‘This is the most dangerous development in UK monetary policy since the late 1980s. Monetary policy should be designed to ensure that we have stable prices. The level of unemployment is mainly determined by a range of factors such a labour market regulation, the benefits system, tax rates and so on. To try to use monetary policy to reduce unemployment when inflation is already above target is playing with fire and could lead us down the road that we followed in the 1970s.
‘This move also calls into question the independence of the Monetary Policy Committee and the Bank of England’s ability to fulfil its statutory duties.’
All these things are true – though a clarification I was not aware of at the time I wrote the statement means that the forward guidance is somewhat more innocuous than I realised at the time. How can the Monetary Policy Committee (MPC) take independent decisions if its hands are tied by prior commitments? How can the requirement to promote stable prices or low inflation be maintained if monetary policy will remain loose despite inflation being above target for nearly four years? The Bank has also decided that, in the long term (and remember that the financial crash started at least five years ago), there is a trade-off between inflation and unemployment and that unemployment can be kept low by taking bigger risks with inflation. Misdiagnosing the cause of low growth and high unemployment and blaming such things on a ‘shortage of aggregate demand’ was precisely what got us into the mess of the 1970s. Though the forward guidance is ‘switched off’ if there is a 50 per cent chance, according to the Bank’s models, of inflation being 0.5% above target, the Bank has shown itself unable to meet a simple inflation target and has had significant upside biases. The new arrangement will leave markets puzzled as to the long-term policy and underlying intellectual framework. Markets will also be suspicious that, if the Bank cannot meet a simple inflation mandate, it will throw caution to the wind with this new approach.
This is bad news.
The IEA statement was put to David Blanchflower, a former MPC member on Radio 5 Live (Segment at 1:14:30). He responded by saying that he was pleased that we had said this because everything that the IEA had said in the recent past was wrong. Blanchflower has a poor record when it comes to predicting the future, as we shall see. However, he really has no excuse for not being able to assess the past and a few facts might help him.
I wonder if Blanchflower was warning in letters to the Financial Times about the dangers of loose monetary policy around 2006. I don’t think so. But, this IEA commentator, with a number of Shadow Monetary Policy Committee (SMPC) colleagues, certainly was doing so. If Blanchflower had taken more notice, the world might have been spared a little pain.
As it happens, both Blanchflower and the IEA’s SMPC called for a reduction in interest rates when the money supply started collapsing after the financial crash. Perhaps that makes it 2-1 to the IEA.
In relation to a different issue, at roughly the time I and others from the IEA were on the Jeff Randall show suggesting that job turnover was so great that the private sector was easily capable of creating sufficient jobs to replace those let go in the public sector, David Blanchflower was saying: ‘that any cuts in public spending could force unemployment up from its current 2.5 million to four million over the coming years.’ He speculated that unemployment might rise to 5 million. That is at least 3-1 to the IEA (though I think we deserve two goals for that), though, I suppose, it could be argued that Blanchflower simply did not understand Osborne’s plans and did not realise that there were not going to be spending cuts. If so, that is no excuse.
In 2010, around the beginning of a period of three years of above-target inflation, Blanchflower said that the best course to avoid the possibility of a deflationary future would be to do more to stimulate the economy now. Only after this has started to bear fruit, he went on, should attention turn to cutting public expenditure. The deflationary future was never going to happen – as we warned.
It is also worth noting that immediately after Osborne’s first budget IEA commentators started to point out the potential for a growth and productivity crisis despite the possibility of a relatively stronger labour market. Indeed, IEA author, David Smith pointed out precisely these risks in a 2006 IEA monograph. That is something else we seemed to have judged correctly.
Growth is promoted by good micro-economic and stable macro-economic conditions. The idea that the economy is simply a set of accounting identities so that a bit more growth can be obtained by increasing government spending, is something that would even fail an AS level in economics. These things are well understood by IEA authors. As an institution, the IEA is often suspicious of forecasters (though we count many among our authors). However, the IEA has not been consistently wrong as Blanchflower suggested. Quite the reverse. Those who understand how an economy works will get the basic trends or ‘pattern predictions’ right. On the other hand, I am not sure that these economic basics are well understood by people who make wild predictions that are way off the mark.