Carney’s forward guidance policy ends in climb-down
Governor and the Bank risk loss of investor confidence
by Colin Robertson and Gabriel Stein
Mon 27 Jan 2014
Last summer, Mark Carney, the new Governor of the Bank of England, launched with great fanfare the Bank's version of forward guidance. With slightly less fanfare, that policy has now been significantly modified.
Whatever the Monetary Policy Committee ends up doing will involve a humiliating climb-down and loss of credibility for the Bank, as well as for Carney personally.
Carney was courted by George Osborne, the Chancellor of the Exchequer, to the point where he could write his own terms for joining. Following the pattern set by the Federal Reserve, he tied British monetary policy to unemployment. Interest rates would remain low until UK unemployment – then about 7.7% – would fall to 7%, expected in 2016.
This forecast was already at the time perceived by many to be too pessimistic. In the September OMFIF Bulletin, we both questioned the new fashion. Gabriel Stein wrote about the limitations of forward guidance and Colin Robertson highlighted a resulting likely decline of central bank influence.
In the January 2014 OMFIF Bulletin, Miroslav Singer, Governor of the Czech National Bank and one of the most independent-minded of Europe’s central bank chiefs, warned that through forward guidance, central banks risk increasing rather than lowering uncertainty.
It now seems likely that the 7% unemployment threshold was reached last December – more than two years ahead of schedule. Governor Carney has retreated from his previous policy and is talking about 'overall conditions in the labour market'.
There will be some policy clarification and explanation in February. What will the Bank do? It could introduce further qualifications to its policy. That would almost certainly be a mistake, since it would dilute the value of forward guidance by complicating it.
More likely, the Bank will modify the unemployment target and restate its intention to keep interest rates low for a prolonged period. But the events of last year have shown – in Britain and in the US – the risks of tying monetary policy to one lagging indicator such as unemployment.
The Bank risks losing the confidence of financial markets, critical for the efficacy of monetary policy. With central banks trying to manage the level of financial markets in recent years, be it through forward guidance or the purchase of financial assets, pleasing investors has become ever more important.
Avoiding specific trigger points for monetary policy action (or for consideration of policy action) would appear to make central bankers less of a hostage to fortune. But this would be likely to go down badly with investors who have fallen in love with triggers. Witness the obsession of defined benefit pension schemes with ‘de-risking’ the liabilities at a predetermined series of bond yield trigger levels.
Another issue for investors is communication and transparency. In the US the regular flow of views expressed by members of the Federal Open Market Committee are stated as their own, reflecting their personal input to policy-making and not official Federal Reserve policy.
Carney’s comments last week were more confusing. Did they reflect just his own views or was this new official policy? What role did members of the Monetary Policy Committee play in this new formulation? Admittedly, Carney’s remarks were hardly contentious, given economic developments, but next time round this might not be the case.
Carney’s chosen channels for communication deserve consideration. His initial remarks were delivered on the BBC’s Newsnight TV programme. His follow-up comment came in a speech in the Swiss resort of Davos. This might give the impression of the views being personal, but that is not the interpretation of the media and investors.
The increased focus in equity markets on how news is communicated, including avoiding the selective briefing of investors, might suggest to central bankers that the audience, timing and nature of briefings need to be considered carefully.
Greater transparency is welcome. But, in trying to please investors, central bankers must be realistic as to what they can helpfully say. Forward guidance should assist investors in assessing the outlook. It should not be a substitute for analysis. Carney’s problem is that, after the embarrassing amendment of his policy, UK forward guidance appears to be fulfilling neither aim.
Colin Robertson is former Global Head of Asset Allocation, Aon Hewitt and a member of the OMFIF Advisory Board.
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Gabriel Stein is Director of Asset Management Services of Oxford Economics and Chief Economic Adviser of OMFIF.