The Bank's search for guidance (cont'd)
- 30 July 2013
- From the section Business
In the short time that Britain's central bank has been given to think about using "forward guidance" to support the recovery, the recovery has started to look much less in need of extra support.
That has left the Monetary Policy Committee (MPC) facing something of a quandary.
You could say the Bank's policymakers have gone in for bucketloads of forward guidance since 1993, in the form of the Quarterly Inflation Report.
But people have tended to assume governor Mark Carney's forward guidance will be completely different from anything that has gone before, and excitingly extra. They have also tended to equate it with looser policy.
A majority on the MPC were against loosening, even before the recent improvement in the economy. You might then wonder why we were still having a discussion about guidance at all.
But we know from the minutes of last month's meeting that even so-called "hawks" on the MPC don't want credit conditions to tighten too quickly, as a result of the US central bank and/or changing expectations in the financial markets.
That provides a defensive motivation for guidance, even among those who do not want the path to the first rate rise to be any longer than it is now. (See The MPC's search for guidance for more on this.)
So assume, for the sake of argument, that a majority says yes to guidance of some form. What might it look like? This gets us into the exciting (!) question of thresholds.
To add real economic content to the MPC's guidance, the ideal "threshold" would be a measure of spare capacity that's both reliable and widely understood.
The MPC could then say it won't raise rates until X amount of that spare capacity has been used up.
Unfortunately there's no such measure. The concept of spare capacity is contentious and hard to measure - even in theory. In practice it can't be pinned down with any certainty at all.
It's also important that the chosen variable is independent of the Bank, not the result of a complex model that the MPC can easily change.
Cash GDP - the amount of spending in the economy - would at least meet that last test. But it's frequently revised and not widely understood. That leaves unemployment.
If I had to guess, I would say the committee will be voting on Thursday on whether to say something like: "The MPC does not plan to raise bank rates or lower the stock of assets held under the Bank's asset purchase scheme as long as the UK unemployment remains higher than X per cent, and the inflation forecast Y years ahead is within Z percentage points of the Bank's 2% target."
The MPC has already had more than half a dozen meetings to nail down the specifics. Nothing will finally be decided until Thursday's vote, but - at a bare minimum - you'd expect guidance that implies that rates will not be raised until 2016.
So if there's going to be an unemployment rate mentioned, it needs to be one that the MPC expects the UK to reach comfortably before the end of 2015.
Pick a number
What might that number be?
Well, unemployment stands at 7.8% of the active workforce. The Office for Budget Responsibility reckons the "natural" rate of unemployment is 5.4%, though the OECD thinks the rate consistent with stable or falling inflation is higher, more like 6.1%. (I hope to say more about the recent evidence on this in a future post.)
It's probably a safe bet that any unemployment threshold the MPC chooses will be well above both those; maybe in the region of 7%.
But whichever number the MPC selects - if it selects one at all - Mr Carney will be keen to clarify that it is indeed a threshold, and not a trigger. The idea is that rates will not rise before that level is reached, not that they will necessarily go up when it is.
And yet the more I think about it, the more I think the really crucial debate isn't around the value of X - but Y and Z, in the part about inflation.
Why? Because the unemployment number only tells you something about the way the MPC is going to judge the recovery.
It's the stuff about still keeping an eye on inflation that will really signal whether the MPC is planning to be more focused on growth in the next few years than the financial markets might otherwise have expected.
All of which takes me back to that thorny question: whether Mr Carney's shiny new guidance needs to be expansionary to be worth doing.
As I mentioned in my earlier post, there are arguments against central banks being super-transparent. But thanks to the US central bank governor, Ben Bernanke, they couldn't be less fashionable. You won't find many on the MPC loudly defending the freedom to be opaque.
The more important objection to the weaker forms of guidance, if it is an objection, is that the Bank is pretty transparent already, and offers reams of forward guidance in its Quarterly Inflation Reports.
That is why the MPC signs off on those reports: they represent the views of the MPC, not Bank of England staff. They both explain the Bank's policy and - often - help to supplement it, by telegraphing the Bank's intentions to investors in the markets and everyone else.
In the midst of political scandals, US journalists ask: "What did they know and when did they know it?"
If there's any forward guidance next week from the MPC, the big question to ask will be: "Have they told us anything we didn't already know?"