Last week’s surprisingly strong GDP figures – up 0.8% in the third quarter, roughly double what the City expected – have significantly increased the likelihood that the Monetary Policy Committee (MPC) will sit on its hands this week. Despite the three-way split, with Sentance and Posen
taking on the hawkish and dovish mantles, and Chancellor Osborne’s way-too-obvious hints, the Committee will probably decide, yet again, that it is just too soon to tell, and leave things at least another three months until February. Certainly, with the strong growth figures for Q2 and Q3 now meaning that this might be the first time in over two years that the MPC doesn’t have to revise down its growth forecast (at least the near-term bit), any surprise move by the Committee would basically signal that it got things massively wrong in the past. And, while I personally would rather Governor King owned up to his mistakes, and made things right, his track record on coming clean isn’t spectacular.
be fair to MPC members, they do face something of a balancing act at the moment. CPI inflation has been above target for ages, and will stay there throughout 2011, unless something drastic happens to offset the rise in VAT to 20%. A credible inflation-targeting central bank does have to worry about inflation, and cannot just focus on the real economy without the kind of explicit remit for full employment that the Fed enjoys. As such, although activity is still 3% below its level at the start of 2008, even after two strong quarters of growth, the MPC is wary about doing more.
Personally, however, I think they are being too cautious. Although the inflation target is supposed to be a symmetric one – deviations below 2% are every bit as important as deviations above it – the real economic consequences of being above or below target are very different. Inflation being a little bit above target, provided wages remain sensible, is no biggy – indeed, one of the consequences of the UK recession is that real wages will have to fall over the next few years (and fall compared with producer prices, not CPI). In contrast, inflation being below target – and even the dreaded threat of deflation – would have much more serious consequences, given both the high level of nominal debt in the UK and the aforementioned real wage adjustment. Ten per cent unemployment really would be on the cards then.
If you buy this argument, then the economic consequences of doing too much is far less than the risk of doing too little. In fact, there isn’t that much of a first-order policy dilemma for the MPC at all, and we should see more spending on Thursday:Â instead, the key challenge would be how to communicate the MPC’s views effectively, especially given its poor track record during the recession. However, the Committee’s normal reluctance to be decisive and move ahead of the curve are likely to result in another month of ‘no change’ – rates held at 0.5% and asset purchases at Â£200bn.
There is, however, an even bigger issue that the MPC just won’t discuss at all. The whole effectiveness of Quantitative Easing (QE) – creating money to buy government debt – has repeatedly been called into question. Back when QE started, various MPC members went on record to say that the efficacy and impact of the policy would critically depend on the extent to which it lowered borrowing costs for businesses and households – its ability to cut ‘real world’ interest rates. Unfortunately, most households and businesses may struggle to see any impact at all. Quite apart from much tighter credit standards – can anyone still get a 95% mortgage? – average household interest rates have typically risen since QE started in March 2009, not fallen. Two-year discount mortgage rates have fallen a bit, mainly reflecting the growing realisation that Bank Rate would stay at 0.5% for a while. Standard variable rates (SVRs) and 2-yr fixed rates are marginally lower – but rates on 5-yr fixed mortgages, personal loans, overdrafts and even credit cards are now actually higher than they were in March 2009.
The MPC should be deeply troubled by this lack of a ‘real world’ impact from QE. Almost a year ago, Adam Posen explicitly said that the BoE should start working on a Plan B, in case quantitative easing failed to revive the economy. After falling suspiciously quiet for too long – did the Old Lady get to him? – he has taken up this mantra again in recent weeks. But, with Mervyn King still firmly against anything other than government debt, the MPC will not be radical.
There is one final option, however. If Mervyn still refuses to buy anything other than gilts, and the economy needs another boost given the lack of impact from QE on the real world, Bernanke’s 2002 playbook offers an interesting alternative. Instead of buying a set quantity of assets – for example, Â£50bn – the MPC could commit to do whatever it takes to keep, say, five-year gilt yields below 1.4%. Despite being an implicitly open-ended commitment, in academic economic terms this kind of ‘price’ target is largely equivalent to a quantity target, and hence may appeal to the BoE’s pointy heads. But in the real world it could make far more difference – particularly given that, with policy rates at just 0.5%, no one really knows what the money demand curve looks like anyway, let alone how stable it is.
Unfortunately, the BoE has shown itself to be quite prepared to take perfectly viable policy options off the table way before any serious debate has even started. And I suspect that, if the MPC does eventually move, we will find out that Plan B does indeed turn out to be more of Plan A. Unfortunately, inaction now will only delay the realisation that the Old Lady is out of ideas.