Mark Carney hints that interest rates may rise at the end of the year, and many of the more compressed media pieces on his intervention turn a hint about the obvious into something that sounds like a racing certainty. For the purposes of balance, therefore, it’s worth mentioning the following:
1. De jure, Carney speaks for how he will cast his own vote only, though, de facto, the voting record shows that the internal members of the Monetary Policy Committee cast votes that are disproportionately correlated with each other.
2. We can recall from Carney’s two interventions around his 2014 Mansion House speech that he is capable of back-tracking quickly. After that, a rational Carney watcher puts a higher weight on any given signal containing more noise. This is to put to one side the debacle of Carney’s unemployment-trigger-forward guidance; the non-stimulative policy that was nevertheless meant to ‘secure the recovery’, and which scuppered the chances of a future MPC using genuine forward guidance as a preventative tool against the next crisis.
3. Weighing against the policy guidance are several factors: the hard to quantify, depressing effects of the ongoing Eurozone crisis and the risk of a disorderly workout; the continued headwinds from fiscal policy, which, despite the inappropriateness of this when close to the zero bound, will be tight for the foreseeable future. And not to mention the fact that inflation has failed to begin its return to target as predicted. On Radio 4 this morning Andrew Sentance claimed that rates needed to rise before inflation began rising back to target. Waiting until afterwards would be waiting until it was too late, he implied. Well, that’s not consistent with the Bank’s own model, I wager, nor with any that I know.
4. Despite the confident assertions that the MPC ‘have the tools’ to loosen should it be necessary, the reality, in my view, is less heartening. Even QE believers worry that the marginal returns from this policy have fallen. Despite needing to ‘secure’ that recovery, Carney urged the MPC to set aside this tool, probably for the reason that they felt those marginal returns had fallen too far. Interest rates can be lowered a bit, but to what effect we don’t know. The Government has boxed itself in again so that a significant loosening would be an embarrassing back-track. (Although against that there is no real opposition to capitalise). On the other side of the risk-management balance sheet: should it prove necessary, fiscal, interest rate, asset purchase and macroprudential tools can all be tightened, with at least 3 of those policies highly likely to work in the way intended.
5. These factors mean that the risks of a premature tightening outweigh the risks of one that is too late, considerably, a judgement that is coloured by recent anecdote in the form of the Swedish and Eurozone experiences. In David Miles’ last speech he concluded that there were not great risks of a deflationary spiral as the economy approached the zero bound. But I don’t agree. The crisis has given us one observation only on that issue. And one that can be read a number of ways [eg: it takes extraordinary, extreme monetary and fiscal stimulus to avert a deflationary spiral]. And the models we have to make sense of most macro policy issues tell us that there are tangible risks of such spirals. David leaves the Committee with central bank rates having been trapped at the zero bound for the duration of his stay. Not necessarily an experience that endorses the view that we know how to provide adequate monetary stimulus to combat a large recession.
So, don’t be too sure that it would be optimal to raise rates quite that soon, nor that the MPC will conclude that it is.