Bank of England’s Catherine Mann and RBNZ’s Paul Conway say raising and cutting interest rates quickly was the right thing to do during the crisis

Top central bankers say bigger monetary policy moves are more effective at anchoring inflation expectations and tackling economic uncertainty than smaller ones.  

Catherine Mann, a member of the Bank of England’s monetary policy committee, told attendees of the Reserve Bank's (RBNZ’s) policy conference that gradual rate moves were becoming old-fashioned. 

Mann voted to cut the United Kingdom’s benchmark interest rate by 50 basis points in February but was overruled by other members, who preferred a 25 basis point reduction to 4.5%. 

“The Monetary Policy Committee collectively judged that a gradual and careful approach to the further withdrawal of monetary policy restraint was appropriate,” she said. 

“Gradualism, as the preferred monetary policy strategy, was promulgated at a time when financial flows were small and markets stable. Gradual moves in the policy rate were seen to prevent monetary policy from creating excess volatility in financial markets, which would hamper transmission”. 

But nowadays the financial markets themselves were the main drivers of volatility, particularly due to cross-border spillovers. International factors had overwhelmed policy decisions and driven outcomes in the short end of the yield curve.

“The founding premise for a gradualist approach to monetary policy is no longer valid. Hence, 50 basis points to cut through the turbulence,” she said. 

“Monetary policy has to navigate through the choppy financial markets, the shock-ridden economies, and these stick and drifting [inflation] expectations. So larger cuts, as the one I voted for at the meeting, cut through this turbulence to more effectively communicate the stance of policy and to influence the economy”. 

She called this an “activist monetary policy strategy” which was defined by large moves in policy rates and longer holds at desired levels.

Least regrets?

This style of strategy seems similar to the RBNZ policy choices throughout the pandemic. It quickly loosened monetary policy when the lockdowns first hit, and then tightened once inflation left the target range.

Now the Monetary Policy Committee has decided rates should be neutral, and it has been cutting in 50 basis point steps to get there. 

The Reserve Bank has adjusted the Official Cash Rate 17 times since 2020, mostly in double or triple steps. Traditional 25-basis-point moves accounted for less than a third of these changes. 

In contrast, nearly 90% of policy moves in the five years before the pandemic followed the 25-bps standard.

Critics would say it was exactly this strategy of large moves and overly long holds, which led to the mediocre economic outcomes New Zealand has experienced. Inflation is back in the target range but it took a serious recession to get there. 

Paul Conway, chief economist at the RBNZ, said the “least-regrets approach” used by the bank during the covid response was closer to an activist strategy than a gradualist one. 

“It wasn't incredibly different from other central banks, but we did go a bit higher, and we got there a bit more quickly. What I'm hearing is that may well have been an optimal response to the shock and the inflation that we were experiencing at the time,” he said, after the speech. 

However, several conference attendees seemed skeptical of Mann’s activist strategy during a question and answer session. 

Senior Fellow at Motu, Arthur Grimes and Treasury’s Dominick Stephens both asked about the negative externalities of more dramatic policy moves. For example, the RBNZ’s strong response sent house prices soaring and caused a “huge destabilisation of the economy”.

Mann’s response was that asset prices aren’t in most central bank remits and therefore shouldn’t be a priority in policy settings. 

Another questioner challenged her idea that larger policy moves could be used as a way to counteract uncertainty. In a dark room, shouldn’t you take small steps, they asked? 

“Part of the reason why the room is dark, or the fog hasn't lifted, is because monetary policy hasn't taken a decisive stance,” Mann replied.