Introduction to Monetary Policy

Thanks to the Pictet Research Institute for their invitation to participate in their inaugural symposium. It is a great honour and pleasure to engage with such a distinguished group of academics and practitioners on contemporary issues of monetary policy. Those issues are many, inter-related and complex. While I don’t expect to attract much sympathy in making this remark, we live in challenging times for monetary policy makers like me!

Quantitative Tightening (QT) Explained

This morning, I will focus on one such monetary policy issue: the pace at which central banks should shrink their balance sheets via ‘quantitative tightening’ (QT). QT entails reducing the stock of bonds (typically government bonds) held by central banks for monetary policy purposes whose purchase was financed by the creation of reserves. It represents the unwinding of previous quantitative easing (QE). I hope you will permit some parochialism here, as I will discuss this issue in a UK context.

UK Context and Global Concerns

I appreciate that this discussion may seem a little ‘niche’ or narrow to an international audience. But it sits within a broader web of institutional and policy questions relating to monetary policy and central bank independence. These are topics of global concern. Last week the Bank of England’s Monetary Policy Committee (MPC) announced a slowing in the pace of QT from £100bn per year to £70bn per year. This decision was taken on the grounds that a number of factors – larger term premia on long-term government bonds, greater global economic policy uncertainty, and weaker demand for longer-term government debt stemming from structural changes in the UK bond market – may have increased the risk that QT would disrupt on market functioning.

Principles of QT and MPC Decision

In August 2021, the MPC set out a set of principles to govern the implementation of QT in its Monetary Policy Report. Paraphrasing that document, the Committee has a preference to use Bank Rate as its active policy tool when adjusting the stance of monetary policy; Sales would be conducted so as not to disrupt the functioning of financial markets, and only in appropriate conditions; and To help achieve that, sales would be conducted in a gradual and predictable manner over a period of time. These principles have served the MPC well. They have helped keep QT “in the background” and have supported the clarity and simplicity of our monetary policy communication around the “active” Bank Rate instrument.

Reasons for Dissent

Nonetheless, I dissented from the majority MPC view on this issue, favouring instead a continuation of the £100bn annual pace of QT that has been implemented in recent years. This dissent reflects the high weight I place on maintaining continuity and consistency in the MPC’s approach to QT. Operating within our established principles has allowed the market to price the impact of QT and has thereby allowed the MPC to set Bank Rate to achieve the inflation target given the impact of QT – as well as a multitude of other factors – on the yield curve, bank behaviour and wider financial and credit decisions.

Conclusion

In conclusion, I believe that the principles established in 2021 have served the MPC well and should continue to guide our approach to QT. While I acknowledge the risks and challenges associated with QT, I do not believe that slowing the pace of QT is the best solution. Instead, I think it is essential to maintain consistency and continuity in our approach to QT, and to use other tools to address concerns about market functioning and public debt management. I hope I have convinced why I voted to maintain the pace of QT at £100 billion over the coming year. It was driven by a motivation to provide continuity and consistency in the MPC’s approach, particularly as gilt market developments had been predominantly unrelated to QT.

The text has benefitted from helpful comments from various individuals for which I am most grateful.