibly, and with more data, to visual judgments.
The results are shown in the figures below. All figures show the changes (a) and (b) on the y and x-axes respectively.
The first three figures, A1 to A3, one for each zone, take (a) to refer to the entire period from the “present” central bank rate change, back to the previous bank rate change.
The second set of three figures, A4 to A6, takes (a) to refer to the period from the last observation of the 3-month rate before the bank rate change, back to the previous bank rate change. The rationale for this is that that my "schoolboy" central bank manager would see the historical series only up to that last observation point.
Figure A7 amalgamates the data of figures A1 to A3. Figure A8 does the same for figures A4 to A6.
Figures A9 to A11 reverse the implied direction of cause and effect of figures A4 to A6. The current bank rate change is correlated with the change in the 3-month rate in the period after that change, up to the last observation point before the next bank rate change. The normal story is that bank rate change determines this future.
In all figures, the equation of a straight-line least-squares fit and the value of R-squared, the correlation coefficient, are given. These data are calculated automatically by the Excel program, to the (probably unjustified) number of significant figures shown. Since R-squared takes no account of the number of points and degrees of freedom, the derived value of the Snedecor F has been inserted. For the sorts of numbers involved in these graphs, if F exceeds 8, the probability of the apparent correlation being produced by chance is less than 1%. This is the more rigorous of the two levels of confidence (5% and 1%) generally employed. All graphs show correlations exceeding this level of acceptability, mostly by a wide margin. That is, the correlations verge on the undeniable.
The correlation data is brought together in the following table.
| Figure | Zone | Slope | Intercept | Value of F | |
| Abutting sectors (response to past and present) | A1 | UK | 0.94 | 0.01 | 39 |
| " | A2 | US | 0.87 | -0.06 | 10 |
| " | A3 | EU | 0.94 | -0.01 | 88 |
| Non-abutting sectors (response to past) | A4 | UK | 0.78 | -0.01 | 21 |
| " | A5 | US | 0.74 | 0.00 | 10 |
| " | A6 | EU | 0.71 | -0.01 | 43 |
| Abutting sectors | A7 | ALL | 0.93 | -0.01 | 90 |
| Non-abutting sectors | A8 | ALL | 0.74 | -0.01 | 60 |
| Non-abutting sectors (effect on future) | A9 | UK | 0.68 | -0.03 | 13 |
| " | A10 | US | 0.15 | -0.13 | 2 |
| " | A11 | EU | 0.30 | -0.03 | 3 |
It is the second group of three graphs (in bold) which substantiates the general proposition of this and the previous note. The segments of the 3-month series involved in those graphs no longer abut each other. Each segment terminates before the bank rate change takes place. Here, there is no automatic assurance that the correlation will yield a predictable response of one parameter to the other. For example, if the 3-month rate stayed static from the last bank rate change to the last observation point before the “current” bank rate change, or if it fluctuated randomly with whatever amplitude about some static level during this period, then clearly there would be no correlation whatever. The correlation would be introduced only after the last point of observation, as, according to the conventional story, the 3-month rate jumped or slid into line with the central bank’s lead.
As it is, the tabulated results show very convincing correlations. The pre-observed 3-month changes account on average for three quarters of the subsequent step in bank rate, leaving only one quarter to be accomplished on average either between the last observation and the moment of the bank rate change, or afterwards.
In line with this, it should be noted that the intercepts are all more or less zero, i.e., the best-fit line passes close to the origin. This implies that, if the perceived pre-history of the 3-month rate is on this measure is unchanging, or fluctuating randomly around a static level, then the central banks would, according to these correlations, make no changes in bank rate. This again is contrary to the conventional story that a group of experts, after careful analysis, announce to a waiting world, the bank rate change which is now to be imposed, in order to restore the economy to health.
It lends weight to my thesis of a process which is pre-determined in a fairly mechanical way, that in all three zones, the slopes of the correlations are very close to each other, all within the range 0.74±0.04. This means that three different institutions, with very active teams, analysing according to the usual story all kinds of economic indicators, are reacting, on average, in exactly the same way to what I would term the "signals" given by the preceding 3-month rate changes.
The data show that all three zones behave in the same way statistically, i.e., on average. But the F-values (which relate to the spread about the average), while indicating reliable correlations in all cases, do seem to show a pecking order in the degree of detailed predictability. If there was total predictability, all points would lie precisely on one fitted curve, R-squared would be unity and F would be infinite. Even if the three central banks are aiming at the same target, it seems that the EU central bank has the least whimsical aim, and the US Federal Reserve the most, with the Bank of England somewhere in between. Be that as it may, a note of caution has to be sounded - all three have four or five instances (out of twenty or thirty) where the bank rate change is of the opposite sign from that of the pre-observed 3-month change.
