Mark Carney hasn’t started work in London yet and he’s already talking about a policy that goes beyond what is considered acceptable in U.K. monetary circles.
As the first foreigner appointed governor of the 318-year-old Bank of England, Carney used one of his seven remaining months as head of the Bank of Canada to remind his future colleagues on Dec. 11 that targeting nominal gross domestic product is potentially a “more powerful” tool for central bankers whose economies are stuck in a rut.
Less impressed are U.K. central bankers and economists who say the risks of committing to returning output to its pre-crisis trend are that it may end up spurring inflation and investor uncertainty more than growth. While Carney stressed his comments were hypothetical and may not apply to the U.K. --where the central bank has an inflation target -- even outlining the options may still signal an easier monetary stance once he crosses the Atlantic in July.
“Nominal GDP targets have big drawbacks and feel like a nuclear option,” said Rob Wood, who was a Bank of England economist until his move earlier this year to Berenberg Bank. “But to the extent there was a message from Carney’s speech, it’s that he could use more aggressive policy.”
As well as repeating his support for a “flexible-inflation targeting framework” in Canada, Carney’s speech suggested fiercer policies in times of major economic pain. These included making conditional commitments for keeping interest rates low over a certain time frame, as the Bank of Canada did in 2009, or announcing Federal Reserve-style thresholds for inflation and unemployment that must be met before policy is tightened.
Carney, 47, is set to succeed Mervyn King in July at the Bank of England. Nicknamed the “Old Lady” of Threadneedle Street, it’s known for its doormen in pink coats.
It was Carney’s mentioning of the more untested nominal GDP target that grabbed attention in the U.K. Such a policy would require the central bank to pursue a path for GDP not adjusted for inflation. For the Bank of England now, that would likely mean policy makers acting to stimulate the economy back toward its pre-crisis trend.
“Under NGDP targeting, bygones are not bygones and the central bank is compelled to make up for past misses,” Carney said. “When policy rates are stuck at the zero lower bound, there could be a more favorable case for NGDP targeting.”
Such a policy would mark a revolution in the U.K., where the central bank is mandated to keep inflation at 2 percent. Citigroup Inc. economist Michael Saunders in London said the target is too precise and attempts to hit it have at times come “at the expense of wider economic stability.”
A change would mean that with the shortfall in nominal GDP between its pre-crisis trend and now at about 16 percent, the Bank of England would be compelled to run “much looser monetary policy than at present,” according to Nick Bate, an economist at Bank of America Corp. in London and a former U.K. Treasury official.
The Bank of England has already cut its benchmark interest rate to a record-low 0.5 percent, bought 375 billion pounds of government bonds and started a credit-boosting program. Policy makers halted bond buying in November, with some raising concerns about its effectiveness.
Stephen Lewis, chief economist at Monument Securities Ltd. in London, said a reasonable aim might be for nominal GDP growth of 4.5 percent per year, reflecting 2 percent inflation and real GDP growth of 2.5 percent. That would have meant “ultra-accommodative” policy throughout 2009, a slight tightening at the start of 2010 and then easing from late 2010, he said.
Trying to restore lost output by managing growth and prices is not without challenges, as Carney himself acknowledged in a February speech when he noted the strategy treats change in prices and the economy “as a package.”
A key criticism is that the U.K. may be suffering a permanent loss of output and productivity after the financial crisis, rather than a cyclical lack of demand which can be reversed through stimulus. That means the economy is more prone to inflation at weaker growth rates than before.
“It’s fine for a central bank to target unemployment or nominal GDP if you are sure that the only problem you have is a demand problem,” said Erik Nielsen, chief global economist at UniCredit SpA in London. “But if you have a structural problem that prevents growth, then such a move would likely fuel inflation or asset bubbles.”
Nominal GDP is also frequently revised. That means the bank could miss the target on the basis of the first estimate before hitting it when data is updated, fanning policy uncertainty, said Brian Hilliard, chief U.K. economist at Societe Generale SA and a former Bank of England economist.
There is also criticism from within the Bank of England, which would matter for Carney given he will carry just one vote out of nine policy makers. Chief Economist Spencer Dale said last week that a GDP target could harm BOE credibility as it may require the economy to overheat, raising doubts among investors about whether that would be allowed to happen and among policy makers as to whether it was wise.
Carney is not alone in showing signs of greater creativity as record-low interest rates and asset purchases fail to buoy their economies by much and raise questions about focusing on low inflation.
The Fed tied its interest-rate outlook to unemployment and inflation earlier this month and the European Central Bank is standing by to buy bonds of cash-strapped governments. Japan’s incoming prime minister, Shinzo Abe, wants his central bank to pursue faster inflation.
“The world’s major central banks are starting to move away from pure inflation targeting,” said Mansoor Mohi-uddin, global head of currency strategy at UBS AG in Singapore.
Open to Debate
While Chancellor of the Exchequer George Osborne said Dec. 13 he has “no plans” to change the U.K.’s monetary framework, he left room for discussion by acknowledging the debate and praising Carney for leading it. Business Secretary Vince Cable already says he would like the BOE to have a more explicit target to bolster growth.
The drawbacks of nominal GDP targeting suggest to Malcolm Barr, chief U.K. economist at JPMorgan Chase & Co. in London, that there is no more than a 33 percent chance of the government changing the Bank of England’s remit next year although he pegs the chances of Osborne starting a consultation at 50 percent.
Saunders at Citigroup suggests the U.K. mimic Canada in adopting a point target for inflation in the medium term and a tolerance band around it for the shorter-run.
For Kevin Daly, chief U.K. economist at Goldman Sachs Group Inc., the bigger lesson from Carney’s speech is that he appears more likely to lean toward more monetary aggression if economic growth disappoints next year.
“The BOE under his tenure will be more prepared than it has been to undertake ‘unconventional unconventional’ policies,” said Daly.