There are many uses of the phrase “new normal” in economics these days. Usually, it is used to signify lower growth or a different type of growth than in the pre-crisis period. Mark Carney went onto the radio this morning to talk about the “new normal” in monetary policy.
Interest rates would be materially lower in future than the 5 per cent rate widely seen as normal before the crisis. The Bank of England governor’s words have been widely reported as a big new statement of policy.
Is this a new policy?
No. Carney first talked about future interest rates being “well below historical norms” in his January speech at the World Economic Forum in Davos, which confirmed the BoE had ditched its original forward guidance linking interest rates solely to unemployment. The important passage was reported clearly in the FT at the time and is copied below.
Undergraduate economics teaching has taken a (deserved) bashing since the crisis from some high-profile names in academia and officialdom. And, most importantly, the students themselves.
Among those leading the reform effort is an impressive group at the University of Manchester, the Post-Crash Economics Society. Today it has published a manifesto that is well worth a read for anyone with the slightest interest in why the discipline failed so spectacularly to spot the financial crisis.
The manifesto is all the more important as the group’s attempts to install an optional course on alternative theories on financial crises on the undergraduate syllabus were rejected earlier this month. The bashing, it appears, has not been bruising enough to trigger root-and-branch reform of the way economics is taught.
By Philip Stephens
You may think the big commercial banks got away with it after the great financial crash. But what about the Bank of England? Britain’s central bank was asleep at the wheel when the storm hit in 2007. Mark Carney’s radical shake-up of personnel and responsibilities in Threadneedle Street is an uncomfortable reminder that failure is sometimes richly rewarded.
The blame does not lie with the present governor. Mr Carney was drafted in from Canada last year to replace the departing Mervyn King. The cutbacks in banking supervision that preceded the crash came on the now Lord King’s watch. A reorganisation that leaves Mr Carney with a total of five deputies, however, is a reminder of just how much additional power has accrued to the Bank during the past few years. When the BoE was first granted independence during the late 1990s, the then governor happily settled for two deputies.
Bank of England Governor Mark Carney faces a grilling from MPs on three separate subjects this morning. The Treasury Select Committee will ask him about the BoE’s latest inflation report and its revision to forward guidance, Scottish independence, and the allegations of manipulation of the forex market.
By Sarah O’Connor and John Aglionby
Forward guidance is central banking’s latest fad. Since the nadir of the crisis, all four of the major central banks have adopted their own version of it.
But is this fashion for keeps? That depends on whether the policy works.
Guidance involves saying what you’re going to do, before doing it. This, central banks hope, will temper markets’ uncertainty about what happens to interest rates.
Whether it works or not, then, depends on how much markets trust policy makers to do what they say they’re going to do. If investors think policy makers are lying, or central banks lose credibility by reneging on their pledges, then the guidance could harm reputations for a long time to come.
So does it work? According to a paper, published by the Bank for International Settlements today, it does. Well, sort of.
Yet the research also flags that if forward guidance does succeed, it could end up doing more harm than good.
I’ve written quite a bit about the effectiveness of the Bank of England’s forward guidance on monetary policy. One reason is that the BoE has been willing to say guidance “makes the exceptionally stimulative monetary stance more effective”, but not by how much. Indeed, the governor and other officials have always — and sometimes embarrassingly –dodged questions about whether the BoE thinks guidance imparts stimulus at all.
There is no easy answer to the question of how much stimulus has forward guidance imparted. That said, I think I have found a reasonable method for reverse engineering the answer to a different question: what effect did the Monetary Policy Committee believe could be attributable to forward guidance?
At Wednesday’s Bank of England inflation report, the Monetary Policy Committee took a look at its August economic forecasts and said “what bunch of extreme pessimists produced these?” No one needs to answer that question.
The MPC then revised its growth forecast sharply higher with the consequence that unemployment was expected to fall much quicker, hitting 7 per cent 18 months earlier than it thought in August. But the best news for people in Britain was that in the November forecasts imply the people in charge of interest rates think inflationary pressures are weaker than in August, so more rapid growth and lower unemployment comes without the cost of higher inflation.
In times past, such an inflation report would have been seen as dovish. Even with stronger growth expected, the inflation forecast was revised down so there was less need to tighten monetary policy. Everyone would have understood the meaning.
The Office for National Statistics has just published October 2013 inflation figures. These show the consumer price inflation rate falling from 2.7 per cent in September to 2.2 per cent last month, a much greater fall than the average of economists’ expectations of a drop to 2.5 per cent. The discredited retail price index, which is still used to uprate index-linked government bonds, rail fares and other utility bills fell from 3.2 per cent in September to 2.6 per cent. The essential news and context comes in the following five charts.
1. Inflation falling faster than Bank of England expected
Mark Carney, the Governor of the Bank of England, announced a dramatic easing of the central bank’s attitude towards financial companies with temporary funding difficulties, he buried the policies of Lord King, his predecessor, and adopting a stance much more similar to the Federal Reserve and European Central Bank.
Reaction from our economics team:
It might appear unsurprising that a global citizen such as Mark Carney tonight proved such a champion of globalisation. However, this misses the fact that since the crisis a debate has raged between central bankers on the merits of the internationalisation of finance.
Since the crisis global capital flows have collapsed. During it, the risks associated with cross border contagion were all too obvious. The UK has a banking system far more reliant on foreign branches based here than either the US or the eurozone. In recent years, their support to businesses here has waned spectacularly.
Still, Mr Carney was clear that he believed international capital was more blessing than burden. He said he was still keen for London to maintain its status as a global financial centre.
Forget triggers, thresholds, knockouts and long lists of conditions, Paul Fisher, the Bank of England’s head of markets, says everyone is wrong to think forward guidance is complicated. The policy was summarised in a single simple sentence of the BoE’s explanatory document, he said in a speech today.
This is the sentence: