Here's why new Bank of England staffer Kristin Forbes is defending inflation targeting
18 June 2014 3:34pm
In a mission to understand UK monetary policymaking, Kristin Forbes has already been asking important questions.
Speaking before the Treasury Select Committee (TSC), Forbes told MPs that she had asked the Bank of England why its inflation mandate sees the central bank target a two percent inflation level.
The answer Forbes received was "very vague", said Forbes, relating to something about there being some academic papers supporting that level of inflation as the right one to target.
Forbes will join the Bank's Monetary Policy Committee (MPC) in July as an external member, one of three replacements to join the committee this year. Forbes will be the MPC's first female member in five years when she arrives.
Asked whether the Bank's mandate should be changed, towards a system that targets total spending in the economy such as nominal GDP (NGDP) targeting, Forbes said she "would need to see very strong arguments" in order to be persuaded of that change. Mark Garnier MP suggested that NGDP was a "much broader measure", and would capture more than inflation.
Despite conceding that NGDP targeting makes "more sense" in some circumstances, Forbes argued that the Bank could lose something by choosing to target a more complex variable, such as spending. There is something to be said "for having things you can explain to the public", said Forbes.
Those words seem to marry up with critics of the Bank's forward guidance policy. Since February the Bank has adapted its forward guidance, moving its focus from an easily understood measure - the unemployment rate - to the more arcane yardstick of spare capacity. Forbes also suggested that inflation targeting had weathered the recent financial storm well. She argued that "you need a policy goal across the business cycle, and that's where inflation targeting has done very well".
Ben Southwood, head of policy at the Adam Smith Institute, argues the opposite. "Under half of the population can tell you who sets the base interest rate", says Southwood, implying that policy simply isn't well understood. As for working well throughout the business cycle, he says that a regime of inflation targeting has seen spending growth "anemic" since the financial crisis. NGDP growth still remains below its long-term trend.
In written submission to the TSC before today's hearing, Forbes said that normalising monetary policy is the "main challenge" facing the UK's interest-rate setting committee over the next three years. Assessing the effectiveness of quantitative easing (QE) is "challenging" said Forbes, as it's "impossible to know the counterfactual of what would have occurred in the economy without QE - especially over the past few years."
Forbes also described the challenge of co-ordinating monetary and macroprudential policy as an "imminent issue given the recent increase in UK housing prices" and corresponding increase in the debt held by homeowners and financial institutions.
Questions during the TSC hearing also revealed that Forbes will, at least until next summer, be making weekly trips between London and Boston, USA. The Bank of England is set to cover reasonable costs of her relocation, as it did governor Mark Carney's. It's yet to be seen whether the expense of those biweekly flights are considered "reasonable", and as such whether the Bank will foot the bill.
Forbes is considered an expert in areas such as financial contagion and capital flows, so it could be a price well worth paying.
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