On August 7, the Bank of England issued its first quarterly Inflation Report under its new governor, Mark Carney. Governor Carney clearly got the economics right in his accompanying first press conference on behalf of the Bank’s Monetary Policy Committee (MPC). He dismissed unfounded fears of high inflation in the United Kingdom, and spoke sanely about the overall benefits to the British economy of keeping interest rates low (opposing the rate increase that some crazies or special interest hacks advocate).
Carney had committed to announcing this month some form of nearer-term target for British monetary policy beyond the medium-term (two to three years out) inflation target. He was responding to the Cameron government’s review of the Bank’s mandate earlier this year. He and the committee were right to make unemployment the threshold for marking the circumstances in which policy will tighten. Unemployment is something directly measured, of great economic importance, and a good reference point for the overall state of the economy, and it is preferable as a marker to an estimate of nominal GDP or some other economic variable that is less familiar to the public and subject to later revision. That said, the latest announcement is not the unveiling of a bold new policy tool. The impact, if any, of such an interest rate commitment will only be felt when the recovery takes hold.
The problem remains that the governor and the MPC have chosen to engage in forward guidance, substituting a promise that interest rates will not be raised for a long time for actual policy easing today. Like their counterparts at the Federal Open Market Committee (FOMC), the MPC has found out—to its frustration—that when you specify that you will not raise rates, you also strongly imply a reluctance to do more quantitative easing (QE) or other positive measures. So just as with Chairman Ben Bernanke’s press conference a few weeks ago, the market impact of the latest announcement is to strengthen the pound and raise lending rates, meaning a de facto tightening of policy. Also, just like their counterparts at the FOMC, the MPC has created a divergence between the policy implications of their forecast of on target inflation and their forecast of very slowly decreasing unemployment (at best), suggesting that a bias towards tightening is driving their decisions. This creates uncertainty and makes the longer-term commitment to keep rates down less than credible.