The past week has seen a lot of excitement in the UK with the announcement of forward guidance by the Bank of England. In my day job I’ve been writing and talking (at 1:22) about it a lot lately, although I tend to leave the macro blogging to Matt. However, I’m going to make an exception for this announcement because there was just so much hype surrounding it.
If you want to know what others are thinking, Britmouse has a great round-up of the reaction so far and it is overwhelmingly negative. Views are split into two distinct camps: there are the people who think there is no output gap and rates should rise sooner, and there are the people who think it didn’t go nearly far enough.
The negative reaction to the announcement probably reflects the split in the Bank’s Monetary Policy Committee. For months they’ve been divided on the need for further easing, with a third of them voting for more QE and the remainder opposed. The new Governor, Mark Carney, has managed to unite them around forward guidance but the deal he made smacks of compromise. On the one hand he placates the doves by promising not to lift rates or reduce QE until a mild recovery eventuates. On the other hand, he has avoided easing policy at all and the forecast path of inflation has actually fallen since the previous round of forecasts.
By avoiding a commitment to ease policy he has ensured that the guidance threshold will be a feature of monetary policy in the UK for years to come. Indeed, the Bank is forecasting unemployment to remain above its 7% intermediate threshold for another 3 years. When you consider unemployment has already been pinned at 8% since 2009 it’s possible that the NAIRU, which was previously around 5-5.5%, will have risen. That highlights one of the risks of tying the threshold to a real variable that the Bank cannot alter in the long run. They’ve tried to avoid the problem by picking a very high threshold but that merely weakens their commitment to supporting the recovery. Nevertheless, Carney’s compromise is a small step in the right direction and for that he should be applauded.