Figures A7 and A8 merely confirm what is said above. The fact that central banks in all three zones are reacting in the same way to market led changes in the 3-month rate ensures that the F-value in correlation A8, where data for the three zones are amalgamated, is extremely high. So, when all the data is taken into account, the probability that changes in central bank rate follow prior signals observable in the market becomes a virtual certainty.
The tabulated results corresponding to Figures A9 to A11 show that for the UK there is a weaker correlation between the present and the future than there was between the past and the present, that is the predictive value of the past 3-month rate change for the current central bank rate change is better than the predictive value of the latter for the future of the 3-month rate. For the US and the EU the effect of the bank rate change of the future short-term rate does not pass the normal tests for a reliable correlation at all, and in the case of the US is hardly perceptible.
Thus, strong evidence that the central bank rate follows the signals of the 3-month rate is accompanied by strong evidence that the 3-month rate is not influenced (or, in the case of the UK, not so much) by the signals of the central bank rate.
.gif)
.gif)
.gif)
.gif)
.gif)
.gif)
.gif)
.gif)
.gif)
.gif)
The conclusion can only be that by the normal standards of statistical testing (which by their nature must always fall short of proof), the 3-month bank rate leads the changes announced by the central banks in their base rates. It is virtually certain that it is not the other way round, as portrayed in the normal commentary of bankers, politicians, journalists, and for the most part, academic economists.
There is a striking difference between the general tone of the commentary above and that of the very many discussions which take place before and after central bank base rate decisions are expected, and to a lesser degree, at all times in between. For most of us, perhaps, these discussions take place in the local daily newspapers such as the Financial Times, in local weekly magazines such as the Economist, and on local radio and TV. But I have seen no public evidence that academics are at pains to publicise a different perspective, and I do not doubt that public comment in the United States, Germany or France follows a similarly respectful and pseudo-learned course.
These discussions often go into some detail of all the “indicators” that must be gravely weighed up - inflation, exchange rate, unemployment, house prices, fears of boom or bust, exports and imports, retail sales, savings rates, consumer spending, manufacturers’ confidence indexes, and so on and on. The nearest, most direct, indicator, the current commercial short-term interest rate, is never mentioned. Often, the central bank is said to be too late, or too early, or to have cut too much or too little. “Economic policy”, often shortened to “policy”, is the term used to denote this one decision on one number. Mr Greenspan is (so far) the nearest approach to God that we have.
The picture conveyed in my commentaries above, on the other hand, could not be more different. It is boring, and gives little scope for “informed” discussion. At the risk of appearing flippant, it might be said to be that, far from needing immense skill, any reasonably able child in the higher classes of any school could look at the trend of US 3-month market rates, subtract a third of a percentage point from them, and issue his or her decision at intervals, as and when a quarter point or a half point adjustment to the base rate was necessary to keep up. That is not to gainsay the skills of Mr. Greenspan. But his skills are in leadership, politics, rhetoric and theatre. If he also has unusual skills in economic analysis, they are not needed in this particular part of his job.
It is by no means clear why the normal forces of a market - the invisible hand - are so widely discounted, in media which are generally only too enthusiastic about the merits of the market in every other sphere. Depending on a highly complex set of factors, there are always people and institutions who have money they are anxious in varying degrees to lend, and others anxious in varying degrees to borrow. Generally, it might be guessed that borrowers are anxious to borrow money in times of boom, but they neither can nor will do so in times of slump unless the lender brings his price (interest rate) down. The central banker story turns this on its head. He is presented as deciding, after analysing in immense detail the health of the economy, and as matter of his free and independent choice, to lower interest rates, in the latter case, “in order to stimulate the economy”! This is a very visible hand, as visible as that of a Soviet planning ministry. Even if my numerical evidence is disregarded, this is a priori such an implausible idea that it is astonishing that it attracts any, let alone the observed universal, credence.
