Rocking the boat on the MPC
Someone gave a deeply subversive speech in the north of England today and it wasn't Ed Miliband. The MPC member, Adam Posen, has raised eyebrows at the Bank with some of his past speeches. But speaking to business people in Hull this afternoon, he lobbed several hand grenades into the debate over UK monetary policy, some of which may take a while to explode.
The first is the assertion that "we should do more quantitative easing now in the UK," or else risk a Japan-style period of slow growth and high unemployment.
Policymakers, he warned, must not "settle for weak growth out of misplaced fear of inflation".
True, inflation in the UK has been higher than expected, for longer than expected. As he himself has pointed out, not all of this overshoot can be explained. But looking two to three years ahead, he thinks that inflation is more likely to undershoot the Bank's target in a few years' time than again come in too high.
No, he thinks the risks are all on the other side.
"There are, however, very serious risks if we make policy errors by tightening prematurely, or even if we loosen insufficiently. Those risks are not primarily the potential for a double-dip recession or even of temporary measured deflation...The risks that I believe we face now are the far more serious ones of sustained low growth turning into a self-fulfilling prophecy, and/or inducing a political reaction that could undermine our long-run stability and prosperity. Inaction by central banks could ratify decisions both by businesses to lastingly shrink the economy's productive capacity, and by investors to avoid risk and prefer cash. Those tendencies are already present, and insufficient monetary response is likely to worsen them."
Or, as he puts it: "we are a long way from home, and a long, long, way from overheating."
Dr Posen has spent a lot of time in Japan. He's an acknowledged expert on what happened there, and he sees too many parallels between their experience - and the US experience in the 1930s - and our own. He also thinks we're in danger of making their crucial mistake, which was to underestimate, in the wake of a major financial crisis, the economy's potential growth.
Japanese policymakers thought that the crisis had drastically reduced the country's potential output, so they were wary of taking extreme measures to stimulate the economy, out of fear of overheating. As it turned out, the crisis did do permanent damage. But Posen believes the sheer scale of the downturn meant there was a lot more spare capacity - and more room to grow - than the policymakers allowed. The result was a long period of unnecessarily high unemployment and slow growth.
Looking at the UK, he believes that similar risks apply: policymakers will look at the growth we've achieved since the end of the recession and conclude that the economy is not able to grow as fast as we did before, and the Bank will shortly have to think about putting on the brakes.
You might say this was overdoing it. There is one member of the MPC - Andrew Sentance - who supports higher rates now. The OECD has also suggested that the bank should tighten sooner rather than later. But they are the exception. Most think there is still a lot of spare capacity in the UK, and the Bank should keep policy loose for some time to start using it up.
However, that brings me to the second, more subversive, piece of Posen's message: in his view, the Bank can't afford to just hang around waiting for this potential to be used up, because time is money. Or rather, time is lost output and lost jobs.
Why? Because if you're a firm that's trying to hang on to their under-employed workers - and still oiling that unused production line - growth next year is simply not the same thing as growth today. By next year you might have had to lay those people off, or shut down that production line for good. The extra capacity will be gone.
This might seem like common sense. But if you're a central banker, it is dangerous talk. It suggests that monetary policy can have a lasting impact - not just on inflation, but on the real level of output as well. Efforts to raise output above the sustainable level caused a lot of inflationary grief in the 1970s - central bankers have been understandably nervous about it ever since, insisting that they could only affect inflation, not long-term growth.
But, says Posen, these fears "can be taken to unjustified extremes, and there is a risk of our doing so now when the damage could be great by so doing. When the overwhelming bulk of pressures in the economy are disinflationary, and when the level of output and employment are clearly likely to be below potential for an extended period."
In those circumstances - in these circumstances - he thinks it makes sense for central bankers to go the extra mile to get that unused capacity on stream before it disappears forever and our long-term growth fulfils our gloomiest expectations. (It's worth noting that Charlie Bean, the deputy governor, has also expressed sympathy with this idea.)
I have spent a long time outlining Posen's argument, not just because he is an interesting and influential member of the MPC, but because this speech is perhaps the most detailed statement of the case for "QE2" that anyone has provided - on either side of the Atlantic - since the debate was re-opened over the summer.
That discussion has got "legs" in the US from the Federal Reserve's recent statement suggesting they would move in that direction. Indeed, some might say Dr Posen - a US academic previously based in Washington - is raising the debate in the MPC that he would be like to be having inside the Fed. In many ways his argument looks stronger when applied to the US.
Whether or not you agree with him, this is the case for further - substantial - quantitative easing which less dove-ish MPC colleagues will have to answer at next month's meeting.
It is far from clear he will get his way. Bizarrely, in the speech he says that we cannot even assume - on the basis of this speech - that he will be voting for extra QE next month.
The minutes of the September meeting suggested that a majority of members thought the downside risks to growth over the next few years had gone up, while the inflation risks were about the same. It's not an impossible leap from there to further QE, but it is a leap.
Even if he does prevail - you might ask, how do we know it would even work? Posen has two answers to this.
The first is that "fear of being ineffective should not be a deterrent to doing the right thing. When facing a worsening situation, you work with the tools you have."
The second answer is that you try a lot more QE, but if it looks like even that's not going to be enough, you bring on the big guns: fiscal stimulus, directly financed by the central bank. That is the most subversive suggestion of all, and worthy of a post in its own right.