Mark Carney please listen to “Reform”

The UK think tank Reform has good advice for Bank of England governor Mark Carney. This is from Reform’s latest publication “Kick-starting growth” (I stole it from it from Britmouse):

“The upshot is that ideal Bank policy should pin the two or three year forecast of inflation at 2 per cent, unless there are extenuating factors. Figure 6 shows that monetary policy performed exceptionally well on that score prior to the recession.

However, when the financial crisis hit the Bank was slow to respond, with the two-year inflation forecast dropping to just 0.3 per cent in 2009. That, coupled with the huge fall in nominal output, indicates a need to massively loosen monetary policy, which the Bank eventually did when it dropped its interest rate to 0.5 per cent and implemented a programme of quantitative easing.

Those actions have often been represented as constituting extremely loose monetary policy but the persistently low inflation forecasts tell a different story. In fact, monetary policy has been tight by the Bank’s own measures, with forecast inflation well below target throughout much of the recession. The low forecast path looks even worse in light of the series of external shocks to the CPI, such as VAT and tuition fees, detailed previously. Bearing in mind the large, positive shocks to the CPI, the forecast path shows even tighter policy, which suggests the Bank may have been focussing on inflation concerns to the exclusion of growth.

As Milton Friedman famously remarked, “Low interest rates are generally a sign that money has been tight, as in Japan; high interest rates, that money has been easy.” The UK’s low interest rates are not a signal that policy is easy, but rather a sign that nominal growth expectations are low. That problem can largely be laid at the feet of monetary policy.”

It hardly gets more Market Monetarist than this and we can only hope that Carney have read the Reform report ahead of tomorrow’s crucial and long-awaited announcement of BoE’s new “strategy”. I doubt we will get an announcement of an NGDP targeting regime, but we might get the announcement of a Evans rule style monetary policy in the UK. That would be NGDP targeting ultra light.

Even though I am not too optimistic about major regime change in UK monetary policy I must on the other hand say that there is no country in the world where Market Monetarists ideas have had such a big impact on the intellectual debate as in the UK – particularly among the UK think tanks. That makes me optimistic that UK monetary policy in the coming years will move even closer to the Market Monetarist ideal – even if Carney disappoint us all tomorrow.

HT Mike Bird

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5 Comments

  1. Chris Papadopoullos

     /  August 6, 2013

    Hi Lars
    With regard to the cpi data, forecasts may well have been below target (i havent checked) but in actual fact it rarely fell below 2%. So does the cpi over the period really suggest policy shouldve been looser?

    Reply
  2. Thanks for your kind comments on our report, Lars.

    Chris, you’re right that the CPI doesn’t make a case for loosening. However, pretty much all the other data does so the question is really whether the CPI gives enough information to offset that. If you look at our report (it’s pretty short) there is a whole section on that. The CPI has been above target since the GFC but that’s largely because of supply-side shocks. If you look at domestic measures of inflation, such as the GDP deflator or nominal wage growth, you’ll see a very different picture.

    Reply
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