Thursday, 8 August 2013

Forward guidance takes [UK] monetary policy even further down the wrong track

By Anthony J. Evans

I don’t view today’s announcement by the Bank of England as being a major change in monetary policy. The inflation target of 2% remains in place and the tools with which the Monetary Policy Committee (MPC) can hit it (interest rates and quantitative easing) stay the same. It is an example of the dynamics of intervention – when existing methods are seen to have failed they get tweaked, and augmented, as opposed to replaced.

This isn’t to say that there’s nothing new. The Bank of England’s introduction of forward guidance with an explicit unemployment threshold is a new way of achieving their goals. The Federal Reserve has previously done the same, albeit it has a dual mandate that makes unemployment data already part of monetary policy. The fact that the MPC plans to keep interest rates low for as long as unemployment remains above 7% places more weight on this particular indicator. Whilst it’s true that it isn’t targeting unemployment directly, there is an incentive to use monetary policy to boost output, and boosting output might be expected to lower unemployment. To the extent that the MPC want to exit from historically low interest rates, they will want to use monetary policy to improve labour market figures.

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