“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