Mark Carney Is Preparing for Brexit and the Next Crisis

What it's like to be the U.K.'s central bank chief as Britain negotiates its traumatic exit from the EU.

Mark Carney seemed revolutionary enough in 2013 when he became the first non-British citizen to be appointed governor of the Bank of England. But the 53-year-old has since had to contend with a much greater upset: the U.K.’s vote to leave the European Union. In an interview last month, he revealed that he spends half his time preparing the financial system and economy for Brexit, which takes effect in March. Born in Canada’s remote Northwest Territories and educated at a public school in Edmonton, Carney graduated from Harvard and Oxford before working at Goldman Sachs Group Inc. and the Canadian finance ministry. In early 2008 he became the eighth governor in the Bank of Canada’s history, winning praise for his quick reaction as the financial crisis developed. He succeeded Mario Draghi as chairman of the Financial Stability Board (FSB) in 2011, becoming the point man on global financial system reform. At the Bank of England, Carney has juggled Brexit, negotiating new regulatory standards, and adapting the 324-year-old institution to its expanded supervisory responsibility. As the BOE’s 120th governor, he says some disruption was in order. “You don’t need an outsider all the time, but at the time it helped.”

This interview appears in the August / September 2018 issue of Bloomberg Markets.
Cover artwork: Caroline Pool for Bloomberg Markets

STEPHANIE FLANDERS: Five years. If you think back to starting your tenure in this building, then you were mostly known as the guy with the star résumé who was going to be the first non-national governor of a major central bank. Remembering your expectations on that first day, how has the experience measured up?

MARK CARNEY: It has exceeded my expectations in terms of the quality of the organization, the importance of the issues, both the intellectual and practical policy challenges.

My expectation coming in was that the platform here would help increase the ambition and effectiveness of international [financial] reforms because of the expertise that’s present in the organization, the importance of the U.K. financial system, and because many of the ideas for not just fixing the problems that caused the crisis but potential solutions for a more resilient system had been generated in the U.K. I could help with that, and obviously I had the advantage of coming in as still chair of the FSB. It has very much met or exceeded expectations in all those respects.

Of course it’s hard to go from concept to agreed global policy and then have that implemented, but I think—others will judge—relative to my expectations it’s been pretty faithfully implemented.

Secondly, it was about securing the recovery here, which at the time I took the position [Carney was appointed in November 2012] hadn’t really begun, or at least it didn’t appear on measured statistics. By the time I showed up [Carney started in July 2013] it certainly had begun, and the question was how to embed that.

The third issue coming in that I expected to spend time on was the managerial task of how you refresh the organization, how you get the most out of it. Of course the bank at that time had just doubled in size in terms of the number of people and tripled in responsibilities—not just microprudential but macroprudential supervision—so how can we make the most of that? That managerial challenge I expected to be a big part of the job, and if anything, it’s been a bigger part of the role than I expected coming in. The first few years were kind of the easy bits: trying to get the institution operating as one institution after you’d merged two institutions; to have all of the policy responsibilities on an equal footing, equally resourced, people being able to move between the various policy areas. Now it’s much more an agenda around true diversity and inclusive decision-making processes to get the benefit of the diversity and getting much better at communication.

SF But the Bank of England did, when you arrived, have a reputation for being old-fashioned, traditionalist, also somewhat autocratic in terms of the way your two predecessors had operated. Do you think you fundamentally changed the culture?

MC First off, there are the tremendous strengths of this culture built up over 300-plus years, and the intellectual leadership, the dedication to public service is at the center of it. So you build on the strengths, but cultural evolution is necessary to get the most out of those different areas.

Historically all central banks have been quite hierarchical. The longer a central bank has been around, the more hierarchical it’s been. That’s not a modern way of managing an organization. Every organization has certain people responsible—whether it’s a CEO or a minister or whoever has ultimate accountability—but the decision-making process tends to be less hierarchical, more inclusive, more diverse.

