Wednesday, August 07, 2013
To boldly go forward
Posted by David Smith at 04:00 PM
Category: Thoughts and responses

The Bank of England's unveiling of forward guidance, under its new governor Mark Carney, was not as exciting an event as some had predicted - the man himself was understated and softly-spoken - but it was far from being a non-event either.

Most will by now know the basics - a 7% unemployment threshold, which when reached will encourage the monetary policy committee to start thinking about whether policy should be tightened (though won't necessarily result in them doing so), with three "knockouts" by which this threshold may be overrode.

So if the MPC is predicting inflation above 2.5% 18-24 months ahead, it might tighten policy earlier, though not if factors outside its control are pushing up inflation. Or, if the Bank determines that inflation expectations are no longer well-anchored. Or, if the Bank's new financial policy committee deems that continued low rates are threatening stability, perhaps by encouraging excessive borrowing.

Any or all of these three could result in policy being tightened before the unemployment rate, currently 7.8%, gets down to 7%. But if all goes well, the implication of the threshold, and the Bank's new unemployment forecast, is that Bank rate will remain at 0.5% until 2016.

Does this make any difference? Yes, according to the Bank's forecast. Predictions for both growth and inflation are higher with guidance than without it, because rate rises the markets are pricing in are removed from the equation. Is forward guidance a good idea? We will see. But anybody who thought it would be straightforward would do well to look at the Bank's explanatory document, here, and the new inflation report, here.