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July 31, 2013 7:02 pm
To judge by his first month in charge of the Bank of England, Mark Carney is a man of action. He has appointed a woman in his own image to take day-to-day management off his desk; hired an old friend to be a deputy and chief international negotiator of financial regulations; softened the time pressure on some banks to meet new regulatory standards without conceding any important principles; published archives highlighting the BoE’s murky role in helping the Nazis loot Czechoslovak gold; and dealt with the BoE’s self-harming decision to remove the only historical woman on any British banknote.
Certainly, no one can say Britain’s Canadian import as BoE governor is afraid of a quick decision, and the change of pace has energised the “Old Lady of Threadneedle Street”. But the truth is that these easy decisions will be quickly forgotten. The harder task starts now.
Mr Carney was not hired to stamp out witless sexism at the BoE, nor did George Osborne court him primarily to shake up the institution, though that was a necessary condition. He was appointed to transform the first element of the government’s three-pronged economic strategy of “monetary activism with fiscal responsibility and supply side reform”.
More monetary activism, the chancellor’s team is quite clear, does not necessarily imply a further expansion of the BoE’s balance sheet. Accordingly, the minutes of the July Monetary Policy Committee meeting showed the members cooling on quantitative easing as a strategy.
But it does mean using the bank’s authority to do more than simply use guidance to verify financial markets’ expectations of the likely future path of interest rates. Mr Carney signalled his intent on this score by persuading the other eight MPC members to issue a statement after the July meeting that market expectations of earlier interest rate rises “were unwarranted”.
Alongside the signals to markets, Mr Carney has always insisted that forward guidance in Canada worked because “it reached beyond central bank watchers to make a clear, simple statement directly to Canadians”.
But jawboning alone about how long interest rates will remain low holds little credibility with cynical investors, households and companies who expect policy makers to change their minds at the drop of a hat.
To work as an effective stimulus, guidance has also to involve some form of pre-commitment to looser monetary policy for longer than expected from which it would be difficult for officials to escape. This is where the MPC will have to define which economic variables it will target before considering monetary tightening. To aid credibility, the BoE will also consider adopting a stance that will cause the central bank to lose money if it reneges on its commitments.
This monetary activism is likely to come alongside a new economic forecast that is more open about the trade-off between growth and inflation assumed optimal at the BoE. For greater stimulus, we should expect a higher growth forecast alongside an expectation that inflation will take longer than two years to fall back to target.
Achieving all these elements of a new, more active monetary policy will not be easy when the governor faces a committee of individuals voting afresh every month. The MPC cannot easily tie its hands. So, for all his mini-triumphs in the first month, Mr Carney’s big first test is at hand. I think he will succeed, not because of his brilliance, but because MPC members are in no mood to rain on the new governor’s parade so soon and so publicly.
More important than the incentives, however, is the economy. With continued deficit reduction, a fragile recovery is now under way, but it is far from secure. Genuine inflationary pressure is non-existent. Cash-spending growth remains weak, as does wage growth. The chances are that if the economy grows quicker, at least some of the feeble productivity performance of recent years will disappear as output rises without matching employment.
There will not be a better time than now to spend some of the BoE’s monetary policy credibility in search of a more robust recovery. If the MPC passes on the opportunity, all Mr Carney will have left for the next five years is the relatively easy task of bringing the BoE a little more up to date.
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