How to avoid sunburn, or the sorry state of UK monetary policy

A James Alexander post

When Mark Carney was appointed Governor of the Bank of England back in 2012 hopes were high. The Bank of England was mired in failure. For Market Monetarists it had a poorly understood monetary policy that could and should have been more proactive in 2007-2009 that directly led to the UK’s experience of the Global Financial Crisis being so much worse than most other countries. Whatever the cause, the BoE had totally failed to ensure financial stability. Somewhat surprisingly, it actually got more powers as a result of the crisis rather than less. Perhaps the price of gaining more power was that an outsider had to be appointed Governor to reform the Bank.

Carney certainly started with a bang. He made his famous speech on Guidance in late 2012 while still basking in the glow of being Governor of the very well-regarded Bank of Canada. The Canadian central bank had had a good crisis, although this was not really much to do with Carney who had been appointed only in February 2008. While he acted as a decent firefighter, drawing on his time in investment banking, the principles of flexible inflation targeting and tight banking regulation had been established for a couple of decades.

Much new blood has since been brought on board and there has been a major internal shake up. But has anything really changed? Not by the evidence of this woeful article by one of Carney’s new faces Kristin Forbes.

“As the summer holiday season begins and the date of an interest rate increase draws nearer, this is a good time to remember the importance of timing.

With both sunshine and inflation, there is a peril to living only in the moment. One should plan for the future – especially if precautionary actions take time to be effective. But it is also important to monitor last-minute changes in the weather forecast – or in the economic outlook – and adjust your plans accordingly.

We all know the enjoyment of that first day on holiday. It is tempting to stay outside all day – whether you prefer to doze, read a good book, or go for a swim or for a long run. But linger too long in the sun and your skin may take on a slightly pink glow.

While you probably won’t want to move from your comfortable spot in the sun, if you ignore the warning signs you may have a painful sunburn that evening. Yes – you can treat the sunburn, but it might spoil the rest of your holiday. Better to take preventive action.”

Is there where the level of monetary economics has got to at the Bank of England? Maybe the elite macro specialists on the MPC have to dumb down to get their point across to the readers of the Daily Telegraph but this is ridiculous. Ridiculous and wrong.

Wrong because the BoE appears to have learnt nothing from Japan’s decades of failed monetary policy. Creating a 2% ceiling and constantly threatening to raise rates any time there is the faintest whiff of prices rising ensures you will never come close to the 2% target. The market automatically tightens policy with its reaction to “good” economic news by raising short term rate expectations and by buying the currency. This tightening slows the nominal economy. “Bad” news then becomes good from prospective loosening of policy – the currency weakens and short term rate expectations fall back. Repeat.

These rapid market reactions show that Forbes is just wrong about lags. It is very tired, old school, thinking indeed:

“But unfortunately monetary policy works with lags much longer than a sunburn affects your skin. An increase in interest rates is generally believed to take somewhere from one to two years to have its maximum impact. Maintaining interest rates at the current low levels during an expansion risks creating distortions.”

Wrong because the underlying concept of “full capacity” causing inflation has been falsified for many years. Monetary policy causes inflation, or rather, nominal growth, not full employment. It is perfectly possible to have full employment without inflation. The long-run Phillips Curve is vertical – the somewhat painful lesson of the 1970s stagflation. At very low levels of inflation the Phillips Curve does, in the short-run, well, curve, due to downwardly sticky wages.

Wrong because even on their own terms of Inflation Targeting UK inflation is dead in the water. Forbes’ claim this is simply false

“Much of the weakness in core inflation can be explained by low energy prices and sterling’s strength, suggesting that core inflation should begin to recover from current low levels as last year’s sharp fall in energy prices rolls off.”

The Daily Telegraph helpfully supplies some charts in its article reporting on Forbes’ comments showing exactly what is going on with inflation.

Wrong because there is so little evidence presented for the damage to the economy from waiting too long. it is just asserted continually by hawks regardless of the dangers in acting too soon, a much bigger issue as the ECB so painfully found out in 2011 when it caused the second leg of the Eurozone crisis via the two rate rises.

“Therefore, interest rates will need to be increased well before inflation hits our 2pc target. Waiting too long would risk undermining the recovery – especially if interest rates then need to be increased faster than the gradual path which we expect.”

The phrase “well before” tightened policy the moment it was read, judging by the moves in Sterling overnight. It is scary that our MPC members can be so irresponsible.

Of course, she also raises the bogeyman of wage-push inflation still surprisingly current in central bank circles by worrying about wage growth. This stance is especially cruel on the mass of the population as it will ensure no real wage growth over the medium term, and probably no falls in inequality as it seems that the low paid suffer more from a weak labour market than the higher paid. The current modest uptick in wage growth to something still below the good but not great growth rate of the Noughties is something to be nourished not crushed, The danger the MPC seems oblivious to is that even talk about crushing it will kill it.

All these common mistakes seem to flow from the addiction to Inflation Targeting. Ultra-low inflation is not and never should be an end in itself. Prosperity is the end we all should seek. If ultra-low inflation conflicts with prosperity then the Inflation Target should be ditched. To be fair to Forbes she is mostly parroting Carney – more shame on him!

One thought on “How to avoid sunburn, or the sorry state of UK monetary policy

  1. Pingback: Offset here, offset there, offset everywhere | The Corner

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