Do you remember forward guidance? That’s OK, not to worry — not many others do either. It was the policy launched to enormous fanfare by Mark Carney when he became Bank of England Governor in the summer of 2013.
It was about as simple a rule as one could expect from a central bank. The Bank’s Monetary Policy Committee would not even consider raising interest rates until the unemployment rate dropped back beneath 7%. At that stage, the rate was close to 8% and barely looked like budging. The Bank thought it would take two or three years to get down to 7%. In the event, something amazing happened, which you can see in this chart.
The unemployment rate fell. And fell, and fell. To the extent that not only is it now below 7%, it is at 6% and falling. It it an astonishing drop, which took everyone (including the Bank) by surprise. In the face of this, the Bank could have done three things: it could have said it was now considering raising rates; it could have acknowledged it made a mistake and ditched forward guidance; or it could have fudged things.
In the event, it went for option three. Six months after the introduction of a policy which was supposed to last for years, Mr Carney said forward guidance was not over. It was simply entering a “new phase”. He said that there was still slack in the economy that needed to be consumed, adding that the Bank would base its decision on whether to raise rates on a whole range of factors, including spare capacity and measures of underemployment.
Or, as the Governor put it in a statement to the Treasury Committee recently:
Which is about as unclear as the original version of forward guidance was clear. And as time has gone on, the Bank has mentioned forward guidance less and less. The full phrase itself didn’t even occur in the Governor’s opening remarks this morning, which is a little odd given it is still, nominally at least, a flagship policy. It’s almost as if it has become a little embarrassed by it.
Now, in one sense, one should hardly complain. It’s good news that unemployment has fallen so far and so fast. It’s good news that economic growth is so strong. It’s questionable whether forward guidance made much difference — usually economic policies need many more months, if not years, to be felt. Particularly when they hinge entirely on communication and sentiment rather than actual changes in spending or monetary levers.
However, in the City, many economists openly deride the policy as a failure. Some have called it a joke. They worry that the Bank has undermined its credibility by failing to admit that the policy is either defunct, or that interest rates need to be raised. More deeply, they worry that the Governor’s determination not to raise interest rates even when his landmark policy is pointing in that direction shows that he is simply unlikely to raise rates anytime soon — whatever the excuse.
Since the Governor often gets an easy ride on such matters, I asked him about such City concerns in today’s Inflation Report press conference. You can see my question, and his answer, in the video below:
Ed Conway asks Mark Carney about forward guidance at the November 2014 Inflation Report press conference
So. I’ll admit that the Governor did mention “guidance” in his opening statement (once), though he never mentioned “forward guidance”.
However, it’s worth fact-checking the other key element of his response — that his second phase of forward guidance, which stated that when interest rates rise the increases would be “limited and gradual”, has “become a mainstream view in financial markets.” This seems to imply that it was only after forward guidance was introduced that markets realised that rates would only rise very gradually.
But look at the chart below. As you can see, a full year before forward guidance, in July 2012, markets expected interest rates to go up only in late 2015 (the red line below). They would only go up gradually. In July 2013, just before forward guidance phase one was introduced, the profile was similarly gradual. You can see that, if anything, since forward guidance mark II (the purple line), rate expectations actually came forward, and there is hardly much difference in the overall profile shape of the curve — certainly the rate of initial increases.
In the Governor’s defence, in the past year or so the economy has strengthened, which will have a bearing on rate expectations. But it is nonetheless simply not true to credit forward guidance with the shape of the market curve for future interest rate changes. It had a very similar shape well before his policy was introduced.
The ironic thing is that had Mr Carney acknowledged that the policy had come to an end of its useful life earlier, this pesky issue wouldn’t keep cropping up in trading floors and banks around the country. But one supposes you can’t do that with your main, eye-catching flagship policy.
Forward guidance may well have been successful. Certainly, it hasn’t actually harmed the economy. But if so, it is still difficult — extremely difficult — to work out precisely how it has been the roaring success the Governor suggests.