Last updated: December 11, 2012 10:44 pm

Carney broaches dumping inflation target

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Mark Carney©Bloomberg

Mark Carney, the next governor of the Bank of England, has suggested he will act much more aggressively to revive the UK economy when he takes charge next summer, including dumping the BoE’s much-vaunted inflation target if growth fails to pick up.

In a clear break with the views of the BoE’s current senior management, Mr Carney, now governor of the Bank of Canada, said on Tuesday that central banks should consider more radical measures – such as commitments to keep rates on hold for an extended period of time and numerical targets for unemployment – when rates are near zero.

If those measures fail to have the desired effect, Mr Carney said central banks should consider scrapping their inflation targets – a cornerstone of economic policy around the world in recent decades, including in the UK.

“If yet further stimulus were required, the policy framework itself would likely have to be changed,” Mr Carney said in Toronto in his first speech since being named successor to Sir Mervyn King last month. He cautioned that the benefits of any regime change “would have to be weighed carefully against the effectiveness of other unconventional monetary policy measures under the proven, flexible inflation targeting regime”.

The comments are likely to rankle with Sir Mervyn, who masterminded the campaign for an inflation target for the UK, introduced in 1992. The BoE targets inflation of 2 per cent, though prices have risen at a faster rate since 2009.

Any decision on scrapping the inflation target would rest with George Osborne, the chancellor, and would be influenced by the Monetary Policy Committee’s other eight members.

However, when questioned in a press conference following his speech about the implications of his views for the BoE, the future governor said: “That’s not signalling anything, that’s not guidance. It’s not only not guidance about the stance of monetary policy in Canada, it’s certainly not the stance of monetary policy anywhere else.”

Mr Carney suggested that a nominal GDP target, where a central bank sets monetary policy based on both inflation and growth, would do more to boost economic output. “For example, adopting a nominal GDP-level target could in many respects be more powerful than employing thresholds under flexible inflation targeting,” he said.

A nominal GDP target allows central banks to act much more aggressively to counter an economic slump. Mr Carney argued that a regime change would become far more effective when central banks had cut rates to near zero when “the exceptional nature of the situation … could make such a policy more credible and easier to understand.”

Canada last year flirted with dropping its inflation target but eventually renewed it.

Mr Carney has in the past indicated that he is willing to take exceptional measures to support growth. The Bank of Canada was the first central bank in the Group of Seven leading economies to commit publicly to keeping rates low for an extended period – a policy later aped by the US Federal Reserve.

Mr Carney said on Tuesday that the conditional commitment, introduced in April 2009, “worked because it was exceptional, explicit and anchored in a highly credible inflation-targeting framework.”

The BoC was also the first in the G7 to raise rates, leading some to suspect that Mr Carney would prove a more hawkish governor than Sir Mervyn. However, the decision for the increase owed more to the strength of Canada’s economy, which relies on natural resource exports.

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