The Bank of England, the chancellor, and the target

Bank of England

Does the chancellor want to set a new target for the Bank of England? The answer is no.

But does he want have a debate about it? The answer is an emphatic yes - for political reasons as well as economic ones.

With the UK economy starting the the new year no larger than it was 12 months ago, it makes perfect sense, from an economic standpoint, to consider whether there is more the central bank can do to help.

Unreliable numbers

At last week's meeting in Davos, many policymakers and economists from around the world were debating the same thing - particularly Japan and the US.

The arrival of a new governor at Threadneedle Street provides a perfect opportunity for such a debate to happen, without anyone getting too defensive (not that anyone would dare call Sir Mervyn King defensive).

But clearly, for the chancellor, the debate also has an added political benefit: the more the focus is on what the Bank of England can or should do to revive the economy, the less that harsh spotlight may fall upon him.

The Financial Times reports that the Treasury has cooled on the idea of formally replacing the inflation target with a target for nominal - or cash - GDP. In fact, I don't think Number 11 was ever very hot on the idea.

There are just too many practical obstacles standing in the way, including those flagged up by soon-to-be Governor Mark Carney.

I mentioned the big ones in my previous post on this. Right now, for example, there is no monthly measure of cash GDP. You would need to create one for the central bank to feel comfortable targeting it.

Much more important, the Bank would need to have some confidence that those numbers were not going to be constantly - and extensively - revised. Neither seems very likely.

As one respected central bank governor said to me in Davos: "If I ever thought I could have anything close to the same level of confidence in nominal GDP numbers that I have in the Consumer Prices Index, I would be happy to target cash GDP. But I just don't see that happening."

'No bygones'

But there is another big objection to the pure form of nominal GDP targeting, as described by Mr Carney in his December speech - which is that it does not let bygones be bygones.

For supporters, it's a plus. For politicians and practical-minded officials, it's a potential minefield.

If you've targeted a particular growth rate of cash GDP and the economy has not reached that rate, over a sustained period, the point of cash GDP targets is that the central bank is not supposed to just forget about those failures and look to the future - as the Bank of England has done with the inflation target.

It's supposed to try to get back to the path that was originally mapped out.

Supporters like this aspect because they say it would force the Bank of England to do more, right now, to make up the economic ground lost since 2007, even if inflation overshoots.

In practice, even that's not guaranteed: if you take 2005 as the last time that the UK was "on trend" (or operating at exactly its capacity), the growth in our nominal GDP between then and 2012 looks about right. If you start the clock in 2007 - as I did in my earlier post on this - it looks far too low.

Precisely because the "no bygones" approach is so sensitive to the starting year, the Chancellor's advisors don't think it would ever fly politically.

Even if voters understood what nominal GDP was - as they currently don't - will they really ever believe that a government is going to withstand years of well above, or well below, target inflation, simply to get back to a particular, fairly arbitrary path for the cash value of the economy that was laid down by the folk who were in power before them?

The general view in Number 11 is that the answer to that question is no.

Politicians are always going to let bygones be bygones - for the very good reason that voters expect them to think and talk about the future, not the past.

If that's right, then one of the big supposed benefits of nominal GDP targeting - that consumers and businesses will have some certainty about the future path of their nominal incomes - largely evaporates.

Could you have a target for the growth of cash GDP that did not have this feature? Perhaps. But even if you weren't thinking about where you were, with regard to the past level of cash GDP, you would still have to worry about whether the numbers themselves were right.

Bending over backwards

If all this has messed with your brain, you're not the only ones.

All in all, the conclusion many in Whitehall and the city are drawing is that the debate about nominal GDP targeting is more trouble than it's worth.

There's a reason, it turns out, why the monetary policy target most loved, in theory, by academic economists for the best part of 40 years has never made it to the point of actually being used.

But - as I said at the start, Number 11 really does want a debate about all this. And not just because everyone else around the world is debating it.

As Governor Carney reminded his audience in Davos, the Bank of England and many others have a system of "operational independence". That means the government sets the target, and the central bank is free to work out how to meet it.

