A few – especially those with a monetarist or Austrian inclination – publicly expressed concern about policy in 2005-2007, but nobody from the mainstream predicted a financial meltdown. As such, it would not be surprising if economists became a little more introspective for a while.
Against this background, however, the Bank of England seems to have become more self-confident. It is increasingly ditching rules and trying to use its own day-to-day judgements to make trade-offs and micro-manage markets. Indeed, it seems to be going beyond the remit that Parliament has given it.
Perhaps more worryingly, while Mark Carney says that he wishes to promote diversity and there has probably never been a greater need for dissent at the Bank, none is apparent. Indeed, it is rather concerning that Kristin Forbes, the only MPC member who is currently suggesting that an alternative path might be needed, is on her way out.
In a recent speech, the governor of the Bank of England talked about the need to avoid cognitive groupthink, and yet 91 of the last 92 votes that have been cast on interest rates by MPC members have been cast the same way.
Not only that, it seems that the Bank has chosen to ignore its mandate. It is supposed to target inflation of 2 per cent. Yet it is keeping interest rates at historically low levels, despite expecting inflation to rise to 2.8 per cent and still be over target in 2020. In order to avoid taking action, the Bank has argued that “the MPC’s remit specifies that in such exceptional circumstances the Committee must balance the trade-off between the speed with which it intends to return inflation to the target and the support that monetary policy provides to jobs and activity.”
This is a bogus defence of its policy. The question the Bank faces is not the speed with which inflation returns to target but whether inflation should be allowed to go above target in the first place.
Of course, if there is a shock to the economy and inflation rises to 5 per cent, it makes no sense to bring it back down to 2 per cent within six months and ignore the damage that will do to the economy. A slower return to target which can be built into the expectations of investors and wage setters is likely to do much less damage. But that “get out clause” does not permit the Bank of England to allow inflation to go above target while it takes no action. Not only that, all this is happening when the economy is more or less fully employed.
Ultra-slack monetary policy has its side effects. Asset prices are high and bond yields are low. House prices are also dangerously high, though this also reflects government planning controls that restrict house building.
Under the guise of “macroprudential” regulation the Bank of England is now regulating specific parts of the financial sector in order to reduce bank lending. This takes us back to the 1970s. Once again, we are pumping air into the monetary balloon and then, worried about the consequences, squeezing part of that balloon and hoping that the problem will go away.
These are aspects of what Hayek called The Fatal Conceit. We have a central bank believing it can find the optimal trade-off between unemployment and inflation. We then have the same central bank believing it can micro-manage the allocation of credit to alleviate the consequences of following a loose monetary policy. We need somebody at the Bank of England who thinks differently and who will stand up and say so.
This article was first published in City AM.