One thing we’ve tried to reinforce is, in a safe way, getting more ideas out there. Through the Bank Underground [research blog], through more people giving speeches, there’s a lot we can share. I think we’ve gone across that watershed where not everything that comes out of the bank is instantly interpreted as “This is the new MPC [Monetary Policy Committee] or FPC [Financial Policy Committee] policy,” but “Here’s an interesting idea; here’s the research on it,” and then it gets taken apart or taken up by others. That’s a much healthier environment for intellectual rigor, for policy development, and for attracting and retaining good people.

Photographer: Felicity McCabe for Bloomberg Markets

SF From the outside it feels like, particularly on things like the Monetary Policy Committee, there has been an ongoing failure to get enough female representation on the committee. Do you think there just aren’t enough women economists out there who are interested in macro?

MC I think it’s eminently solvable. Yes, there are issues in the pipeline—25 percent of people who study A-level economics and 25 percent of people who study economics at university are female. It’s 1 in 7 professors or lecturers in the U.K. There are ways to attack that, including just attracting people into the discipline, which is why we have this outreach program that we’ve just put in place for 100,000 students at state schools across the country over the course of the next 18 months to just draw people in. And I’ll tell you that one of the experiences of meeting people like me is that people get over the impostor syndrome pretty quickly, right? Canadian state school [graduate] ends up at the Bank of England? Well, why can’t I do the same thing?

One of the things I learned personally through the crisis, and it sounds trite, but diversity of thought, diversity of perspective are hugely important.

Our new intake is now 50 percent economists—­therefore 50 percent of the people studied something else from law, finance, humanities, sciences, etc. So you have a bigger pool from which to draw female colleagues.

The tragedy is always if a good mid- or senior-management position comes up and somebody can’t get it because they haven’t fulfilled the criteria. Let’s say they haven’t managed people. We now look at mid-upper-level management positions on a batch basis. So you don’t sequentially take a series of decisions in which each individual decision might be rational, but the team that you’re creating as a whole isn’t. So we’ve looked to move away from that. We’ve gone from 20 percent of senior management five years ago to 30 percent of senior management now. The question is, where can we move from here?

And, to state the obvious, we don’t appoint the members of the policy committee. [The chancellor of the exchequer does.]

SF There was a referendum that was barely on the horizon when you arrived which has since come to dominate your time. Do you worry that Brexit will dominate the way you’re perceived, that you will be the guy who happened to be at the Bank of England when all this stuff happened?

MC In central banking, you’re always the guy or the woman who’s at the central bank when other stuff happens. You’ll go mad in these jobs if you start thinking about how you’re going to be perceived, so I honestly don’t.

In terms of Brexit specifically, let’s be clear: It takes 50 percent of my time now. We spent a fair amount of time in the contingency planning, but now it certainly does crowd out other things. But it should, because the issues are incredibly important. We have a responsibility, at a minimum, to manage through the downside if there were a disorderly outcome, something unpredictable. We have to take as many of those risks off the table, make sure the system functions as well as possible. We’re doing that. But also it’s this opportunity of constructing this new arrangement and helping the government.

SF Rightly or wrongly, there was a perception that economists had a lot of dark predictions about Brexit that didn’t turn out right. That perception has outlasted the fact that we are now seeing real economic damage. Do you think that earlier perception that the dark forecast was wrong is actually making the British public complacent about the economic damage of Brexit?

MC I don’t want to speak for the British public. I think that what we did as an institution and specifically the FPC—the macroprudential authority—was take a look at what could happen and then take a series of steps to mitigate those risks. And that took away some of the downside. This institution, I will say this, was very well-prepared for the referendum result. We had put in place everything we needed to do with the major central banks around the world. We had used our supervisory authority to get the banks in a position for a vote they never expected to happen. They were not happy that we were moving them into position to be resilient for that. We had prepositioned £250 billion of collateral—more than that, of realizable ­collateral—with us so we could stand up and be prepared the morning after the referendum.

SF And objectively you had done a lot more preparation in terms of hours than the Treasury.

MC I suspect that’s probably right. We can compare time sheets afterwards. We did think, though, that the exchange rate would go down. We took a lot of heat for saying that in advance, but it was the easiest call one could make, probably the easiest call I’ve seen in macro in 25 years in terms of what was going to happen to the exchange rate if the vote went a certain way. It did. We thought inflation was going to rise, we thought the economy would slow. And all of those have transpired. Every prediction, every forecast, every comment in that environment has been amplified. But I think the institution was well-prepared, and because it was well-prepared, the financial system was well-­prepared. And because the financial system was well-prepared, the transition has been better. And we instantly turned to supporting the government as required during those negotiations.

