In much of the recent discussion of the Bank of England mandate, it has been forgotten that the BoE has much wider responsibilities than pursuing inflation and output objectives. It has always been responsible in a vague and general way for the health and stability of the UK financial system. The present coalition government has made these responsibilities both larger and more specific. So much so that the shadow chancellor, Ed Balls, once remarked that it would require a superman to take on the role of governor. We shall find out soon whether or not Mark Carney is that superman.
In the meantime, there has been much argument about whether the BoE’s mandate needs to be changed. At present it states that: “In order to maintain price stability, the government has set the bank’s Monetary Policy Committee a target for the annual inflation rate of the consumer prices index at 2 per cent. Subject to that, the MPC is also required to support the government’s objective of maintaining high and stable growth and employment.”
Despite a sometimes over literal interpretation of the inflation objective there has been no single year since 2002 in which it has been anywhere near achieved. It has almost always been overshot, with the exception of 2009 when the CPI fell by 0.5 per cent compared with the year before. I remember pointing out when the target was announced that in the Victorian heyday of price stability the movement of prices in a single year was often much larger. The point was that anyone forecasting the price level 10 or 20 years ahead could not do much better than quote the existing level.
Not all deviations from the present 2 per cent target represent failures. Some deviations are essential in a dynamic economy, although the MPC has tied itself in knots explaining them. For instance it has tried to tie expansionary measures to the supposed danger of inflation falling below target, as if there would be rioters in the street chanting: “Out. Out. Inflation only 1 per cent.” I would simply change the first sentence of the mandate to read “the bank has a duty to maintain price stability”, leaving the number crunchers to argue about what that means. This is not so different from the mandate given to the admired German Bundesbank in its heyday.
It is more difficult to improve on the second sentence. It has become fashionable to talk of contingent undertakings. For instance, the US Federal Reserve has undertaken not to tighten until unemployment has fallen to certain levels. Although having their roots in some highbrow theory, such undertakings represent hostages to fortune. What happens if there is a war in the China seas or an earthquake in an important country – or even if unemployment remains high for reasons which have little to do with Fed policy?
What then happens to nominal gross domestic product, which I have long supported as an objective for monetary policy? There is no magic in it. It is simply the national income in money terms, as distinct from “real GDP”. The logic is fairly straightforward. It can be stated as real GDP plus inflation. If the nominal GDP growth objective is 5 per cent a year and inflation is 2 per cent, then real growth can be allowed to be 3 per cent.
Again there is no substitute for common sense. If a surge in nominal GDP reflects, say, an international energy price explosion, then there is little case for trying to roll it back in the short term. The objective then must be to prevent domestic pay and prices from increasing in a vain attempt to protect living standards. I must leave it to statisticians to determine whether it is feasible to devise indices of internally generated inflation to stop the domestic economy from being crucified in an attempt to offset unavoidable impulses from abroad.
Much more important than these arguments about targets is what is happening to the economy now. UK nominal GDP, so far from soaring, is 12-15 per cent below its pre-2008 trend. So is its real counterpart. Many reactions are possible. At one extreme is the view that the crisis and its aftermath had a large one-time effect and we cannot recover lost ground. At the other extreme is the view that we can, given more expansionary policies from the Treasury and BoE. The optimal policy may be to “suck it and see”.
It is difficult to quarrel with the main judgment of the new BoE inflation report that the prospect is for a slow but sustained recovery. This is subject to five “key judgments”, most of which have risks on the downside. Let the BoE therefore increase its “quantitative easing” and let George Osborne introduce a slightly more stimulative Budget than expected. If as is probable this is associated with some perceptible but hardly breathtaking improvement in growth without generating more inflation, carry on with further steps. If not there is plenty of time to slow down again. Oh for a Lord Keynes who could put all this more eloquently than I can!