On July 1, former Bank of Canada governor Mark Carney will replace Sir Mervyn King as governor of the Bank of England. For many observers, this will herald a new dawn in the conduct of British monetary policy. We agree, but think the process will be more evolutionary than revolutionary.
We certainly don’t expect any fireworks at Mr. Carney’s first Monetary Policy Committee (MPC) meeting on July 3 and 4. Neither the prevailing view of the MPC nor recent strong economic data support an immediate change in policy.
But this doesn’t mean that important changes aren’t coming—and the reasons aren’t hard to find. Notwithstanding recent figures, the UK’s economic performance since the credit crunch has been dire. Many independent forecasters expect the economy to be operating below full capacity for at least the next five years.
Against that backdrop, there can be little doubt that the government wants to see greater “monetary activism” to deliver the growth needed to make its fiscal arithmetic work. The chancellor, George Osborne, has already changed the Bank’s remit to encourage the MPC to be more flexible in interpreting the inflation target. And the new governor has indicated that he may share the government’s appetite for easier policy.
So what form might this take? Mr. Carney has left no doubt that he sees an important role for central banks to offer “forward guidance” when the economy and monetary policy face exceptional challenges. Such guidance could take the form of a commitment to keep policy loose until, say, the end of 2015. But a more radical approach would be to make such a commitment contingent on a certain indicator (or indicators)—e.g., the unemployment rate or the growth rate of nominal gross domestic product (NGPD)—reaching a particular threshold.
This latter approach would represent an important change in the UK’s monetary policy framework. Using an indicator in this way would effectively set it up as an intermediate target and might be seen as the Bank of England’s first step towards a dual mandate (i.e., giving equal precedence to growth and inflation).
All eyes will now be on August, when the Bank’s first Inflation Report will be published under Mr. Carney’s stewardship. The report is likely to include some important changes in presentation and communication. At the same time, the government has asked the Bank to provide a separate report considering the merits of forward guidance.
But even if Mr. Carney has government backing for a more radical approach, he may find it difficult to win support from his colleagues on the MPC. Anything other than a modest change in the policy framework could cause confusion over the Bank’s real objectives and damage its credibility—something the MPC has been very sensitive about in recent months. Moreover, the adoption of an aggressive threshold for an indicator like the unemployment rate or NGDP growth might point to the need for an immediate easing of monetary policy. In light of recent data, there does not seem to be broad-based support for this on the MPC.
So, while we expect the conduct of monetary policy to change markedly under Mr. Carney’s stewardship, any changes are unlikely to happen overnight. We anticipate an evolutionary rather than a revolutionary process.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
Darren Williams is Senior European Economist at AllianceBernstein.