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Last updated: September 24, 2013 10:27 pm
The Bank of England has hit back at critics of its new forward guidance framework, saying sceptics have misconstrued its message as a commitment to keep its main interest rate at a record low for another three years.
When the Monetary Policy Committee in August pledged to hold the rate at 0.5 per cent at least until unemployment falls from its current level of 7.7 per cent to 7 per cent, the initial reaction was mostly favourable.
Since then, however, investors have grown more sceptical about the policy as markets price in a rate rise before the date forecast by the committee for unemployment to reach that level.
But three members of the Monetary Policy Committee – Ben Broadbent, David Miles and Paul Tucker – have this week argued that market doubts do not mean there is a flaw in the BoE’s framework. In the weeks ahead, most of the other six members are expected to do the same.
That investors do not subscribe to the BoE’s view that employment is unlikely to drop to 7 per cent until the middle of 2016 is no reason to write-off guidance, policy makers are saying.
Mr Miles said on Tuesday: “These movements [in market rates] may not persist, but that is far from clear. Either way, I find it hard to see them as a sign that forward guidance has somehow failed at the outset.”
Policy makers’ apparent lack of concern about the difference between when they expect interest rates to rise and investors’ expectations is explained by the nature of their guidance.
Rather than committing to keep rates on hold for a set period of time, the BoE forward guidance is what is known in central bank speak as “state-contingent”, that is a pledge from rate-setters to support the recovery until the economy is in a much better state of health.
Mr Tucker said on Tuesday that while it was inevitable that markets would translate the MPC’s “state-contingent” guidance into predictions of when rates will begin to rise, there were clear reasons why the BoE would not promise to keep rates fixed for a set period, no matter what happened in the economy.
“We cannot wave away the uncertainties surrounding the performance of the real economy,” Mr Tucker said. This has made policy makers reluctant to respond to market doubts over their forecasts for the labour market.
Simon Wells, economist at HSBC, said: “What [policy makers] are trying to do is spell out why they didn’t go for ‘time-contingent’ guidance. They were never going to commit to keeping monetary policy loose come what may. They’re trying to provide that clarity. Of course by doing so, you make it more uncertain when rates might eventually rise.”
The puzzle of why productivity in the UK has fallen so sharply in recent years lies behind policy makers’ caution in forecasting what will happen to unemployment.
Mr Broadbent said: “If we don’t really have a good explanation for the way something has behaved in recent experience we should surely be less confident about our ability to forecast the future.”
The uncertainty is reflected in the BoE’s models, which show small changes in growth and productivity can make a substantial difference to how long it takes for unemployment to hit the 7 per cent threshold.
If productivity picks up as the economy recovers, the unemployment rate would take longer to fall to 7 per cent, because existing workers would produce more rather than companies adding more employees.
On the other hand, if productivity remains weak because the UK’s labour force is less well equipped to do the sort of work needed for the economy to return to its pre-crisis growth levels, jobs could be added more quickly.
Policy makers are split on what will happen. Mr Miles believes workers’ output will improve substantially as the economy recovers. Mr Tucker and Mr Broadbent are less convinced.
Mr Wells said: “The productivity puzzle has been the big issue over the past few years, but they don’t seem to have any more compelling explanations than there were . . . Given that the MPC finds it hard [to figure it out], we could forgive the average household or business for not knowing as well.”
‘Mark Carney? He’s that Bank of England dude’
While the Bank of England has been trying to clarify its forward guidance, the public appears stuck in a bit of a fog, writes Chris Tighe.
Yesterday in Newcastle, where David Miles, an external Monetary Policy Committee member, was addressing a well-informed business audience on details including “the short end of the yield curve”, assorted members of the local public were battling to answer a much more basic question: Who is Mark Carney? In relatively well-heeled Gosforth, staff in two estate agents – a trade where interest rates really matter – told the Financial Times that they had no idea.
But in Café No. 95, Umar Yusufu, founder of a mobile commerce platform, said: “He’s that Bank of England dude.”
Moving on to the tricky question of what Mr Carney has said or done recently, only one dominant feature stood out for this straw poll of respondents. He’s Canadian.
Among those willing to have a stab at the key question – what is the BoE’s policy on interest rates? – Ken Miller, a local shopkeeper, came up with one of the better answers. “To hold them down till something happens,” he said. Quite what that “something” was remained elusive.
Amy Whyte, another coffee shop customer, correctly thought the trigger might be a reduction in unemployment. But she incorrectly guessed that it would have to fall to a rate of 1.5 per cent – the correct figure is 7 per cent.
David Cook, a retired retailer, pointed out that for small businesses it is the activities of High Street banks that hit home. “It bears no relation to what Mark Carney, or Lord King, or anybody else is doing.”
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