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?