Can insider trading overcome the time inconsistency problem?

The Bank of England wants to raise inflation expectations, as it is one way of escaping from a liquidity trap.  But the public is skeptical, and inflation expectations remain below the long run trend for Britain.  The solution is to invest BOE employee assets into “linkers,” the British version of TIPS.

From the Daily Telegraph

Last week’s revelation that the Bank of England had switched 70pc of its own pension fund into index-linked gilts has raised the question of whether these government IOUs could be the answer to savers’ inflation worries.

The bank’s pension fund is the nearest thing to a legal insider trader, because the bank also sets the interest rates that control inflation. If the pension fund thinks inflation will rise, maybe we should all sit up and take notice.

(Thanks to Current for the link.)  A few months ago I discussed the issues raised when the central bank was an “insider trader.”


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14 Responses to “Can insider trading overcome the time inconsistency problem?”

  1. Gravatar of Current Current
    17. June 2009 at 07:07

    Hmm, I have a more cynical interpretation. I think the bank believe their policies will cause a lot of inflation. They will get the sack and retire on fat pensions paid for by the taxpayer.

    What my theory lacks in theoretical elegance I think it makes up for in simplicity. A bit of reading of Buchanan and Tullock could improve it but I don’t think that’s necessary.

  2. Gravatar of Current Current
    17. June 2009 at 07:58

    Central banking forever quantitatively teases us with the contrast between its ideals and its realities, between its heroic possibilities and its sorry achievements.

    Apologies to Agnes Repplier.

  3. Gravatar of azmyth azmyth
    17. June 2009 at 18:22

    I like Buchanan and Tullock, but I don’t think that a rational profit maximizing central banker would opt for high inflation. They’d probably lose their job and once they got out, few people would respect them. As a side note, excess pension funds typically go to the government (or the company in private plans) not to pensioners.

  4. Gravatar of Current Current
    18. June 2009 at 00:25

    In Britain the head of state finance is the chancellor. We have a saying in Britain “there are two sorts of chancellors, bad ones and ones that get out in time”.

    I think the same is true of central bankers. These ones want to get out in time.

  5. Gravatar of ssumner ssumner
    18. June 2009 at 04:13

    Current, If their investments became a source of great controversy, it could also cut the other way, making them afraid of inflating for fear they’d look greedy. I do like public choice theory, but also think idealism plays a bigger role in public policy than some people imagine.

    Azmyth, That’s a good point, but it raises the issue of the incentives facing the pension manager. Why would they try to maximize returns? And if the answer is that their commission is based on performance, then the question goes back to whether those managers have inside info. Or am I missing something here?

    Current#3, Good observation. It fits two great American central bankers. Greenspan, who got out in 2006, and Strong, who got out in 1928. (Actually Strong died.)

  6. Gravatar of Current Current
    18. June 2009 at 04:46

    Scott: “If their investments became a source of great controversy, it could also cut the other way, making them afraid of inflating for fear they’d look greedy.”

    That’s a good point.

    Scott: “but also think idealism plays a bigger role in public policy than some people imagine.”

    I used to think that too until recently. Then the Daily Telegraph* revealed the expenses UK MPs.

    http://www.telegraph.co.uk/news/newstopics/mps-expenses/

    Some of the “dirt” they dug up wasn’t so impressive. Much of it was very impressive indeed though. The amount of troughing uncovered was ridiculous. They had about three continuous weeks of front page headlines from it.

    * I don’t work for them, scout’s honour.

    Scott: “Good observation. It fits two great American central bankers. Greenspan, who got out in 2006, and Strong, who got out in 1928. (Actually Strong died.)”

    The “got out in time” gag is one Gordon Brown used to make himself, he may have made it first, which is ironic.

    It could be an age related thing too. Perhaps being a central banker isn’t a job for an older person.

  7. Gravatar of ssumner ssumner
    19. June 2009 at 04:08

    Current, The idealism question is tricky. Both Bernanke and I did research on the Great Depression. So although he is a much more distinguished economist than I am, I can sort of put myself in his shoes. If I were fed chairman I would try to act idealistically. Obviously one could be cynically and say that’s exactly why I would never be picked.

    I do think, however, that it is important not to be so cynical that one claims mistakes are never made, that it is all just secret agandas. My sense is that policy failures took a huge emotional toll on people like Hoover and Lyndon Johnson, and Bernanke looks pretty stressed out by the current crisis. There is no doubt in my mind that things haven’t gone the way that Bernanke had hoped, and I’m pretty sure he would have done things differently if he could go back in time.

  8. Gravatar of Current Current
    19. June 2009 at 04:37

    Yes. Mistakes have to be relevant in such a difficult and stressful job. I think whether it can ever be done well is an open question.

    However, you don’t have to believe that those in power *know* the right course to say that they may take the course that benefits them. Knowing the greater good is much more difficult that knowing your own good or that of your supporters.

    The least stressful option for a central banker in the short run is almost always easy money.

  9. Gravatar of ssumner ssumner
    20. June 2009 at 08:07

    Current, God my spelling was bad in the previous comment. Anyway, if easy money is the easy way out, why is Bernanke letting NGDP fall significantly? You may be right most of the time, but there are times like 1930 and now that they go too far the other way. By the way, I also know people who think the Fed has a deflationary ideology to help bankers. So there are lot’s of different political arguments you can make.

  10. Gravatar of Current Current
    22. June 2009 at 03:48

    Scott: “You may be right most of the time, but there are times like 1930 and now that they go too far the other way.”

    I think I agree with you there.

    Scott: “also know people who think the Fed has a deflationary ideology to help bankers.”

    I think that’s a pretty odd idea. Banks do very well out of inflation due to the Cantillon effect. They may not have an interest in money supply inflation currently, but I think that is their general preference. They are protected from the long term detrimental effects of inflation, that is ABCT, by the Fed acting as lender of last resort and recently by treasury bailouts.

  11. Gravatar of ssumner ssumner
    22. June 2009 at 06:15

    Current, I may have made a mistake by stressing bankers. Bankers can gain a bit from lower inflation, as the rates fall faster on their short term deposits, then on their long term loans. But you are right that they might be worse off, if people can’t replay their loans. I do recall that the old populist politicians claimed that the gold standard was a plot to help eastern bankers and hurt farmers. I think the more modern argument focuses not so much on bankers, but rather lenders, especially long term government bond holders–one of the few groups to gain from the current crisis. I’m not saying I agree with this view, just that it is out there.

  12. Gravatar of Current Current
    22. June 2009 at 06:39

    I see. That does make logical sense.

  13. Gravatar of Lorenzo (from downunder) Lorenzo (from downunder)
    26. June 2009 at 21:32

    On public choice theory, policy makers usually have a wider audience to appeal to. Policies need to at least appear to have functional utility. Not least because policy makers also have reputation effects to consider.

  14. Gravatar of ssumner ssumner
    27. June 2009 at 10:09

    Lorenzo, I agree. I don’t have a firm view of the Fed’s motives, but am inclined to think they are effected by elite opinion.

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