The Bank of England has an excuse for unreliable boyfriend syndrome | City A.M.
If the Bank of England does not increase interest rates today, be prepared for fresh criticism of its forward guidance.
Governor Mark Carney could once again find himself labelled an “unreliable boyfriend”.
But the critics sharpening their knives should pause for thought.
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Forward guidance doesn’t enjoy a good reputation in the UK. The policy, introduced with some fanfare by Carney on his arrival at the Bank, was meant to give greater clarity about the path of interest rates. But critics claim it just confuses households, investors, and businesses. The Bank has too often guided people towards thinking monetary policy will go in one direction, only to then change its mind.
This has led to the suggestion that the Bank could improve its forward guidance by providing more information. But more information does not necessarily lead to better-informed people.
The Bank already publishes a lot. On so-called “Super Thursday” each quarter, we get a 50-page inflation report, detailing new forecasts, alongside the minutes from the latest meeting on interest rates. The Bank also uses everything from speeches to Facebook posts to explain its thinking.
Investors in financial markets may study every nuance of these communications, but it’s doubtful whether the general public is equally vigilant. In a busy world, the average person probably takes the view that trying to analyse every twist and turn in the Bank’s thinking is not worth their time.
Carney has argued that guiding people to expect a “limited and gradual” pace of monetary tightening at the present time is perfectly sufficient. More information could arguably even lead to greater scope for misinterpretation and misunderstanding, with firms and households behaving in ways counter to the Bank’s objectives.
Other central banks do find creative ways to guide interest-rate expectations.
The US Federal Reserve’s “dot plot”, where members of the central bank’s decision-making committee give their views on the path they think rates should take, is a good example. Financial-market investors certainly scrutinise it closely.
However, it is subject to exactly the same charge of “unreliability”, since the dots tend to move around as the underlying economic data changes and committee members revise their views.
Nordic central banks take another approach, providing more explicit guidance via forecasts of future interest rates. But again, these forecasts are subject to revision.
Nor should we think that scrapping forward guidance is the solution.
This would mean returning to the kind of “constructive ambiguity” favoured by former Fed chair Alan Greenspan. Such a radical move seems out of step at a time of demands for greater transparency and openness. And central banks themselves still believe firmly in at least attempting to help the average person understand their thinking.
Ultimately, the charge of unreliability may have more to do with a lack of realism about how much certainty central banks can provide in uncertain times. The Bank of England doesn’t know what the final outcome of Brexit or trade wars will be, or much else about the future for that matter. Yet it has to take a view, since the interest rate decisions it makes today take time to have their full impact.
As John Maynard Keynes said, “when the facts change, I change my mind – what do you do, sir?”
Forward guidance only makes sense if the central bank accounts for how economic reality changes over time. Sticking rigidly to it could lead to the Bank raising interest rates even as an economic shock is clearly tipping the economy into recession, or cutting rates in the face of an unsustainable boom in the housing market.
As investors, we should be mindful that forecasting the future path of the economy in an uncertain world is extremely difficult – and it is this fundamental truth that makes the Bank’s task so hard.
Criticising its forward guidance is easy. Providing genuine solutions to improve it is a much tougher challenge.
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