Last month’s announcement that the Bank of England’s Monetary Policy Committee was introducing explicit forward guidance drew considerable interest.
But the disappointment that followed – visible in the markets – was based, I believe, on a misinterpretation of recent history and a misreading of the potential for the Bank to change what it does.
In early August, Bank governor Mark Carney said the bank would keep the base rate at 0.5 per cent until the UK’s unemployment rate falls below 7 per cent unless inflation spikes.
The Bank is also prepared to add to quantitative easing while the unemployment rate remains above its desired level.
According to Office for National Statistics, the UK’s unemployment rate currently stands at 7.8 per cent.
The Bank’s current forecast is that the median unemployment will be 7.3 per cent for the next three years whilst trying to explain directly to businesses and households that interest rates will not go up in the near term despite sceptics in the financial markets.
Earlier this year there were rumours that there might be a significant change in the MPC’s remit.
At the most extreme, there was the suggestion that the inflation target might be replaced by a target for nominal gross domestic product.
But, on Budget day, the chancellor published, as usual, his annual letter to the governor defining the MPC’s task.
The key statement was: “I confirm that the operational target for monetary policy remains an inflation rate of 2 per cent.”
Not only did the chancellor George Osborne’s letter not change the target – it did not change the weaponry either.
The MPC was not permitted to do anything it was not able to do before the letter was sent, nor was it required to do anything it was not required to do before.
The MPC was asked to be more explicit about how it saw and judged the trade-offs inherent in setting monetary policy.
In retrospect, it would have been better if the MPC had made clearer at an early stage that it was prepared, in the exceptional circumstances of the Great Recession, to allow an extended period of above-target inflation in response to a succession of temporary shocks to the price level.
The MPC’s response to the chancellor’s Budget letter was reported in the minutes of its April meeting.
It said: “In responding to this trade-off [between output growth and inflation], the committee was setting policy in broadly the same way that it had done since its formation.”
Given the high inflation rate at the time, I thought that was the closest the MPC had come in its history to making a joke.
Business activity and confidence in the UK service sector has grown strongly, according to the CBI’s latest survey.
A fortnight ago, revised official figures showed that the economy grew by 0.7% in Q2; better than forecast. In an interview with Bloomberg on 25th August at the Jackson Hole Economic Policy Symposium, Charles Bean ( Deputy Governor of BOE ) said the bank was “communicating not just to market participants, but to people, to households and businesses, to give them a clear signal that interest rates are not likely to rise imminently,” In the circumstances; I do not expect any change in base rates and any increase in QE.