In the UK (probably in other zones something similar happens), the idea is given weight by the fact that responsible and respected people can be heard pleading with the central bank for a cut in its base rate. This may stem from the circumstance that in practice, the Bank of England leads an informal banking cartel, in the sense that individual commercial banks often write contracts for business loans with variable interest “based on” the individual bank’s “base rate”. After each Bank of England base rate change, it is normal for banks of any importance to place advertisements announcing, voluntarily, that their own base rate is changing in unison with the central bank’s base rate. Mortgage lenders are generally more independent, both from the UK central bank and among themselves, but they follow on too, if more untidily. It may be imagined that the spokesman for a sector of business could not afford to be perceived to be absent from such a seemingly important debate. The point is, though, that, according to the view expressed above, the hard-pressed (business) agents represented by those spokesmen have already, individually, made their market signals directly or indirectly to the money market agents who determine the short-term rates, by withholding their borrowing until the price drops. The seemingly powerful central banker could as well, in this picture, be replaced by the able schoolchild mentioned above, who merely responds in a moderately skilful way to the changes in those short-term rates. It is true that until 1997, the UK bank rate was finally settled by a politician, and my data does not go back far enough to see what effect this had, but it is difficult to believe that such a politician could long resist the pressures of the money market conveyed from the lending institutions via the central bankers and his Treasury officials.
Although I have tended to portray the central bank as merely reacting to readily available market signals, there can be little doubt that the intense debate which goes on concerning the central bank’s supposed analysis of the economy must be present in the minds of all the agents who determine the daily or hourly variations of the 3-month rate. Thus it might be argued, not that the central bank is following the lead of the 3-month market, but that it is indeed analysing the situation, and coming independently to the same conclusion as that of the market agents. However, it strains belief that agents in a market engaged merely in the making of deals between lenders and borrowers, are in any substantive way influenced by thoughts of “what is good for the economy”, the concern which is portrayed as that of the central bank.
If the interest-setting role of the central banks is said to be of paramount economic importance, and if this perception is near universal, how can it be that my analysis of it not only shows it to be in fact illusory, but shows it easily and by the most simple means? After all, having found that an able schoolchild would have all the equipment needed to do Alan Greenspan’s job, my method of demonstrating it is also at the level of schoolwork. There is no learned bibliography, no invocation of Smith or Walras, no mention of heteroskedasticity, of unit roots, or of the Dickey-Fuller test, or indeed of any notion outside of the normal vocabulary of conversation. That, be it noted, is not because academic treatments are in this case over-powerful, but because they are hopelessly simplistic and inadequate.
How is it possible that legions of extremely clever people apparently subscribe to the conventional terms of a story which is patently implausible? This is indeed extremely puzzling, but it is by no means an unusual situation. It appears to be a rooted part of the way we are. The above-mentioned schoolchild might demonstrate in a very few words, and irrefutably, that legions of the good and great subscribe to religious and moral stories which are quite patently culturally determined, and therefore unlikely to be, as claimed, “true”. When observations, ranging from mere asides to sustained homilies, couched in these traditions, are made, they wing on their way unopposed. It is not as if they are unopposed because they are thought to be not worth opposing. No, we nod our heads. They are part of the comforting social matrix we live in. Indeed, the view, recently read, that “ .... faiths ... have been the biggest of the big ideas that have organised our lives across continents for up to two centuries”, is perfectly plausible, even while accepting that those faiths are mutually contradictory.
Nor, of course, is there anything new in the sort of message I am conveying. It is exactly the message perceived and conveyed by Andersen in his story of the small child and the emperor. This message, that the essential quality of the truth-seer is a total absence of cleverness, is characteristically read, absorbed, agreed with, smiled at - and ignored. Truth, among the learned and the unlearned, the clever and the stupid, the fluent and the tongue-tied, is the concern of only a tiny minority, those for whom career is not or no longer important, or for whom career and the pursuit of truth are in close alignment, namely those active in the hard sciences.
The general view of the media, bankers, business and politicians, not noticeably contradicted by academics, is that one of the main functions, or the main function, of the central bank is to analyse the progress of the economy, and then to steer it with skilful judgement towards health and growth, by making decisions to change their base rate, with carefully chosen timing, amount and direction. The data presented here show that it is impossible to sustain this notion of skilful time-critical steering, or even that the central bank does in fact lead or determine the short term interest rates available to savers or business. The contrary proposition, that commercial short-term interest rates are in fact observed and followed by the central bank, is mathematically sustainable, and generally in accord with the observed facts.
James Buchan, 1997, “Frozen Desire An enquiry into the meaning of money”, Picador
Marjorie Deane and Robert Pringle, 1994, “The Central Banks”, Hamish Hamilton
Financial Times, 19 December 2001, Editorial comment, “A tale of two central banks... ...and a third.”
