Despite boasting an impressive track record for inaction in recent years, the Monetary Policy Committee’s decision to leave rates on hold last week still surprised many. Expectations had built following Mark Carney’s statement on 30 June that post-Brexit “deterioration” in the economic outlook meant that “some monetary policy easing [would] be required over the Summer”.
But far from signalling a change of heart from the governor and the other members of the MPC, the minutes from last week’s meeting confirm that a majority of members expect to introduce some form of loosening next time around. This approach appears to correspond with Carney’s contention that the July meeting would provide an “initial assessment” ahead of a “full assessment complete with a new forecast” in August.
Delivering his last speech before leaving the MPC, Martin Weale this morning provided the Resolution Foundation with some further explanation of this ‘wait-and-see’ stance. While acknowledging the warning signs provided by early evidence of weaker real estate activity, reduced business investment and declining consumer confidence, he was clear that it would be unwise to act without any sense of the magnitude of any associated demand and supply effects.
Although it will still be an exercise in judgement (or educated guesswork), August’s Inflation Report will at least give some indication of the potential scale of trade-off to be drawn between higher near-term inflation (associated with exchange rate movements) on the one hand and reduced output (flowing from near-term demand issues and longer-term supply constraints) on the other.
But what balance will the MPC strike? By way of offering some guide to the future, Weale considers evidence from the past. Using data between 1997 and 2016, his conclusion is that the MPC has tended to give roughly equal consideration to deviations from the inflation target and from the trend output growth path. Given the primacy of the inflation target in the Bank of England’s remit, his contention is that this is technically insufficiently weighted to maintaining inflation at 2 per cent (even if it might produce better outcomes for the economy overall).
Whatever the merits or otherwise of the committee’s position, the implication is that it will once again ‘see through’ some near-term inflation volatility in the interest of keeping GDP growth higher than it might otherwise be.
This feels like the right position to adopt but, with the base rate already at a 300-year low, there is a big question mark over just how much action the Bank can take. I’ve written before about the lack of headroom the Bank faces relative to the position it was in heading into the financial crisis, and the correspondingly reduced potential for stimulating demand in the economy.
As the chart below shows, market expectations for rates aren’t just factoring in a reduction – they also imply slower correction than had been assumed at the time of the May Inflation Report. Nevertheless, these are relatively marginal differences – particularly if banks don’t pass through the full effects to businesses and consumers.
With Andy Haldane, at least, favouring a sledgehammer over a rock hammer – which, less evocatively means a “package of multi-complimentary monetary policy easing measures” – the likelihood of more unconventional policies such as quantitative easing or funding for lending appears quite high.
With that in mind, it’s encouraging that monetary economists have been debating the efficacy of different approaches ahead of time (in marked contrast to the position heading into the financial crisis). What’s clear, however, is that each of the more radical options (from negative interest rates to raising the inflation target) brings its own challenges – none is easy or as well understood as we would hope.
We can certainly expect to hear a new discussion about whether or not a simple repeat of QE as we know it will prove as effective this time round as it was at the height of the financial crisis. Those who don’t believe it can be will be likely to favour more innovative versions like buying private sector bonds or, given the relatively small volume of such bonds, looking at wider purchases of securitised business loans.
The good news is that the financial system is in a much better place than it was in 2008 – this is not a repeat of that crisis. And of course fiscal policy can play a role in the short-term too, with the new Chancellor, Philip Hammond, indicating that the pace and ‘parameters’ of deficit reduction are up for review in the light of new challenges. It may be uncomfortable, but the likelihood is that some combination of fiscal and monetary action can help to deal with any near-term demand shock.
Longer-term however, the truth is – as Mark Carney acknowledged in that 30 June speech – “there are limits to what the Bank of England can do”. If Brexit provokes reduced trade, lower investment and weakening productivity growth, then the country’s potential capacity will face a permanent hit. Avoiding that outcome rests as much on the shoulders of our politicians as our economists.