13 Jan 2015

That letter: Mark Carney writes to the chancellor

The governor of the Bank of England’s letter to George Osborne about low inflation does not have to be published until next month, but economics editor Paul Mason imagines how the draft might look …

The Governor of the Bank of England Mark Carney listens during a Bank of England Financial Stability Report news conference, at the Bank of England, in the City of London



As you know, inflation has fallen to 0.5 per cent – a record low. Accordingly I am required to write this letter of explanation, because the target you have set me is to maintain inflation one percentage point either side of 2 per cent – so I have missed it by a pretty whopping margin.

No one seems very unhappy, but here’s the explanation. Six years ago, during the Lehman panic crisis we had to begin quantitative easing (QE).

Here at the bank that was a big thing because (a) we had to read up on how to do it in a text book and (b) we did not initially know how it would work.

In the end, the way it worked was that by flattening the interest earned on savings to below zero, it forced investors to move into riskier assets, and homeowners into property: house prices rose. We call this portfolio substitution.

But there was still no sustained recovery, because all we were really doing was balancing out the negative pressure on growth created by your decision to slash public spending.

Only when, against the misgivings of my predecessor, we started targeting the way we used QE – into “funding for lending” and “help to buy” – did the recovery gather pace. This was helped by your effective U-turn on cutting infrastructure invesment spending.

So now we have a strong recovery and low inflation. The conventional explanation for this is that the UK, by using its sovereignty over exchange rates, and by delaying the heaviest austerity until after 2015, has been able to compete for what little growth there is in the world. We were fortunate in that our nearest neighbour, Europe, refused to do QE, and it has stagnated while we have recovered.

So QE has kept the economy afloat. And now falling oil and gas prices, filtering into food and other basic items, have acted like a tax cut, stimulating growth further.

I have to tell you there is an alternative explanation: that growth in the world is flat because the sources of it are drying up, as populations age and because the debt overhang from the crisis of 2008 is still huge. Some economists believe that, in this scenario, zero interest rates and low inflation could at some point tip over into deflation.

I don’t need to remind you why deflation is bad: people hoard their money and stop investing in real things, convinced they will get more bang for their bucks later on. Meanhwhile the real interest rate on existing debts rises, as incomes fall.

So in this alternative view, quantitative easing actually causes stagnation and deflation, rather than curing it. I am not talking about uncouth journalists like Paul Mason, but people in the Federal Reserve and Bank for International Settlements, who warn that the world economy is suffering from and addiction to stimulus, the result of which is “expansionary in the short run but contractionary over the longer term”.

That is, because six years into the crisis we are still stimulating the economy, bad businesses can’t fail. And indeed low-profit, low productivity business models are encouraged – look around you, chancellor, for example, at the record number of coffee shops in London, employing graduates on the minimum wage, for what this might mean.

Of course, if QE is expansionary in the short term but in the long term flattens the economy like a pancake, this is not a major problem for somebody who faces an election in 100 days time; indeed it is the opposite of a problem.

Therefore, I suggest you let me and the economics team at the Bank worry about the long-term impact of QE.

One of the world’s most distinguished monetary theorists has suggested that, given the scale of global QE, we are at a turning point in our whole understanding of monetary and fiscal policy, and that the two are effectively fused, and that all kinds of tools may be used that stimulate growth that make the old ones look puny. If your algebra is up to it, John Cochrane’s paper is here.

If not, here’s a quote to chew on:

“We have ended up, really, at a once-per-generation redefinition of the role and nature of monetary policies, and of the institutions that generate price stability and fïnancial stability, the proper role of a central bank, the question of what monetary policy can do, what it can’t do, what it should do, and what it shouldn’t do.”

Bizarrely, one of the conclusions, if he is right, is that we should raise the inflation target and raise interest rates. So you would have to write me a letter, hiking the target to maybe 3 per cent, and I would have to hit people with a rate rise. Yup – funny old world, monetary theory.

But as I say, leave worrying about that to us for now. You face a unique situation in modern British history: low inflation and high growth. And an election. Enjoy.

Yours aye,




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6 reader comments

  1. nick j says:

    that’ll be John Cochrane the right wing friend of the plutocrats?

  2. Andrew Dundas says:

    Mark won’t send any such letter. Nor would he ever describe Eurozone stagnation as ‘fortunate’ because it is inhibiting growth in the UK too.
    What Carney should remind our Chancellor is that we had a recovery going up to summer 2010 when Osborne decided to create his crisis of Recession. And the delusion that very low interest debts matter.
    That crisis was accomplished by ramming up VAT by a third to stop people buying. Especially buying premium grade goods and services that are inherently more productive than the cheap stuff.
    Mark might even go on to reminding Osborne of the difficulties of measuring productivity. That lower prices in a supermarket shows up as lower productivity than when prices and margins were higher. Which is not so in reality. And how difficult is it to assess the value of NHS and teaching outputs?
    If we temporarily cut VAT to 2009 rates (15%), people would go shopping, more meals-out would be bought and investment would be sucked in behind. But no Eurozone government or the UK believes that yet. But they will sometime.
    I suggest Mark Carney finishes his tenure and goes back to Canada where he’ll be appreciated much more than here.

  3. peter says:

    Ha Paul,

    That should be on your wall!


  4. Antsy Bricker says:

    who warn that the world economy is suffering from [an] addiction to stimulus, the result of which is “expansionary in the short run but contractionary over the longer term”

  5. Richard says:

    Up to the neoliberal revolution it was generally accepted among economists that the use of monetary policy in a depression cannot increase economic demand. Keynes described monetary policy as ‘pushing on a piece of string.’ QE is NOT ‘printing money’ it is changing the portfolio composition of the commercial banks’ reserve deposits with the Bank of England. The government has been using QE to force the banks to invest in businesses rather than hold interest paying treasury paper. Put another way it has been using its non-interest paying IOUs to buy back its own interesting paying IOUs. One bizarre effect of this is that a large chunk of the state’s debt is owed to itself. The idiocy of graduates of neoliberal madrassas such as Cochran and their political acolytes is incredible.

  6. Nigel Wilson says:

    When QE was implemented on the basis that `it would prevent deflation’ asset prices, including houses, floated high. However, wages declined or froze and the return on savings deteriorated. Now food prices are falling and fuel prices dropping from the sky. There is already sufficient evidence to suggest that commercial profits are in decline. Deflation is now with us. So much for QE.
    QE gave a short term boost to assets and since the rich have more assets than the rest, they benefited. Now the beast is turning. Asset values are now so bloated they are unsustainable. Beware the crash!
    This is what you get for cancelling capitalism and replacing it with a melange of corporate back slapping and breast beating. What will the state do? Try to ignore it and hope it will go away. Only it won’t.
    May we live in interesting times.

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