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October 23, 2013 5:19 pm
Few inside the bank would dare be so blunt, especially now an army of McKinsey and Deloitte cost-cutting consultants is prowling Threadneedle Street. But disquiet about forward guidance is widespread and extends much further than the investor community, who are betting on a much earlier rise in interest rates than the current vintage of BoE unemployment forecasts suggest.
To recap: in August the bank said it would not raise interest rates while unemployment remained above 7 per cent so long as three knockout clauses, related to inflation and financial stability, remained unbroken.
Many members of the Monetary Policy Committee have defended the unemployment threshold as enabling the interest rate-setting body to remain “agnostic” about the big questions hanging over the UK economy. This is not guidance but a deep internal MPC argument over the degree of inflationary pressure cloaked in language of common policy. On balance, being more open about divergent views on the MPC would have provided a better guide to the future path of monetary policy than the current consensus.
Worse, unemployment has proved over the past 11 weeks to be a bad and partial proxy of what it is intended to shadow – the spare capacity in the economy that governs inflationary pressure. The October MPC minutes said it was “unusually difficult” to conclude anything about spare capacity even as the MPC had to concede that the fall in unemployment since August had been much larger than expected.
In any case, the guidance was calibrated with sufficient caveats to ensure that the committee is not prevented from raising rates if unemployment remains above 7 per cent, nor is it forced to raise them if it falls to the threshold.
Combine all three elements and forward guidance is a lowest common denominator policy based on a bad proxy and without any binding commitments. How this makes monetary policy “more effective”, as the governor insists, is beyond me. Demonstrating the superior effectiveness of the policy was also beyond Charlie Bean, deputy governor. In a speech this week he concluded that “there is scope for much more analysis of the impact of our guidance”. Not since the introduction of quantitative easing has there been such a desire for evidence-making to support policy initiatives at the BoE.
The danger is that households and companies will borrow now, thinking the central bank has guaranteed to keep rates at rock-bottom until at least 2016, and get a nasty shock if rates rise earlier. Mr Carney will be vulnerable to accusations of mis-selling his big idea.
But, for all these good reasons to kill forward guidance as quickly as possible, the collateral damage would be to destroy a kernel of valuable transparency that has accompanied it. The policy has forced the bank to be a little more open about its thinking and judgments and less reliant on mystique. In other parts of Mr Bean’s speech he demonstrated a new and welcome honesty about the BoE’s poor forecasts.
If households and companies know the central bank will be open about how its thinking is changing in future, they will make better decisions on borrowing and spending.
To do this properly we need much more information than some vague guidance about the timing of the first interest rate rise. More critical is a sense of how fast rates are likely to rise; what the MPC believes is the destination for rates; and how quickly the BoE plans to sell the £375bn gilts it now owns.
These variables will be a moveable feast as we learn the extent of persistent damage the crisis has wrought on the economy. Anyone thinking of taking out a mortgage or any company thinking of investing should not be denied knowledge of this information, which already resides in the BoE forecasts but is not currently published.
Mr Bean hinted that more transparency was likely at some point in the next few years. It is more urgent than that. As borrowing and lending picks up strongly, there is no better time for some proper guidance on monetary policy thinking than in the November inflation report.
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