Jeremy Warner: What now for the Monetary Policy Committee?
Wednesday 06 May 2009
Outlook: The Bank of England's Monetary Policy Committee begins its regular two-day monthly meeting today. With no interest rate decision to take – rates are already so low they cannot sensibly be cut further – the MPC may find itself struggling to fill the time. But though the Committee may have been deprived of its usual decision-making purpose, there's certainly plenty to discuss.
Any debate will be instructed by what's in the Bank of England's latest quarterly Inflation Report, due to be published next week. Is the Bank going to follow many outside forecasters into being gloomier about the economy than the Chancellor was in last month's Budget? And what's the outlook for inflation, which was showing stubbornly little sign of falling as expected in the most recent data?
Then finally, is "quantitative easing" (QE) working as it was supposed to, or does the Bank of England need to increase the pace of asset purchases to achieve the desired effect? Long-term interest rates fell markedly in anticipation of QE, but since then they have been rising steadily, albeit not yet back to where they were, on worries about the fast deteriorating state of Britain's public finances.
Already, the Bank is showing a significant portfolio loss on its purchases to date. Is it possible to have an exit strategy that doesn't further magnify these losses, or are the gilts and corporate paper being purchased as part of QE eventually just to be written off as a permanent expansion in the money supply?
But the most important question is the one referred to yesterday in a speech by Rachel Lomax, a former deputy governor of the Bank of England, to the Harold Wincott Awards for Financial Journalism & Broadcasting. During the "Great Stability" of the 10 to 12 years that led up to the banking crisis, monetary policy was a relatively unchallenging affair, or at least appeared so. It wasn't tough keeping inflation low when there was so much disinflation being exported out of the emerging market economies of the Far East and Eastern Europe.
Naturally, Ms Lomax thinks the Bank has also conducted itself reasonably well during the present crisis. Not everyone will agree with that, but what may be true is that the sternest test of monetary policy is yet to come. In attacking the crisis, an unprecedented amount of policy action has been taken in cutting rates and injecting liquidity. Keep this going for too long and the Bank risks stoking an inflationary boom that would eventually plunge the economy into an even worse crisis than the present bust.
Arguably, this was the policy mistake made by the US Federal Reserve back in 2003. In attempting to address the aftermath of the dot.com bubble, the Fed only succeeded in inflating new and much more serious bubbles in asset and credit markets. To judge by the present bounce in share prices, stock market investors think we are already away to the races again. Believe it if you will. Yet tighten policy too soon and any nascent recovery might be snuffed out.
Ever since Britain's ignominious exit from the ERM in 1992, UK monetary policy has been determined by targeting a particular rate of inflation. This seemed to work well to begin with, but over the last two years has manifestly failed to protect the country from financial and macroeconomic instability. Indeed, it may even have contributed to it. The question is whether supplementing inflation targeting with more effective prudential oversight of credit markets is sufficient or whether more fundamental reform to the way macroeconomic policy is conducted needs to be considered. Other than a little unfocused discussion of whether central bankers need, to use the jargon, to "lean against the wind" more than they have, there has been curiously little debate over the future of monetary policy. As a matter of some urgency, it obviously needs to begin.
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