Institutional paralysis at the MPC

Peter Warburton - 1 February 2017

The Bank of England’s Monetary Policy Committee meets this week and another Inflation Report will be published. Hardly anyone expects a change in policy settings. Over the past 8 years, the MPC has created an ever more daunting set of objections to be overcome before daring to raise interest rates. Curiously, they found no such difficulty before their unanimous decision to cut rates by a quarter-point last August. Despite the growing absurdity of that pre-emptive move – ostensibly to cushion the UK economy before it hit a hypothetical air pocket – the path to reversal of the cut is no less tortuous than for the prior, long-contemplated, rate rise
During the summer of 2015, Bank governor Mark Carney put financial markets on notice for an early-year rate rise. His eagerly awaited “turn of the year” speech, just over a year ago, failed to deliver in spectacular fashion. His devastating finale was to list eight forces “that have kept interest rates depressed throughout the recovery and into the expansion”: “demographic change, slower potential growth, higher credit spreads, lower desired investment and a lower price of capital, changes in income distribution, private deleveraging and lower public investment”. He concluded that “the journey to policy normalisation is still young.” Such was the extent of the climbdown that the money market curve pushed out the timing of the first Bank Rate rise 3 years into the future.

There is a longstanding debate in economics – paralleled in other disciplines – about the comparative merits of rules versus discretion. Should you tell schoolteachers exactly what to teach, how to teach it and how quickly to cover the syllabus? Or should you provide guidelines and handbooks and trust them to decide what will work best with their pupils? Should the Bank of England’s Monetary Policy Committee have their hands tied by a rulebook, with sanctions for recalcitrant members? Or should they be allowed to exercise discretion over the way they pursue their mandated objectives?

Long before the inception of the MPC, in the early 1980s, the Thatcherite monetarist experiment experimented with target growth rates of the broad money stock. This may have been the closest that UK monetary policy has come to a rules-based regime. Since then, it has mutated into constrained discretion, as practised by Lord King, and thence into unconstrained discretion after the global financial crisis. Under Mark Carney’s pragmatic and political leadership, unconstrained discretion is tantamount to institutional paralysis.

truth, the MPC has not the slightest intention to confront an overshoot of inflation, a prospect that has honed into view with the jump in headline and core CPI inflation to 1.6%. The Bank has become a cowardly agent of demand management with scant regard to its inflation mandate. Having survived the experience of the 2010-11 inflationary overshoot without serious reproach, it is inclined to repeat the experiment. “The MPC will monitor developments in the light of its inflation tolerance, and will explain its assessment and policy stance accordingly.” A year ago, Mark Carney severely damaged his credibility as a dispassionate executive of monetary policy. In August, he committed an honest blunder. The failure even to correct the error suggests that the threshold of proof that must be reached, before a majority on the committee will begin to normalise Bank Rate, is unreasonably high.

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