In the good old days, before the 2008 crash, running and understanding a central bank was simple. It targeted the inflation rate, while keeping a careful eye on the state of the economy. But in the last three years – and even more in the last three months – the targets have changed dramatically.
The US Federal Reserve is now targeting employment – its justification for the latest round of quantitative easing (QE). The European Central Bank now seems to be targeting peripheral country bond yields, while the Swiss Central Bank has explicitly been targeting the exchange rate.
But what does the Bank of England target? Officially it controls the inflation rate, but no one believes that anymore. Is it targeting growth? The employment rate? The exchange rate? No one has the foggiest idea. It is unrealistic to expect much in the way of fresh thinking from Sir Mervyn King. But the next governor must come up with a better goal. If he or she can’t, then Chancellor George Osborne should set one.
Inflation targets were simple to understand and follow. If prices ticked up, or looked as if they might, the central bank nudged up interest rates a couple of percentage points. If they were coming down, and if the economy seemed to be slowing, they nudged them down a point or two. Rates were changed three or four times a year to fine tune the mix between growth and inflation.
After 2008, all that changed. Take the Bank of England. It no longer uses interest rates to control inflation. Interest rates haven’t changed since March 2009. No one thinks they will change anytime soon. As for inflation, King has been writing the same letter to the chancellor every quarter since February 2010 explaining why he has overshot the 2% target. He has now sent ten of them, and no doubt has a few more tucked away to mail. So whatever the BoE is targeting, it isn’t inflation.
At the Federal Reserve, Ben Bernanke has at least admitted that the game has changed. Launching the Fed’s latest, perhaps boldest, blast of QE, he said the bank now plans to use monetary policy to boost employment. You can agree or disagree with the policy, depending on how effective you think QE is at helping the real economy, rather than just turbo-charging asset prices.
Personally I don’t think it will work. But at least it is straightforward. If firms are laying off workers, we can expect the Fed to print more money. If they are hiring everyone then we can expect the monetary taps to be turned off. Everyone knows what is going on, what statistics to track, and how to plan accordingly.
At the European Central Bank (ECB), Mario Draghi has also changed tack. He has made it clear that his bank’s main aim is to preserve the euro. And that the bank needs to get peripheral country bond yields down as part of its mandate to maintain price stability – and will buy unlimited quantities of Spanish or Italian bonds once a formal request for assistance is made.
Again, you can agree or disagree with it. I think the euro is doomed anyway and they would be better off dismantling it before it does any more damage. But the policy is clear. If Spanish or Italian bond yields spike upwards we know that the ECB will be rolling the printing presses until it gets them back down again. Everyone knows where they stand.
Smaller central banks are targeting different objectives. The Swiss are managing the exchange rate. The strong franc is crippling Swiss industry, so the bank intervenes to bring it down. Its success is mixed. But we know what it is trying to do. The Bank of Japan is not quite so up front, yet it seems to be targeting the exchange rate as well.
But the Bank of England? If anyone knows what targets the Monetary Policy Committee has in mind these days perhaps they could let everyone else in on the secret. It isn’t clear from their actions. This isn’t helping anyone. It is easier for businesses to plan and invest – and for the economy to recover – if they know what the central bank is targeting. Likewise, it is much easier for investors – and the more confidence investors have, the better the economy will perform.
Everyone can debate what the Bank of England’s target should be. Maybe it should be driving down the exchange rate to help exporters and re-balancing the economy back towards manufacturing. Perhaps it should be targeting jobs growth, like the Fed. It could aim to stimulate business and mortgage lending.
Alternatively, it could look to increase the savings ratio. Heck, it could even start trying to get house prices rising by 15% a year again – rampant property inflation has always got the British economy moving in the past, and there is no reason why it shouldn’t again, even if the growth it creates is not exactly balanced.
You can agree or disagree with any of these ideas. But at least we would know what was going on. It is too late to expect Mervyn King to change his ways now, he’s far too set in them. But the new governor – whoever she or he is – will need to come up with a radically new objective for the bank, and soon.