At last month’s Inflation Report press conference, Bank of England Governor Mervyn King said that there were limits to what monetary policy can achieve. Many people took that as a signal that, after opting to pump a total of Â£375bn into the economy in July last year, the BoE was now out of ammunition.
Such views now look entirely misplaced. It turns out that King was one of three Monetary Policy Committee members to support further asset purchases in February, but they were outvoted by the other six. Recent remarks about the possibility of ‘negative interest rates’ – literally, charging banks to hold money at the BoE – suggest that other MPC members are considering different ways to provide more support to the economy.
Much of this talk is likely to be just that: talk. With a new, open-minded Governor set to join the Old Lady later this year, part of me suspects that some Bank executives are just trying to show their prospective boss how radical they can be. Although negative interest rates might be a good thing, there would be substantial risks involved, not least to the (relatively safe) building societies that rely on customer deposits. If your bank is going to charge you money for banking with it, why not keep your money in your mattress?
The sad truth is that, for all the noise and bluster, the MPC – and Mervyn in particular – got monetary policy badly wrong. Buying Â£375bn of assets was reasonably radical. But buying government debt definitely wasn’t. The MPC could have got far more bang for their buck if they had bought private securities and assets instead. What matters for growth right now isn’t so much the interest rate the government pays, but the ‘real world’ interest rates that households and small businesses face. Even with the Funding for Lending scheme, the effective interest rate on household mortgages has only fallen by 0.26 percentage points since April 2009. In contrast, despite spending proportionately less relative to the size of its economy, the US Fed has brought down domestic mortgage rates by more like 2 whole percentage points – around 8 times the impact. King’s insistence against buying private securities – a decision that was kept from the MPC, and essentially made by the Governor himself – has badly backfired.
Mark Carney could face something of an uphill challenge in changing the BoE that Mervyn leaves behind. But he can take heart from the ongoing transition in Japan. The new Governor-elect there, Haruhiko Kuroda, has been an outspoken critic of the Bank of Japan’s record in dealing with deflation. And in recent testimony to parliament, he shows every sign of backing up his criticism with action when he takes office.
Kuroda has optimistically said that a 2% inflation target could be met within two years. Given that Japanese CPI inflation has not hit 2% since March 1998, barring the brief oil-induced episode in 2008, he will have his work cut out to meet that timescale. This means that the kinds of policies he could end up pursuing will necessarily have to be more radical than the BoJ’s efforts so far. The implications of this are two-fold. First, existing monetary policy tools may well be lacking clout. But – more importantly – such radical measures would also imply that monetary policy is nowhere near its limits just yet. Mark Carney will no doubt be watching with interest.