Carney Backs Flexible Inflation Targeting in BOE Testimony
Bank of England Governor-designate Mark Carney signalled a preference for combining flexible inflation targeting with policy guidance over a more sweeping overhaul of the U.K.’s monetary regime.
As the institution he will soon run was saying it would sustain stimulus, Carney told lawmakers in London today that taking longer to meet inflation goals if necessary was “superior” to refocusing on other aims and that providing insight into future policy can enhance its potency.
“Flexible inflation targeting -- as practiced in both Canada and the U.K. -- has proven itself to be the most effective monetary policy framework implemented thus far,” Carney, currently governor of the Bank of Canada, told Parliament’s Treasury Committee. “As a result, the bar for alteration is very high.”
Poised to become the first foreigner to run the British central bank since its founding in 1694, Carney will succeed Mervyn King in July as policy makers grapple with a stagnant economy and the prospect of a fourth year of above-target inflation. He spoke as the Monetary Policy Committee he will soon lead said it will reinvest maturing gilts it bought in its quantitative-easing program to help a “slow” economy.
“Carney is not a conjurer and cannot pull a rapid recovery out of a hat,” said Robert Wood, chief U.K. economist at Berenberg Bank in London. “But we continue to expect modest further easing after he takes over in July, which should boost the growth outlook.”
Case for Stimulus
Having preceded his testimony by saying two weeks ago that monetary policy isn’t “maxed out” and kick-starting a debate in December over the bank’s 2 percent target, Carney today said “slack in the economy warrants considerable monetary stimulus for some time.”
“It is entirely possible -- I hedge because I’m not expert enough on the current situation in the U.K. -- in fact probable, that the current stance of policy is consistent with the economy achieving escape velocity,” Carney said.
Outlining his policy thinking, Carney said central banks “can vary the horizon” over which they meet their inflation goal if there is a threat to the stability of the economy or financial markets or if delay could promote valuable adjustments to financial excesses. Inflation has breached the bank’s current goal for 37 months.
“One of the issues in the U.K. is the speed at which inflation is returning to a target in an environment of necessary public and private deleveraging,” he said.
He was less supportive of shifting to another target, saying he was “far from convinced about the merits” of eyeing a level of nominal gross domestic product given doing so is potentially confusing and hard to achieve. A higher inflation goal also would risk “destroying the hard-won gains that have come from the entrenchment of price stability,” he said.
Carney nevertheless said a review of all the options was worthwhile because it would increase the understanding of the central bank’s work and he revealed he had spoken about it with U.K. Chancellor of the Exchequer George Osborne. “I see value in having a debate,” he said.
“The benefits of any regime change would have to be weighed carefully, not only against the potential risks but also against the effectiveness of other unconventional monetary measures under the proven, flexible inflation-targeting framework,” he said.
The Monetary Policy Committee today said it will buy more bonds with the 6.6 billion pounds ($10.4 billion) associated with a gilt maturing March 7. The bank also held its target for quantitative easing at 375 billion pounds and said inflation may remain above its 2 percent target for the next two years.
Carney reiterated his belief that communications can help a central bank enhance its policies. That may require giving guidance about future actions, something he has done in Canada yet the Bank of England has shied away from.
“Clear and open communication enhances the effectiveness of monetary policy,” Carney said, adding “there is merit” to considering the U.S. Federal Reserve’s recent practice of tying policy settings to inflation and unemployment thresholds.
“To achieve a better path for the economy over time, a central bank may need to commit credibly to maintaining highly accommodative policy even after the economy, and potentially inflation picks up,” he said.
Setting thresholds for when stimulus would be reversed would help persuade investors that the central bank would keep to its commitments even if price pressures pick up, he said. U.K officials under King have resisted such a move because they say it’s wrong to “lock in” future policy.
A decision to pursue a shift would fall to Osborne, who said in December that he would have to be persuaded of the merits of a new approach and there would have to be “very significant rewards from it.”
Pressed by lawmakers to justify the size of his 480,000- pound ($755,000) pay and pension package plus an additional 250,000-pound housing allowance, Carney said “it was offered to me, I accepted.” He noted the support for housing was consistent with that given to international executives moving countries and that he was transferring from Ottawa to the more expensive London.
Having run Canada’s central bank since 2008, Carney was appointed to the Bank of England position in November. As well as overseeing monetary policy, he will take the helm as the organization gets responsibility for bank regulation and ensuring financial stability. He also must address the results of reviews criticizing the central bank’s forecasting ability and management.
Carney’s comments suggest he might want to push for powers to set limits on the loan-to-value ratios banks use to calculate mortgages to protect the housing market against bubbles and price instability. Restrictions on banks’ loan-to-value and loan-to-income models have “contributed to a more sustainable evolution of the housing market” in Canada and Hong Kong, he said in prepared remarks.
When a recovery is in place, the central bank “will need to design, implement and ultimately exit from unconventional monetary policy measures in a manner that reinforces public confidence,” Carney said in his written testimony. “The exit needs to be achieved without disrupting the gilts market. Such disruption could lead to sharp movements in a range of other asset prices, or possibly threatens to financial stability.”
Carney said in his written testimony that there are three main sources of risk to the U.K.: the world economy, the pace of recovery that the economy is able to sustain, and the extent of deleveraging in the banking system, households and companies.
“The near-term outlook in the euro area remains weak” and “the world economy as a whole has a long way to go before reaching a sustainable position,” he said. In Britain, “unemployment remains well above its pre-crisis level, indicating that there is a degree of spare capacity in the economy” and “although funding costs have fallen dramatically since the autumn, major U.K. banks are continuing along a difficult adjustment path.”
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