Recently, the Bank of England has introduced a lot of flexibility to its mandate, in order to avoid tanking an already anaemic recovery with drastic efforts to get inflation back to 2%. Some of that flexibility was already built into the original framework. But it has been stretched pretty far.

If the UK's central bank is going to bend over even further backwards to support the recovery - for example, linking policy to some future state of the economy, as the Federal Reserve has done, or using other forms of communication to lock in policy in advance - then at least some people inside the Bank and the Treasury think the Bank needs a formal mandate to do it.

That is why the Treasury is not ruling out some changes to the monetary policy framework this year, even as it pours a bit of cold water on the nominal GDP debate.

Where everyone seems to agree is that changing the Bank of England's approach - either on paper or in practice - will be a helluva lot easier when there's been a change of leadership at the top.

Stephanie Flanders Article written by Stephanie Flanders Stephanie Flanders Former economics editor

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  • rate this

    Comment number 11.

    The service sector, the only economy left in the UK... other than the square mile in London...costs a fortune.
    Low wage economy will not solve it...because the East will ALWAYS, be cheaper to manufacture.
    Debt will increase.
    Because wages will decrease in real terms, the ability to own one's home will disappear.
    Rachmanism....another sign of a third world economy will be and is, with us.

  • rate this

    Comment number 10.


    "Screw the banks."

    Bit out of date they SCREWED themselves (with the help of the BoE/HM Treasury) - now these bankrupt businesses are being propped up by the Establishment - for personal profit - and the money to do so is coming from the poor!

  • Comment number 9.

    All this user's posts have been removed.Why?

  • rate this

    Comment number 8.

    4+ Solutions

    In 1990's I suggested a tinkering with the mortgage security law to make lender liable fro their loans not borrowers about certain Loan to Value ratios. This may still work now.

    Another idea was to abolish the capital gains tax exemption for principal residences. This may still also work now.

    Above all we cannot afford as an economy to have property so expensive it crushes jobs.

  • rate this

    Comment number 7.

    I think if BBC journalists are going to be allowed to write these opinion pieces they should declare their political stance by stating who they would vote for or voted for at the last election. At the BBC you can mainly guess it, but why they are allowed taxpayer funded blogs to promote their own viewpoint I have no idea.

  • rate this

    Comment number 6.

    The problem with nominal GDP targeting is that it will hurt the poor the most. Take a look at this.

    "Or as a supporter of nominal GDP targeting Martin Wolf of the Financial Times puts it.

    inflation might overshoot"

    Now imagine the impact of overshooting inflation on those with benefits only increasing at 1% per annum....We know what "might overshoot" means!

  • rate this

    Comment number 5.

    You've got to accentuate the positive.
    Eliminate the negative.
    And latch on to the affirmative.
    Don't mess with Mister In-Between
    You've got to spread joy up to the maximum.
    Bring gloom down to the minimum.
    Have faith, or pandemonium's
    liable to walk upon the scene.
    In other words...

    Screw the banks.

  • rate this

    Comment number 4.

    The public must demand HONESTY.

    Asset price inflation MUST be included in any inflation target or it is a JOKE.

    This was blinding obvious that I wrote to HM Treasury in the early noughties and later nineties pointing out their error and offering solutions. They ignored me (and others) and see where it got us! A crashed banking system and an outlook of 20 more years of hard times.

  • rate this

    Comment number 3.

    I dont think it matters one jot which figures they use , voters have seen all the current markers manipulated to the point of being meaningless when set against reality.

    In fact they only thing they dont do is publish the target until after the figures are calculated....this would avoid the embarrassment at least of continually missing them.
    The aim is to save the financial sector not the economy

  • rate this

    Comment number 2.

    What is the point of a target when it has been so comprehensively missed?

    What is more what is the point of an inflation target when the important bubbly parts of asset prices inflation are deliberately left out?

    King knew, or should have, that the structure of the 2% inflation policy WOULD cause an asset price bubble and a debt bubble and then a 25 year depression. He must be sacked -NOW!

  • rate this

    Comment number 1.

    The Government is running scared and will do anything to get higher GDP. They have already robbed savers, pensioners, the young and those on benefits to prop up the banks. Higher inflation is now on the cards to inflate away their mistakes.


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