Winner of the New Statesman SPERI Prize in Political Economy 2016

Wednesday, 7 August 2013

The MPC’s Forward Guidance

So, as expected, the MPC (pdf) is catching-up with the Fed, in introducing forward guidance that looks very similar. There are two notable differences: the unemployment threshold is 7%, rather than 6.5%, and there is a caveat (which the MPC calls a ‘knockout’) about financial stability as well as a caveat about inflation expectations. The MPC has also committed to not cut back on its QE purchases as well as not raise interest rates until unemployment falls below 7%, provided expectations of inflation do not exceed 2.5% and these caveats/knockouts do not apply.

We should be grateful for small mercies. This does clearly show that the MPC is not targeting 2% inflation two years ahead regardless, which I have argued it seems to have been doing recently. It focuses on unemployment, which does at least marginalise the idea that there is currently no spare capacity in the economy. In addition, by saying they do not currently expect unemployment to fall below 7% before mid-2016, they have provided a forecast of interest rates of sorts. The 7% unemployment figure is not a guess at the NAIRU, but just an upper threshold, and there is no commitment to raise rates if unemployment goes below 7%. To those in the Bank, where the regime has hardly changed since 1997, all this will seem like a big deal, even if to outsiders it seems less radical.

Yet this remains a very weak recovery, as the new Governor concedes. Although the Bank has raised its forecast for future growth, it is still a fairly pathetic 2.4% in two years time. The choice of 7% for the unemployment threshold is very conservative: UK unemployment did not go above 6% from 2000 to 2008. A ‘knockout‘ of 2.5% for expected inflation may copy the Fed, but given how high UK inflation has been recently, it is arguably more conservative - and anyway pretty low. I am not surprised by any of these things, because Carney had to get every member of the MPC to sign up to this, and so the numbers were always going to reflect the position of its more conservative members.

One additional thing has become clearer. By saying that, even with this new guidance, they do not expect unemployment to fall below 7% until 2016, the MPC has made it more transparent how prolonged this recession is going to be. Only two conclusions can follow: either high inflation is preventing the MPC from doing something about this, or they do not think they have any effective instruments left. If the first is true, that should focus discussion on whether consumer price inflation should be allowed to be such a tight constraint on growth. If the second, then why not turn to a proven instrument for stimulating demand?  


  1. To the last q: because it is totally farcical to assume we can push NGDP growth up above current rates without pushing up (expected) inflation beyond the 2.5% "knockout". Sorry, totally farcical. Look at the damn CPI numbers with 2-3% NGDP growth. The SRAS slopes up.

    MPC independence failed us today in a very big way.

  2. Simon
    Deep inside the August Inflation Report p30 the BOE staff is forecasting that the unempt rate is going to rise this month. It is currently 7.8% and we already have two of the three numbers for Q2 - both are 8.0% and we drop a 7.4%.

    Danny Blanchflower

  3. As Danny and I concur, SMEs are crucial to recovery. SMEs reliant on banks, big business bypass banks.
    Banks are hoarding cash, give excuses, but prime motivator is their own salary/bonus.

    Force QE money out to real economy ie. SMEs by linking banker's and banks' taxes to the unemployment rate.
    To avoid big tax, they will invest in SMEs; instant growth.
    I ask, what was the link between interest rate and inflation before, ehm, there was a link? Were objections raised about it not being direct etc.

    Anyway, I snookered Danny (he didn't like 'checkmated') here
    Quite obvious steps.
    Check out the full site:

    Harry Alffa

    1. I've got doubts about the "SMEs are short of credit" story. See:

  4. Table 4B of the August inflation report suggests most people's expectations of inflation are already above 2.5%......

  5. Is it too cynical of me to think that Osborne went for Carney because he presided over a Canadian property bubble which hasn't (yet) burst (see Krugman June 15, 2013 'Worthwhile Canadian Comparison')?

  6. I just want to make a case that low labor share is muting the effect of monetary policy by lowering the equilibrium level of GDP. Under these conditions, investment leads to less GDP growth, the lower labor share goes... and labor share has declined in most advanced countries. Once you lower the equilibrium level of GDP, you limit the ultimate utilization of labor too. Thus we see slow GDP growth and slow declines in unemployment.
    There is a simplified model for this. Low labor share needs to be recognized as part of the conversation.

    1. Fully agree that labor is losing compared to the other parts.
      1. However it is hard to see how this can be tackled. Western wages and other related costs are very high compared to wages of comparable quality workers in most EMs.
      Taxing the difference away will most likely be counterproductive (simply an outsource incentive).
      2. Looking at the wages level and worldtrade it looks like this trend will most likely continue for several years to come. It is not only a thing of the years behind us. Also the fact that markets have partly changed (read moved to the East) is not helpful. More and more 'closer to the market' means away from the West.

      Probably labor has to rebalance, but for the worldeconomy largely if not totally in the EMs. Will likely take a long time before that is done. And not much benefit the average Joe, Johann or Francois.

    2. The idea is very important, even if not new.
      The reasoning is straightforward and doesn't even need a numerical example. If there is a higher Marginal Propensity to Consume [=lower MPS] out of wage income than out of profit income, then the Keynesian multiplier is lower if the share of wages falls, because the aggregate MPC falls.
      Michio Moroshima taught a model based on this idea in his introductory LSE course about 25 years ago. I can't remember the exact reference but as a student in 1964 I studied a Kaldor article based on the same idea, and Kalecki used it in the 1930s.

    3. Anonymous,
      and the model is easy to understand. Low labor share lowers the equilibrium level of GDP.

      I use an equation for effective demand that says the LRAS equilibrium level of real GDP is $16.1 trillion in the US. This is below the CBO potential real GDP of $17 trillion. And it is simply due to a lower labor share giving a lower equilibrium level of real GDP.

      Kalecki worked hard on effective demand. Now I need to research the other men you mention. But a simple and solid model for effective demand never came forth. I found one and am using it.

      The funny thing is that economists do not see what is happening between the current lower labor share and such things as monetary policy, inflation, investment, unemployment and real GDP. They are overlooking a critical part of the current frustrations.
      I would love to hear more about your experiences that you mention.

    4. By chance, following up some links, I came across an old DeLong blog: DeLong himself only seems to accepts Kaleck's political insight; but some of the comments deal with modelling MPC out of profits vs. wage income.


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