The Bank of England, the chancellor, and the target
- 29 January 2013
- From the section Business
Does the chancellor want to set a new target for the Bank of England? The answer is no.
But does he want have a debate about it? The answer is an emphatic yes - for political reasons as well as economic ones.
With the UK economy starting the the new year no larger than it was 12 months ago, it makes perfect sense, from an economic standpoint, to consider whether there is more the central bank can do to help.
At last week's meeting in Davos, many policymakers and economists from around the world were debating the same thing - particularly Japan and the US.
The arrival of a new governor at Threadneedle Street provides a perfect opportunity for such a debate to happen, without anyone getting too defensive (not that anyone would dare call Sir Mervyn King defensive).
But clearly, for the chancellor, the debate also has an added political benefit: the more the focus is on what the Bank of England can or should do to revive the economy, the less that harsh spotlight may fall upon him.
The Financial Times reports that the Treasury has cooled on the idea of formally replacing the inflation target with a target for nominal - or cash - GDP. In fact, I don't think Number 11 was ever very hot on the idea.
There are just too many practical obstacles standing in the way, including those flagged up by soon-to-be Governor Mark Carney.
I mentioned the big ones in my previous post on this. Right now, for example, there is no monthly measure of cash GDP. You would need to create one for the central bank to feel comfortable targeting it.
Much more important, the Bank would need to have some confidence that those numbers were not going to be constantly - and extensively - revised. Neither seems very likely.
As one respected central bank governor said to me in Davos: "If I ever thought I could have anything close to the same level of confidence in nominal GDP numbers that I have in the Consumer Prices Index, I would be happy to target cash GDP. But I just don't see that happening."
But there is another big objection to the pure form of nominal GDP targeting, as described by Mr Carney in his December speech - which is that it does not let bygones be bygones.
For supporters, it's a plus. For politicians and practical-minded officials, it's a potential minefield.
If you've targeted a particular growth rate of cash GDP and the economy has not reached that rate, over a sustained period, the point of cash GDP targets is that the central bank is not supposed to just forget about those failures and look to the future - as the Bank of England has done with the inflation target.
It's supposed to try to get back to the path that was originally mapped out.
Supporters like this aspect because they say it would force the Bank of England to do more, right now, to make up the economic ground lost since 2007, even if inflation overshoots.
In practice, even that's not guaranteed: if you take 2005 as the last time that the UK was "on trend" (or operating at exactly its capacity), the growth in our nominal GDP between then and 2012 looks about right. If you start the clock in 2007 - as I did in my earlier post on this - it looks far too low.
Precisely because the "no bygones" approach is so sensitive to the starting year, the Chancellor's advisors don't think it would ever fly politically.
Even if voters understood what nominal GDP was - as they currently don't - will they really ever believe that a government is going to withstand years of well above, or well below, target inflation, simply to get back to a particular, fairly arbitrary path for the cash value of the economy that was laid down by the folk who were in power before them?
The general view in Number 11 is that the answer to that question is no.
Politicians are always going to let bygones be bygones - for the very good reason that voters expect them to think and talk about the future, not the past.
If that's right, then one of the big supposed benefits of nominal GDP targeting - that consumers and businesses will have some certainty about the future path of their nominal incomes - largely evaporates.
Could you have a target for the growth of cash GDP that did not have this feature? Perhaps. But even if you weren't thinking about where you were, with regard to the past level of cash GDP, you would still have to worry about whether the numbers themselves were right.
Bending over backwards
If all this has messed with your brain, you're not the only ones.
All in all, the conclusion many in Whitehall and the city are drawing is that the debate about nominal GDP targeting is more trouble than it's worth.
There's a reason, it turns out, why the monetary policy target most loved, in theory, by academic economists for the best part of 40 years has never made it to the point of actually being used.
But - as I said at the start, Number 11 really does want a debate about all this. And not just because everyone else around the world is debating it.
As Governor Carney reminded his audience in Davos, the Bank of England and many others have a system of "operational independence". That means the government sets the target, and the central bank is free to work out how to meet it.
Recently, the Bank of England has introduced a lot of flexibility to its mandate, in order to avoid tanking an already anaemic recovery with drastic efforts to get inflation back to 2%. Some of that flexibility was already built into the original framework. But it has been stretched pretty far.
If the UK's central bank is going to bend over even further backwards to support the recovery - for example, linking policy to some future state of the economy, as the Federal Reserve has done, or using other forms of communication to lock in policy in advance - then at least some people inside the Bank and the Treasury think the Bank needs a formal mandate to do it.
That is why the Treasury is not ruling out some changes to the monetary policy framework this year, even as it pours a bit of cold water on the nominal GDP debate.
Where everyone seems to agree is that changing the Bank of England's approach - either on paper or in practice - will be a helluva lot easier when there's been a change of leadership at the top.