7 Feb 2013

Mark Carney, the chancellor’s flexible friend

It is official. The inflation target is now a “flexible inflation target”. The phrase peppered Mark Carney‘s Treasury select committee hearing.

That is the system as has been formally described in Canada. It was not how the Treasury or the Bank of England had described the system up until around four  months ago. Now the current governor, and the chancellor are all at it too, and there is a significance.

I don’t think this is just semantics. Monetary policy under Sir Mervyn King since the crisis has been informally flexible. The bank has offered stimulus even when inflation has been repeatedly and persistently above 3 per cent.

Cutting through Governor Carney’s slick presentation it seems that he is not gunning for a radical change to the mandate for monetary policy, but he does, like the chancellor, welcome the debate. He is obviously wary of unanchoring inflation expectations.

But he clearly wants to do more than is being done right now in Britain’s contracting economy. My sense of what is happening here is that we will get a brief review announced at the budget next month. A debate will follow. The parameters of “flexibility” in the inflation target will be more formalised. Carney will then have a mandate, subject to the votes of the MPC (something he doesnt have to deal with in Canada) to pursue “lower for longer” interest rates.

The likely mechanism is a US-style contingent commitment to keep interest rates low until money GDP or employment hit a certain level. Intriguingly, he suggested some problems with his own initial innovation in Canada of simply saying rates would be low for nearly two years.

This will be presented as an incremental move from the previous regime, now rebranded as “flexible inflation targeting”. But outlining a path for rates really is quite different, and had been ruled out by Governor King. Does it make sense to have a monthly debate of a nine-member committee if you have already pre-committed to keeping interest rates near zero into 2015?

All in all, Carney sits firmly with the government’s stated macro strategy of being “fiscal conservatives and monetary activists”. That makes the revelation that some “high-level” discussion about the evolution of the inflation mandate occurred between the chancellor and Mr Carney during the interview process, all the more interesting.

Was part of the recruitment criteria a desire by the coalition Treasury that the new BoE chief be more flexible on monetary policy than Sir Mervyn King? Was it a condition of getting the job? Will Mr Carney’s first announcement confirm 0.5 per cent interest rates into 2015, coincidentally the time of the next election?

Monetary policy and central bank independence should probably change to reflect our exceptional circumstances. Just today, the bank announced the reinvestment of ¬£6.6bn of gilts that were bought by the BoE under QE. It was never envisaged in 2009 that they would be still on the bank’s books.

Exceptional times, yes. But these would be changes, and they would be worth debating.

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