The MPC – looking for a remit (Part 1: the options)

Although the Monetary Policy Committee (MPC) of the Bank of England is independent in setting interest rates, until recently it still had to follow a precise remit set by the government. This was to target inflation of 2% (±1%), with interest rates set to meet this target in 24 months’ time. But things have changed since the new Governor, Mark Carney, took up office in July 2013. And now things are not so clear cut.

The Bank announced that it would keep Bank Rate at the current historically low level of 0.5% at least until unemployment had fallen to 7%, subject to various conditions. More generally, the Bank stated that:

The MPC intends at a minimum to maintain the present highly stimulative stance of monetary policy until economic slack has been substantially reduced, provided this does not entail material risks to price stability or financial stability.

This ‘forward guidance’ was designed to provide more information about future policy and thereby more certainty for businesses and households to plan.

But unemployment has fallen rapidly in recent months. It fell from a 7.7% average for the three months May to July 2013 to 7.1% for the latest available three months (September to November 2013). And yet there is still considerable slack in the economy.

It now, therefore, looks highly unlikely that the MPC will raise Bank Rate as soon as unemployment falls below 7%. This then raises the question of how useful the 7% target has been and whether, if anything, it has created further uncertainty about future MPC decisions.

The following still appears on the Bank of England website:

The MPC intends at a minimum to maintain the present highly stimulative stance of monetary policy until economic slack has been substantially reduced, provided this does not entail material risks to price stability or financial stability.

But this raises two questions: (a) how do you measure ‘economic slack’ and (b) what constitutes a substantial reduction?

So what should the Bank do now? What, if any, forward guidance should it offer to the markets? Will that forward guidance be credible? After all, credibility among businesses and households is an important condition for any policy stance. According to Larry Elliott in the first article below, there are five options.

Articles

Bank of England’s method of setting interest rates needs reviewing The Guardian, Larry Elliott (9/2/14)
Mark Carney set to adjust Bank interest rate policy BBC News (12/2/14)
Forward guidance: dead and alive BBC News, Robert Peston (11/2/14)
What “forward guidance” is, and how it (theoretically) works The Economist (11/2/14)
BOE’s forward guidance 2.0: Cheap talk, or big change? Market Watch (11/2/14)

Bank of England pages
Monetary Policy Bank of England
MPC Remit Letters Bank of England
Forward Guidance Bank of England

Questions