THE ECONOMIST Michael Woodford created quite a stir at the annual monetary conference at Jackson Hole in the US just over a year ago. The basic thrust of his argument was that central banks had deployed all sorts of conventional and unconventional monetary policies since the credit crunch, and even central bankers had begun to talk about them as “maxed out”. Thus, the prospect of something new was approached – but even this novelty now looks to be wearing off.
The essential point Woodford took a full 45 pages to make was that a new campaign could be opened by making promises about the future – so-called forward guidance. An obvious attraction is that, in the present, there is no cost for a central bank to make such a promise. Such a pledge invariably involves saying where interest rates will be in the future – either lower or for longer or both. Thus the bulging balance sheets of the major central banks could take a back seat for a while.
This path has now been followed by the US Federal Reserve, the Bank of England (where new governor Mark Carney appears a particular enthusiast), and finally by the European Central Bank (ECB).
But the ECB, as ever, is proving to be idiosyncratic in its implementation, as Mario Draghi made clear at his monthly press conference yesterday. In the US and the UK, guidance is tied to the unemployment thresholds of 6.5 per cent and 7 per cent respectively. Draghi, however, has been explicit that the ECB mandate is for price stability rather than linked to unemployment.
Along that road, you are likely to come to the conclusion that – aside from so-called “open mouth operations” – there is no difference between this and what ECB policy was before. Indeed, those who believe that ECB policy is invariably set for the benefit of Germany will note that current expansionary monetary policy coincides with the ECB believing that there is “no inflation in Germany”.
But the obvious question is whether central banks can do this? And what happens if forward guidance doesn’t work? What has happened since such policies have been introduced tells a revealing tale.
The yield on the UK ten-year gilt (government bond) yesterday reached 3 per cent – up from 2.4 per cent when Carney first told us it was too high. Look at the equivalent in Germany, the ten-year bund, and it has just passed 2 per cent – around 0.5 per cent higher than when Draghi first uttered the phrase forward guidance. Is up the new down? This effectively means that monetary policy has already tightened in both the Eurozone and the UK.
As these moves take place, there is plainly yet more damage being done to central bank credibility. But there is also a sub-plot to consider. Central bankers may have privately decided that interest rate rises are indeed on the horizon – and probably soon. Could it be that they wish to leave the blame for them firmly on financial markets? Heads they win and tails they blame somebody else.
Shaun Richards is an economist, and writer for Mindful Money. www.mindfulmoney.co.uk