Financial Times, 13 December 2001, Gerard Baker, “The White House fights the last economic war: President Bush's use of fiscal policy in the battle against recession shows what a dangerous weapon this can be.”
Financial Times, 9 November 2001, Tony Barber and Ed Crooks, “Europe gets serious”.
Robert J. Barro, 1993, “Macro Economics”, Wiley
Robert J. Barro, 1995, “Inflation and economic growth”, Bank of England Quarterly Bulletin, vol. 35, no. 2
------------------------------------------------------------------------
Abstract: Following on from the note entitled “The Function of the Central Bank” (see above), this note brings the data up to date. It will be re-issued at intervals. It will monitor the tendency of short-term interest rates, give the author's judgement on the likely movement of the central bank rate in the UK, US and EU zones, and enable the reader to make his own judgement.
Paper in HTML form
Abstract:
We all, including economics professors, statisticians and journalists, know just by looking around that our comfort and prosperity is determined by the plethora of objects produced by technical innovations over the millennia, centuries and decades. The earnings of billionaire investment managers may come from their “services”, but their prosperity is manifest in their possession of, or ability to buy, things which have been grown, cooked, mined, constructed, or manufactured. However, by some quirk of social psychology, those economics professors, statisticians and journalists (and no doubt bankers too) apparently believe, simultaneously, that things are not “important”. Agriculture has already been written off as “contributing only 2% of the economy”, and manufacturing is “declining” towards the same invisibility. Recently headlines appeared in the Financial Times and the Daily Mail that “business and financial services eclipse manufacturing” and “the City is supreme as factories fade away”. What was the source of those preposterous views? None other that our Office of National Statistics, whose own press release had been headlined in a similar way. As usual there was no response from any quarter, not even from the CBI Manufacturing Council, to point out that the ONS data had absolutely nothing to do with the only aspect of manufacturing that matters for national prosperity, namely physical output. This note suggests that the ONS should put its house in order. We need not only facts, but a balanced presentation, without attention-seeking headlines.
Paper in HTML form
Abstract. It seems rash even to raise the question in the title. The universal belief is
that the answer is and must be "yes". Yet factual evidence for this belief is curiously
lacking, maybe even felt to be unnecessary. This paper takes what is thought to be all
the, not very voluminous, post-war factual data which exists and which may bear on
the matter, and treats this data in every plausible way to find if any convincing
demonstration is possible that low inflation is associated with high long term growth
rate in GNP. This includes special attention to Germany, the country which is the
popular (and sole) paradigm among UK authorities and commentators. The paper
concludes that no such demonstration is possible.
Paper in HTML form
Abstract. In a previous paper, the author concluded that there was no evidence that
low inflation was associated with improved growth rate. In this note, he examines a
paper by R. J. Barro which tends to the opposing view. He suggests that the evidence
of this paper in fact reinforces his conclusion.
Paper in HTML form
Abstract. In a previous paper, the author concluded that there was no evidence that
low inflation was associated with improved growth rate. In a later note, he examined a
paper by R. J. Barro which tended to the opposing view, and suggested that the
evidence of that paper in fact reinforced his conclusion. In this note he comments on a
paper by W. R. J. Alexander, concluding that time series analysis, especially with
additional variables as in this paper, is unlikely to be able to contradict cross-section
results.
Paper in HTML form
Abstract. Politicians, journalists - commentators on economic matters generally - evolve a sort of quasi-stable rhetoric. They select two or three foreign countries with which they like to compare their own, either as models to be followed, or traps to be avoided. Other countries are rarely or never mentioned. They repeat over and over again mantras such as "we are the fourth largest economy in the world" in the UK, or variants of "the dot.com revolution" or "the new paradigm" in the USA. In arguments in the UK over the replacement of sterling by the Euro, it is almost a daily occurrence to hear growth in the UK contrasted with recession in Eurozone Germany. It appears likely that these stories emerge in part from appraisals of GDP expressed for the purpose of cross-country comparison in a currency unit (the Euro or dollar, say) calculated at the ruling rate of exchange. This calculation can be done instantly. It is "news". The more recent method of using purchasing power is much more complex and its results are published late. They are not "news", and do not affect the established rhetoric. Nevertheless, they are the truth, or as near to that as economic data can be, and often quite strikingly at variance with the current story.