SF Do you think you and other policymakers will have a clear idea of what the future relationship with Europe is going to look like by the end of the year?

MC It’s the objective of both sides in the negotiation.

SF There are worries on both sides of the channel that the absence of the U.K. around the table in thinking about future financial reforms will fundamentally make the European financial system more inward-looking than it has been. Do you worry about that?

MC A lot of the most important financial reforms in Europe had their genesis in the Bank of England. If you think of the too-big-to-fail legislation, effectively the core ideas came from this institution or certainly this institution plus the broader financial sector. So that’s U.K. leadership there. I think a lot of the capital regime as well came through the U.K. So I think a less direct channel between what will still be the world’s leading international financial center and European policymakers will have an impact.

In some circles in Europe there is a greater predisposition to ring-fence financial activities. That could lead to a very large but effectively local financial center in Europe, as opposed to a global financial center, which I believe London will continue to be. There are real benefits for Europe as well as the U.K. in having access to what is a global, resilient, and fair financial sector, which is what London is.

SF There is a chasm between regulators and economists about whether enough has been done on things like bank capital. Economists say banks should be holding much smaller amounts of leverage than they are now, whereas you and others would say we’ve fundamentally changed the safety of banks. Should we be worried that these experts completely disagree on what makes for a safe bank?

MC Financial reform has been led by the practitioners, not by the industry, but by the policy practitioners, many of whom have academic economic backgrounds but also have finance backgrounds and policy backgrounds. The academic community has lagged. They’re catching up.

Second point, when you look at the scale of the capital, $1.5 trillion of capital put into banks, the scale of liquidity [has undergone] a tenfold order of magnitude shift. We run a stress test. Our most recent stress test: 4.7 percentage points down on U.K. GDP; commercial real estate, residential real estate both down by about 35 percent; the exchange rate down more than 25 percent; unemployment to 9.5 percent; interest rates up by 3.5 percent. This system is capitalized for that—to not just withstand that and survive but to be in a position to lend to the real economy. Having run through those stress tests, one’s pretty hard-pressed to say that there’s a material deficit of capital.

Within nine months we could have a disorderly Brexit stress test. We’re living these stresses. I do think we have put the system in a totally different position in terms of capitalization. In the end, we’re not looking for a system that’s 100 percent capitalized. We are looking for a banking system that can still make a return, because that’s also part of resilience—the ability to make a return. Put on top of that some of the incentive structures you get with having bail-inable debt [debt that converts to equity in a crisis, so that the bank is “bailed in” by its own bondholders instead of “bailed out” by the government]. It means that bondholders have to pay attention and bondholder pressure is real pressure. Prior to the crisis [credit] spreads moved, but there was a judgment made by the sharper end of the market, which was, “Don’t worry, the state will come in and bail them out.” At that time they were right. In the future they will be wrong.

Photographer: Felicity McCabe for Bloomberg Markets

SF Some people do doubt whether those bail-in conditions will actually be triggered. You’ll have all the same reasons not to want to trigger them.

MC That’s the real challenge. To put in the organizational structure—the ability to separate critical economic functions as we do with ring-fencing in the U.K., the ability to make sure that critically systemic markets can continue to function, as we are doing with the derivatives market. So Bank X goes down, the retail side is already carved out—ring-fencing takes effect this year—they can be detached from the centrally cleared derivatives so the contagion risk is dramatically reduced. And they have debtholders that can recap [recapitalize] particularly the trading side. We’re on a process to that; 2019 is a big way station. The Bank of England needs to be very clear where institutions stand at that point. Do they have enough bail-inable debt? Have they met the 2019 requirements? Have they ring-fenced? How credible are their resolution plans? Then we need to take stock and figure out what needs to be done.

SF When you think of those building blocks that you’ve highlighted, that you think make the system fundamentally safer, is there anything you see in the way of backtracking—­particularly out of the Trump administration—that you think fundamentally undermines those building blocks or could undermine them?

