Despite the econospeak that’s been erected around it, Mark Carney’s policy of forward guidance used to be rather straightforward. Basically, the Governor of the Bank of England wanted to let folk – investors, policymakers, average joes – know when interest rates might go up again, and he decided to do that by linking it to the recovery. Once the unemployment rate settled down to 7 per cent, he and his colleagues would consider raising the main rate of interest from its current level of 0.5 per cent. Now go make your microeconomic decisions based on that, people.
But then something absolutely terrible happened to complicate Carney’s plan: the labour market started recovering much quicker than the Bank expected. How much quicker? Well, in the November Inflation Report – which improved the forecasts made in the August Inflation Report – it was noted that “the Monetary Policy Committee attaches only around a two-in-five chance to the LFS unemployment rate having reached the 7 per cent threshold by the end of 2014”. And yet, yesterday, that unemployment rate slumped to 7.1 per cent from 7.4 per cent. So will the Monetary Policy Committee start giving consideration to a rate rise, then?
All the noises coming out of Threadneedle St have been defiant ones. Despite the growing proximity of that 7 per cent threshold, the Bank’s 24-hour policy people are saying that they won’t be moved. In fact, they’re effectively acting as though their original forecasts were right all along. One MPC member, Paul Fisher, has given a timely speech today, which the press release describes thus:
“Paul notes that, after nearly 6 years since the start of the financial crisis, the level of output in the economy is still 2 per cent below its peak in 2008. That suggests to him that ‘with unemployment still elevated, and diminishing signs of inflationary pressure in both goods and labour markets, we can be reasonably confident that the economy needs to grow strongly for some time to come, to regain a stable and sustainable medium-term trajectory.’ …
… Against this backdrop, Paul explains that: ‘even if the 7 per cent unemployment rate threshold were to be reached in the near future, I see no immediate need for a tightening of policy. The MPC has been clear all along, that upon reaching the 7 per cent threshold we will have to consider what the medium-term pressures on the economy are and make an appropriate judgement about the direction and pace of policy, and any further guidance that we may choose to issue in future.’”
This is, for the most part, understandable. The Bank has always said that it would only consider raising interest rates once the unemployment rate has declined to 7 per cent – it’s not bound to do anything. It’s also been clear that other considerations, such the rate of inflation in the medium term, will factor in its thinking.
But there’s still something embarrassing about all this for Carney. For starters, it draws attention just how crummy some of the Bank’s forecasts are; something that I used to have fun highlighting in the case of inflation. But, more importantly, it calls the whole forward guidance thing into question. Sure, the threshold may not be binding – but doesn’t it seem a little pointless if the unemployment rate keeps on going down and… still nothing? Doesn’t the policy just reduce to “we’ll raise interest rates when we decide to raise interest rates”? Hence why the papers have raised doubts about it today. The Times says (£) that it should be “quietly shelved”.
And so the question about forward guidance becomes: how long can Carney stand the embarrassment? He seems a tough sort of Mountie, so I’m sure he’ll be able to stick it out. Besides, it probably wouldn’t be good for market confidence to have the Bank start fiddling with its own guidelines. The threshold will most likely remain at 7 per cent, and the MPC will still only consider increasing interest rates. [See update below]
Whatever the case, a rate rise will come at some point – and George Osborne, more than most people, will need to be prepared for it. The Chancellor will probably be encouraged by the Bank’s attitude towards yesterday’s employment figures, as it suits him to have rates held low a while longer, for two main reasons: i) it means that the Bank isn’t too concerned about the prospect of inflation, and specifically a housing bubble, and ii) it fits in with the story he’s told, since the birth of the Coalition, about low interest rates and mortgage repayments and yadda, yadda, yadda. But he’ll certainly need a response ready for when the Bank’s attitude changes.
What will that response be? Here, Osborne is helped by the fact that interest rates are currently at “emergency” lows. Once they are increased, he can say, it’s because the emergency is largely over. Job done, mission accomplished, thank you very much – and interest rates may still not be so high that borrowers are brought low. Indeed, this is the message that the Chancellor’s team seems to be seeding right now. The Financial Times reports that a rate rise is being described as a “sign of success”. Expect this to be a large part of the Tories’ economic argument in 2015.
8.45pm update: Ah, er, okay, I didn’t see that coming. According to the Financial Times’s Chris Giles, Carney has suggested to the press corps in Davos that he’s going scrap the link between interest rates and unemployment levels – so I guess he, or perhaps more correctly the entire MPC, couldn’t stand the embarrassment for very long, after all. Apparently, the Governor of the Bank of England has said that he is against “unnecessarily focusing on one indicator”, whilst declining to confirm what indicators the Bank might focus on now. Of course, as I explained above, forward guidance, as it’s currently written, takes in more than just unemployment – but this is definitely a major shift from Carney & Co. The policy that he introduced to much fanfare, last year, could last less than six months. Meanwhile, the interest rate remains where it is for the foreseeable.