Paper in HTML form
Abstract. The notion of de-industrialisation arises from the fact that industrial
employment, having risen rapidly, is now in equally rapid decline. This paper presents
the view that agriculture and industry together form, and have always formed, a
"primary" sector which from the beginning, because of its inherent capacity for
productivity gains, has progressively freed labour for non-productive work. The
"industrial" revolution was really a "primary sector" (in the above sense) revolution.
There is no new phenomenon of de-industrialisation, merely a speeding up of a process
of labour-freeing from the primary sector, whose ever decreasing work force produces ever increasing output.
Paper in HTML form
Abstract. Economic theory is dominated by abstract structures. Underneath, there is no firm foundation. Above, there is a lack of rigorous confrontation with established fact. Basic theoretical concepts have no acknowledged definition. The apparatus of graphs, algebra and technical vocabulary are often vehicles for rhetoric rather than descriptions of truth. In this abstract world, it seems to be accepted without embarrassment that all opinions are possible, while adopting the style of science in delivering each conclusion as if it was a fact. The closest parallel is perhaps with theology, where also each practitioner presents his story as fact, but there are differing stories. This paper illustrates this theme, with particular reference to "deindustrialization".
It points out that it is tangible things which are the primary measure, literally the sine
qua non, of all material, cultural and intellectual progress. Official statistics necessarily
aggregate market transactions involving tangibles and intangibles at monetary
exchange values. However it is an error, in the sense of being a misperception leading
to wrong action, to mistake this equivalencing of things and non-things as more than a
necessary procedural fiction. In this system, one opera performance equals, say, 100
lorryloads of gravel, but the logical reality is that gravel is part of the primary
inventory, opera and all other intangibles are secondary or consequential. This
inversion of the important and the estimable lies behind the paradox of the
deindustrialization which is in process and the deagriculturalization which has already
run its course in some parts of the world - namely that our entire civilisation rests (and
logically and factually must always rest) on the output of this (in employment terms)
disappearing sector. Eventually, the sector which ultimately produces all value
will appear in the statistics as one which adds zero value in current terms.
Fortunately, the real word of affairs shows no sign of acting on this erroneous
perception. For those accustomed to see the world in abstractions, misperceptions still
seem to obscure the reality.
Paper in HTML form
Abstract: Is industrial production relatively in decline? No, it is not. This note displays the evidence that for the last 40 years, in the 6 largest economies of the world, industrial production has kept pace with total output.
Paper in HTML form
WoPEc - Working papers in economics - WUSTL December 2002 Paper in pdf form
Abstract: The author of this note takes it as self evident that prosperity and the provision of "things" (buildings, roads, furniture, furnishings, clothes, machines and equipment of all sorts) go together. The way people generally speak and act is in line with this view. If this is so, domestic manufacturing must continually keep pace with gross domestic product, provided that the necessary "things" are not imported from elsewhere. However, many people are persuaded that domestic manufacturing is in terminal decline, and that the lost output is being replaced by imports from the developing world. Almost daily, one may read of manufacturing jobs being "exported" to the Far East. However, it is simply impossible to import goods without a more or less balancing volume of exports, and there is in reality limited scope for exporting a sufficient volume of services. Imports of goods must more or less be balanced by the export of domestically produced goods. How can a widespread perception of decline be reconciled with a reality of growth? The answer is that the "decline" which is perceived is a decline in employment in the industrial sector, but this decline is more than counterbalanced by the rise of productivity, so that the domestic output of goods by and large keeps pace with the growth of GDP. This note summarises the statistical evidence for the accuracy of this view. A substantial footnote discusses the role of journalists and academics in sustaining the perception of the decline of manufacturing.
Paper in HTML form
Abstract:
When Pigou vigorously attacked Keynes immediately the General Theory was published, he wrote that, “since a detailed running commentary would be both tedious and un-illuminating, I shall not adopt that method”. These reading notes follow precisely this tedious route. The truth cannot always be entertaining. Keynes was one of the most fluent and plausible rhetoricians of his age, and it could be argued that his work can be examined only by dismantling his rhetoric line by line to expose the total logical vacuum which in cold objective fact the General Theory is.
Keynes’ book was seemingly written at speed, contains no bibliography, virtually no mention of factual data, little evidence, pseudo-algebra only for appearances, no attempt at anything which could be called scientific method. His acknowledged greatness lay in his cleverness, and his great skill as a debater, negotiator, journalist, and politician, not at all in his ability or interest in searching out the truth. His “theory” is presented in terms of mechanistic cause-and-effect models of economic society, but quite demonstrably, these models are based on nothing but the repetitious re-statement of Keynes’s prior and evidence-free conviction that the cure for unemployment and recession is to stimulate spending, any spending, useful or useless, either by individuals or by governments. Keynes used every rhetorical trick imaginable to hide the empty centre of his work, from “as I shall show … ” onwards. His mainstay, as Pigou remarked, was a deliberate lack of precision and clarity. The great sociological mystery is - how did this transparently fact-free “theory” sweep everything before it?