MC One of the most important things had been to make sure that we or the American authorities can manage through a resolution process, keep the organization functioning while this bail-in process is going on. I think that the most recent reforms—and full credit to the houses of Congress and the U.S. administration—they have kept that. I will admit that prior to the final agreement on that, that was something we were really concerned about, because it’s so central. The administration has worked hard.

When we look at the changes to Volcker, the Volcker Rule is unique to the U.S. The way it ended up being implemented, maybe not surprisingly with five different regulatory authorities involved, proved to be incredibly complicated, and so they’ve made some adjustments. When a jurisdiction is super-equivalent to the international standards, I don’t think we can complain if they adjust for efficiency reasons.

SF We know there will be another recession at some point. Do you feel that we are fundamentally less likely to have a financially caused recession now?

MC When we look at various reforms, as well as the optimal level of bank capital, we look at to what extent have we reduced the probability of a financially generated recession or, in the extreme version, a financial crisis. And by how much more would we reduce that probability if we added on another 3 to 5 percentage points of capital, and is that worth it relative to what we would do to the path of growth over that period of time? That’s not the only way we come to these determinations, but that is one of the things we look at. And we think we have substantially reduced the probability and the severity of financial crises. We haven’t eliminated them. It’s not the “stability of the graveyard.” And because we haven’t eliminated them that means that things like ending [the problem of financial companies that are] too big to fail, things like making sure that the financial infrastructure, CCPs [central counterparty clearinghouses], and other things themselves are resilient so that they can withstand failure.

It’s a kind of forward orientation of financial reform and financial policy. We had some very specific things we needed to fix. And some of those things were common errors that happen over history, and they just reappear because people get complacent, so those were fixed. Some of them were unique. But part of what we’d like to change in the thinking is to make the system as resilient as possible to unknown unknowns. What’s the shock that could happen? Do I have enough capital? If somebody fails can I clean up the mess in an orderly way?

How should institutions be reorganized so that it’s easier for the system to withstand the loss of a major piece of financial market infrastructure or a major financial institution? Think about the bad scenario: a big bank being taken out by cyber—are you organized to deal with that? And obviously, first and foremost, institutions and others—and we—should be working on making it very unlikely that’s going to happen. We should also be prepared that, if it does happen, the system can function.

SF Is the lesson of the last few months [in Italy] that the euro zone is still not as far away from another crisis as we would like?

MC It’s been the case since the Five Presidents’ Report [in 2015] that the euro is unfinished business. A series of requirements are needed to finish the business of the framework and construction around the euro. Some progress has been made around ESM [European Stability Mechanism], some early progress around capital markets union, but neither of those have yet been completed. Banking union, as we know, probably won’t be completed by the time this gets published. I’m on record observing that currency unions usually have some form of fiscal sharing.

Until all of those elements are in place, it’s likely that there will be more strains. It’s just tougher to run that currency area than it is one that’s part of fiscal federalism with a banking union, capital markets union, other risk-sharing mechanisms.

SF If you think about the challenge of normalizing policy, for many years the risk was not giving enough support to the economy rather than too much. Is that shifting back to more 50-50?

MC If I talk globally—so not specifically for the U.K.—I think that to talk in absolute terms of interest rates and effective interest rates if you talk about quantitative easing, it’s more likely than not that the equilibrium level of policy has begun to rise. In other words that the balance of savings and investment is such globally that some of the extreme pressures on r* [the neutral level of real ­interest rates] have begun to abate. That’s a cyclical point. ­Structurally the forces go both ways. There is more balance in the risks around the stance of policy. But any given jurisdiction has to take into account its own domestic forces, whether there are headwinds from fiscal policy, headwinds from uncertainty, headwinds from trade discussions or other factors.

SF The early skirmishes from the U.S. were largely ignored by investors and economists, but are we getting to the point where we have a genuine global trade war in the offing?

MC The impact of the actions to date is likely to be small—reflecting the small share of overall exports affected—and would be largely confined to the countries directly involved.

However, a larger increase in tariffs would have a substantial impact. For example, an increase in tariffs of 10 percentage points between the U.S. and all of its trading partners could take 2.5 percent off U.S. output and 1 percent off global output through trade channels alone.

