E is no doubt that Mark Carney will be a breath of fresh air at the Bank of England, and will make many useful changes, especially in terms of culture and management style. His appointment will also ensure that there is a single, simple line on financial regulation, one which is very tough – he wants, but may not get, even less bank leverage – but not rabidly anti-City, and which understands all of the various trade-offs between restrictive regulations and the availability and cost of credit.
That said, the chances that he will turn out to be a monetary policy radical are receding; his views, as expressed yesterday, were pretty mainstream by international standards. Unfortunately, that means that some of his proposed changes will for be the worse – though others, of course, will be for the better.
There will be substantial reforms but they will build on, rather than break with, the past and other countries’ experience. First, and most radically, we may see a shift towards more of a US-style dual mandate, with high levels of employment as an objective of monetary policy, on top of price stability. The Americans do this, but it doesn’t really work.
Changing interest rates or varying the supply of money only has an effect in the short term, and only if it is unexpected. The risk is that one ends up with permanently higher inflation with no gains in output or jobs. In a famous paper in the American Economic Review in 1968, Milton Friedman argued that monetary policy cannot control unemployment; his critique remains valid.
Second, we will probably see a flexible inflation target, rather than a fixed two per cent target, or a more radical shift to targeting nominal GDP. My own preference would be for an even more radical change to a totally different type of target – on that, more in another column – but at least Carney’s reform will see a far more honest policy. At the moment, the target is clearly being treated as de facto “flexible”– in other words, it is inevitably missed. It will now become de jure flexible. The danger, of course, is that this merely rationalises permanently high inflation. So this change could be positive – but it is fraught with risks.
Third, Carney wants the MPC to announce its long-term intentions: for example, that rates will stay low for two years. If credible, this reform will help businesses and investors plan. But it will also create problems: at the moment, losers from monetary policy are given some hope that their situation could change at any MPC meeting. Under Carney’ system, pensioners suffering from low rates and QE will lose hope – and therefore become politically frustrated. On balance, however, this is an excellent reform.
We shall see whether there is a fourth change. It is unclear whether he may eventually agree to the Bank buying private sector assets, rather than just gilts. The new governor is rightly lukewarm about ever more QE but believes that overall policy will have to remain loose, citing vast amounts of slack in the economy.
I have two issues with this: he is giving too much credence to the idea that the amount of spare capacity is easily measurable. Despite high levels of unemployment, there is probably far less slack than he thinks. Regrettably, he is equally unlikely to have any solution to the problem of zombie firms: many companies are only being kept alive via cheap money, which is preventing the liquidation of dud businesses and the reallocation of assets to more productive uses. One thing is certain: Carney isn’t taking on an easy task.
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