Paper in HTML form
Abstract. It has been said, fairly plausibly, that "Bayesian inference is one of the most
widely known eponyms in all of science". But unlike common scientific eponyms, it is
by no means clear exactly what "Bayesian" means, and what it has to do with Bayes.
"Bayesian", and the dozen or so words and phrases which are usually associated with
it, seem to be more like unspecific words of the English language, deployed by an
author as he wishes, rather than fixed technical terms. The obscurity of the language,
relative to the precise meanings associated with, say, Newton's laws or Heisenberg's
uncertainty principle, is matched by the obscurity of the history - the virtually unknown
Bayes, the posthumous paper, the impenetrable and incoherent style, the muddled
logic, the virtual silence on his work for 200 years, the sudden emergence in the last
several decades, not of new knowledge, but of new Bayesian additions to the
vocabulary. This note surveys the notions and the history. It concludes that the
Bayesian vocabulary is vague and pretentious, and serves no useful purpose.
Paper in HTML form
Abstract:
Wittgenstein and Russell both in their different ways showed that they believed that ultimately, there were better things to do with one’s life than study or talk about philosophy. Both were remarkable men. The words of both appear in the English translation of the Tractatus, Russell’s in his introduction to Wittgenstein’s book. This note comments on these words, almost one at a time. The lack of clarity, logic and coherence of both authors raises the puzzling question – in what does greatness lie? Is it in personality, debating skill, membership of a mutually admiring elite? This note discovers nothing of interest or importance in anything actually written between the covers of this book.
The note is essentially reading notes, as was my note on Keynes’ General Theory. I recall that when Keynes’ friend and rival, Pigou, vigorously attacked Keynes immediately the General Theory was published, he wrote that, “since a detailed running commentary would be both tedious and un-illuminating, I shall not adopt that method”. The notes below follow precisely this tedious route. The truth cannot always be entertaining. Pigou chose to challenge Keynes on the latter’s home ground, as a debater, a predictably hopeless task. For Wittgenstein, as for Keynes, I might argue that his work can be examined only by dismantling his rhetoric line by line to lay bare its lack of discipline, of coherence, of logical development, and of content.
Paper in HTML form
Abstract:
These are critical notes made while reading Deborah A Redmans's "Economics and the Philosophy of Science". The philosophy is largely that of Popper, Kuhn and Lakatos. Redman begins in the style of a neutral reporter, but later shows her impatience with the confusions sown by those eminent people. Hutchison supplies the main sceptical comments. My main comment is that neither Redman, nor the philosophers she quotes, appear to recognise that it is simply impossible to discuss "science" if the unstated assumption is that science is whatever anyone chooses to call science. One has to start with the strikingly observed worldwide unanimity of physicists and chemists within their respective disciplines, and take account of the fall-off of unanimity (that is, the widening scope for disagreement) as one moves through biology, medicine, etc. (that is, as the matters studied become more and more complex). Economists are in the absurd situation of claiming to be scientists, or at least, wanting to appear to be scientific, when the matters they study are simply too complex ever to lead to consensus. The absurdity is demonstrated when, for example, Friedman is cited in this book as claiming that there is no fundamental distinction between economics and the physical sciences. At the other end of the spectrum, historians and philosophers do well to ply their trade without making inappropriate claims of objectivity.
Paper in HTML form
This is my own translation of a work which appears from the bibliography to have a significant English-speaking audience, but of which there seems to be no readily accessible English version.
English translation
Abstract:
E O Wilson’s book "Consilience" is a notably unscientific plea for science to take over the so-called social sciences, from economics to psychology, and extend also into art and religion. The text rambles on, with exalted brilliance according to one reviewer, over this whole field, but the brilliance sheds no new light, and fails to explain exactly what consilience is, how it might be achieved, and what benefit would result if any of these subjects (for example, art) was connected back to genes, biology, chemistry and finally physics. It is not mentioned that such a connection to the "harder" sciences is in any case a pipedream.
Paper in HTML form
This counter is freely available from John and Ann Lockett's site at
www.lockettpots.uklinux.net