Stephen King: More relaxed approach to policy party-going risks a worse hangover

The Government is now asking the Bank to act more as a party organiser than a party controller
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The Independent Online

The period between Christmas and the New Year is always a bit weird. You're just recovering from one hangover, but know full well that another hangover lies just around the corner. Even though economists assume that we're all rational human beings, always seeking to maximise our happiness or utility, I sometimes wonder whether this really is an appropriate simplification of human behaviour. If you're rational, why would you plan on having a hangover or, even worse, a second hangover - particularly when, as you get older, each hangover gets a lot worse relative to the initial alcoholic intake?

Policy-makers are - or certainly should be - rational, and they really don't like economies to have hangovers. They supposedly go out of their way to ensure that we don't collectively suffer that nasty feeling of headache and sickness that leaves the overly-exuberant party-goer on the verge of a good vomit the morning after.

In truth, though, policy-makers are walking the same precarious tightrope as the rest of us. At parties, the temptation is always to have one more glass of champagne, one more lager, one more Bacardi Breezer (depending, of course, on the kind of party you tend to be invited to). At the time, the attraction is obvious. You're having a good time, the atmosphere is great and you really can't believe that one more drink will leave you with a mouth that feels like it's full of sandpaper and a head that seems to be throbbing to a symphonic poem of pneumatic drills the very next day.

The same goes for policy-makers. When do they decide that the party has gone on for too long? At what point do they demand that the music should be turned down, that the guests should be encouraged to leave, that the sudden rush for minicabs and night buses should take place?

The difficulty is obvious. Act too soon and everyone says the party was rotten - and no one is going to thank you for that. Act too late and, although you will find things very easy for a short period of time, slowly it will dawn on people that things aren't so good after all. No one really wants to suffer those hangover feelings, whether they are the result of excessive alcohol abuse or of excessive spending.

Policy-makers are there to keep our worst excesses in check. To prove this point, imagine a world in which central banks didn't exist and where capitalism was left unchecked, with the market ruling every aspect of our lives. A good recipe for an economic party, perhaps, but also a potentially disastrous path towards eventual economic ruin. The problem is all too transparent: we may all want to borrow and spend a lot, but if everyone does so, we're all in big trouble. Too much debt and too little output point to some form of economic mess: either a rise in inflation, or a collapse in asset prices and savings, but certainly no ongoing economic expansion. It is, therefore, the authorities' job to ensure that things never get out of hand. Central banks must always be there, thinking about the best time to turn off the music, turn on the lights, and draw the party to a close.

The trouble with the current crop of central banks, though, is that they've got themselves a bit confused. Are they there to bring the party to a close, ensuring that our worst temptations are always brought under control? Or are they there to get the party going in the first place, plying us with plenty of alcoholic drinks and hanging around in the toilets, offering all manner of other substances, to ensure that a good time is had by all? You might think this description is a little harsh, but metaphorically I'm not so sure that it's so wide of the mark.

It's not entirely the fault of the central banks themselves. It's more a result of what they're required to do, either because of the convictions of the population at large or of the government of the day. Take, for example, the latest changes to the inflation target in the UK. The shift from the old RPI-X target of 2.5 per cent to the new harmonised target of 2 per cent might seem innocuous enough, but it basically implies that the Bank of England now has an easier job: the risk of inflation being too high on the harmonised measure is a whole lot less than under the old RPI-X approach. Put another way, under the new arrangements, the Bank is more likely to undershoot the given inflation target, whereas there was a more symmetrical risk with the old objective.

How does this change the Bank's behaviour? In effect, the Government is now asking the Bank to act more as a party organiser than as a party controller. There is now a greater chance that inflation will be too low rather than too high. In essence, this means the party can go on for longer: more champagne, more alcopops, more pill-popping of one sort or another. The key question, though, is whether this more "happening" party is one that will leave us with a hangover no worse than usual, or whether the Bank will have to deal with all manner of undesirable "morning-after" effects.

What can we expect from this more "relaxed", "chilled-out" approach to policy-making? In one sense, the Bank of England is being placed in exactly the same position as those of us who might be thinking about our second hangover of the season in a few days' time. It is being asked to accommodate more demand, to allow for more debt, to boost the economy even more in the short-term, just because it has a bit more flexibility on inflation than it did under the old regime. But this is a fairly weird situation. Inflation being under control provides no guarantee that a post-party hangover will be avoided altogether.

I'm not suggesting that all debts are bad, or that all attempts to keep growth going are fraught with difficulty. I'm not siding with the Archbishop of Canterbury, who tried over Christmas to link "the problems surrounding debt" with gambling difficulties. It may be the case that foolish gamblers will find themselves in debt, but it can hardly be the case that those who legitimately borrow to buy their first home can be regarded in the same light. A puritanical approach to debt is hardly helpful now that debt is an essential part of many people's lives.

I do think, though, that central banks need to think more carefully about debt in its broadest sense, and not just to the degree that it may affect the rate of inflation over the next couple of years. The growth of debt has undoubtedly lubricated the engine of economic growth over the last 30 years or so, but any change to institutional arrangements that may encourage even more rapid growth in debt should, in my view, be treated with suspicion.

Stephen King is managing director of economics at HSBC

stephen.king@hsbcib.com

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