Mark Carney abandons Thatcher-era supply-side policy
The era of laissez-faire monetarism is over, as the world moves by small but inexorable steps towards a new kind of Keynesian demand management. One after another, governments and central banks in the leading economies are accepting a responsibility for managing unemployment that they abandoned in the 1970s, during the monetarist counter-revolution against Keynesian economics. On Wednesday it was Britain’s turn, as Mark Carney, the new governor of the Bank of England, joined Ben Bernanke in making the reduction of unemployment his main monetary policy goal.
Carney was until recently Canada’s top central banker and was headhunted by the British government specifically to inaugurate a new era of “monetary activism.” On Wednesday, at his first official press conference, he lived up to this billing.
Instead of merely promising to keep British interest rates near zero for a predefined period of a year or two, as had widely been expected, Carney did something bolder and intellectually more controversial. By announcing that the BoE would not even consider any reduction in monetary stimulus until unemployment fell below 7 percent, Carney deliberately broke a taboo that has dominated British economic policy since Margaret Thatcher’s election in 1979.
For the past 30 years no British central banker has dared to openly challenge the Thatcher doctrine that monetary policy can only contribute to economic prosperity by keeping inflation under control. Indeed, the BoE had never previously published an unemployment forecast, as Carney pointedly remarked at his press conference, on the grounds that dealing with unemployment was the province of structural, supply-side measures connected with labor flexibility and competition, not of central banking. But now the governor was predicting that unemployment was likely to remain at about the 7 percent threshold until the end of 2016 — and therefore that interest rates would remain at their present near-zero level for at least another three years.
The markets and the media initially failed to understand the significance of this week’s announcements. Instead of pushing down Britain’s long-term interest rates, as Carney clearly hoped and probably expected, investors drove them up, on the grounds that his “forward guidance” was hedged about with conditions. But this instant reaction is likely to be reversed as investors ponder the deeper significance of what Carney said.
Carney laid out three conditions under which the commitment to refrain from considering a monetary tightening could be “knocked out”: if the BoE’s forecast of inflation in two years’ time rose above 2.5 percent; if “medium-term inflation expectations” ceased to be “sufficiently well anchored”; or if the zero-rate policy threatened financial stability in ways that could not be controlled through tougher application of the BoE’s regulatory and supervisory powers.
On closer inspection, however, none of these conditions is likely to arise in the years ahead. Inflation forecasts and market expectations are not solid statistics like the 7 percent and their interpretation is entirely under the BoE’s control. For example, the BoE never published a medium-term inflation forecast above 2.5 percent, even when current inflation was running as high as 5 percent. So it is almost inconceivable that inflation fears could “knock out” the new commitment to reach 7 percent unemployment.
As for the financial stability knock-out, Carney’s comments on Wednesday provided revealing pointers to the future of all central banks. Threats to financial stability, he said, should ideally be met not with monetary tightening, but with tougher regulation and supervision. The implication was that the BoE is now accepting powers and responsibilities even broader than the U.S. Federal Reserve Board’s dual mandate of keeping both inflation and unemployment under control. But even a triple mandate that includes financial stability may not be broad enough. In reality there are further macroeconomic objectives that central banks and governments must manage together. These include fiscal solvency, current account sustainability and sometimes exchange-rate stability, as in the case of Switzerland.
With so many objectives, many policy instruments will be needed, as Carney suggested, in addition to the standard tools of classical monetary theory — interest rates and size of the central bank balance sheet. But even with a wide range of policy instruments the plethora of macroeconomic objectives is unlikely to be precisely and continuously achieved. The implication is that, rather than trying to hit precise numerical targets, whether for inflation or unemployment, central banks should try to keep all the main macroeconomic indicators within reasonable bounds. In periods when inflation is a serious problem, controlling it will have to take priority, even at the cost of higher unemployment than would otherwise be ideal. But in periods, like the present, when unemployment has been unacceptably high for many years on end, stimulating more growth and creating jobs must be the top priority of monetary policy, even if that means taking some risks with inflation or financial stability.
Central bankers around the world are gradually acknowledging the complex trade-offs between inflation, unemployment, financial stability, fiscal sustainability and so on. They are recognizing, though not yet publicly admitting, that all of these objectives must be managed simultaneously, but imperfectly, giving priority to whichever indicator is moving towards a danger zone. The Keynesian demand management of the postwar period failed in the late 1960s because governments and central banks devoted too much attention to unemployment and allowed inflation to accelerate out of control. In the years ahead, policymakers will have to remember this experience. But the right lesson to draw is not that inflation is more important than any other objective. It is that macroeconomic policy must concentrate on dealing with whatever is the most pressing problem — and right now that is unquestionably unemployment.
PHOTO: A dealer works on the trading floor at financial spread betting company IG Index, as an inflation report by new Bank of England governor Mark Carney is televised in the City of London August 7, 2013. REUTERS/Luke MacGregor