Moreover, these estimates consider only direct trade channels, but there are likely to be indirect effects via business confidence and financial conditions—something the experience of Brexit has underscored.

Adding on a fall in business confidence and tightening financial conditions to the direct trade channels and the possibility that the tariffs could be viewed as permanent could plausibly double the losses in output from direct trade channels alone.

SF Is this something that could seriously dent the global recovery?

MC There are some tentative signs that this more hostile and uncertain trading environment may be dampening activity. For example, survey measures of global export orders and manufacturing output have fallen back from highs at the start of this year, and growth in U.S. and euro-area capital goods orders fell to zero in the first quarter of this year. For now, these are only straws in the wind.

SF European Central Bank President Mario Draghi has voiced some concerns recently about the rise in unilateralism around the world—not only in trade but global politics. Do you share that concern? How does it affect the way a central banker thinks about the world if we see an erosion of the rule-based approach to international policy—if it gets to be less about rulemaking and more about big countries striking deals?

MC We can choose between a low road of protectionism focused on bilateral goods-trade balances and a high road of liberalization of global trade in services. The low road will cost jobs, growth, and stability. The high road can support a more inclusive and resilient globalization.

Taking this high road could help solve the problem of persistent trade imbalances. Bank of England research suggests that reducing restrictions on services trade, to the same extent as those on goods have been lowered over the past couple of decades, could reduce excess global imbalances by close to one half.

SF Former Federal Reserve Chairman Ben Bernanke said after he left in 2014 that he didn’t expect to see the federal funds rate at 4 percent in his lifetime. But he’s quite a lot older than you.

MC He’s in good shape, though.

SF In the U.K., the long-term average for the bank rate is about 5 percent. Do you expect to see the U.S., U.K., and other major economies’ policy rates back at their long-term average in the next decade?

MC There was a Bank Underground article from some of my colleagues that looked at historic estimates of r*. And one of the observations was that there are these periods, sort of regime shifts, that can go on for a fairly long period of time but then shift out of them relatively quickly in the long cycle of history.

And so a decade down the road, is it possible that a combination of a pickup in productivity, shift in the nature of investment, some of the demographic bulge moving through [and losing] some of the uncertainty wedge that’s been in there [will raise the long-run interest rate]? Yes, it’s possible. But a lot of things have to go right in order for that to be the case.

SF It could happen sooner than we think?

MC I wouldn’t want to say it that way. Well beyond my horizon, but hopefully in my lifetime.

SF When you look back, do you feel there are things you would do differently now in terms of communication?

MC One can always parse over any specific comment, especially with the wisdom of hindsight. But I think the general thrust of the bank’s communication, and the bank’s moves to transparency, has been right.

I do think it’s very undervalued that we communicate with the public at a minimum in parallel with financial markets but really, in this country, first to the public.

The questions I get at the press conference and when I go around the country, they’re around-the-supper-table kinds of questions. What’s the impact on jobs, house prices, what’s happening with my mortgage? It’s important to have relatively clear messages. Now they have to be accurate, but telling people that rises will be limited and gradual, people kind of need to know that. Should people in the country be oriented that rates are more likely to go up than not? Yeah, they should, because that is more likely—but not at a more rapid pace. Should they know whether there are risks from Brexit? Should they be worried about another 2008 from Brexit? We need to be absolutely clear with them [about] the extent to which there are those risks and what we’re doing about it.

You have to stand up and say, “Here are the three or four problems. We can knock off these two really easily. This one we’re pretty sure of, and that one we need to sort out with the Europeans.”

Some of it will be cast in the light of the politics of the day, but in the end, if you repeat it enough, it gets across.

SF How do you stay grounded? How do you stay sane?

MC One of the ways you stay grounded is you sit here and think, I’m the 120th person to be here, there’s going to be another, and so try to leave it better than you found it. My main utility, if I had any, was that outsider, different perspectives helped to catalyze some changes that probably would have happened anyway but helped bring them together.

SF You think it helps being an outsider?

MC I think it helps, yeah. And you don’t need an outsider all the time, but at the time it helped.

SF Are you definitely going back to Canada?

MC I was just there!

Flanders is senior executive editor for Bloomberg Economics in London.