David Blanchflower, the man who knew too much

September 10, 2009

Goodhart’s Law states that if you rely on a single measure to set economic policy, it will mislead you. Charles Goodhart coined it in 1975 when he was senior adviser to the Bank of England it was targetting growth in the money supply. It’s taken longer for the law to apply to the Bank’s targetting of inflation through interest rates set by the Monetary Policy Committee, but it’s arrived now.

The MPC’s brief is simple; the committee must set Bank Rate at a level to keep inflation, measured by the Consumer Price Index, as close to 2 percent as it can. The acceptable range is one per cent either side. By and large, helped by a decade when the cost of goods was constantly falling, it had managed to do what it’s supposed to do. Today’s decision to leave Bank Rate at the nominal level fof 0.5 percent reinforces the expectation that the CPI will stay inside its range.

Unfortunately, it’s all gone horribly wrong, and David Blanchflower, who served for three years until May 2009, is savage in his criticism of his fellow-members. Writing in the New Statesman, he accuses them of being victims of  “group think”, under “the old iron fist” of Mervyn King, the governor of the Bank of England. Starting in October 2007, Blanchflower voted for lower interest rates every month until Bank Rate finally hit 0.5 percent in March this year. He was frequently alone.

With hindsight, he has every right to his told-you-so, but it’s worth recalling how different conditions were two years ago.  When he first voted for a cut, the CPI was just over the 2 percent target, and clearly headed upwards. Experience of previous inflationary surges in the UK economy suggested (at least) that if the genie of expectations gets out of the bottle, putting it back is a long and painful process, and the MPC’s projections looked ominous.

They were right. The CPI rose to a peak of 5.2 percent in September 2008. Even now, after the worst recession for at least half a century, this measure of inflation is only slightly below the 2 percent target.

Blanchflower may be crowing, but he first voted for a rate cut in March 2007, at the peak (as we can now see) of the house price boom. Had the committee agreed with him, there would have either been a final frenzy of buyers acquiring property they could not afford, or a gut-wrenching U-turn as the MPC (unanimously) raised rates two months later.

Today, he believes that the risk of a long-lasting recession is not over. He castigates the “feeble six” members of the MPC who disagreed with King’s proposal to raise the ceiling on the amount of stock the Bank plans to buy in. Yet the efficacy of this policy of Quantitative Easing is far from proven. The bizarre spectacle of a UK Treasury, desperate for money, spewing out new stock in vast quantities one day only for the Bank to buy almost identical stocks the next, defies common sense.

The consequences of governments round the world resorting to the printing press are already apparent in the prices of shares, desirable houses, gold and commodities. At some stage these rises will filter into the sort of inflation that the CPI measures. At that point, the Bank’s store of stocks will be added to the government’s continuing borrowing needs, and the hunt for buyers will begin.

While it’s always possible to find a seller of a government stock, at a price, the converse is not always true. There have been times when almost no price looked attractive enough to the buyers, and interest rates were forced to ruinous levels – as they did shortly after Goodhart proposed his law. Do not think it can never happen again.

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