Mark Carney, the new governor of the Bank of England, has lost little time in making big changes in the way in which British economic policy is conducted. He has already said that the Bank will start setting out ‘forward guidance’ on its plans for interest rates, and may do so as early as next month.
The trick is one Carney is famous for in Canada. And while there is nothing wrong with it in principle, the trouble is that the guidance is likely to be of the wrong sort. Carney will almost certainly be telling us to expect near-zero interest rates for years to come.
But he should be telling us that interest rates will have to rise one day, that the government is too deep in debt to keep most of its promises to us and that, without the stimulus of cheap debt, real wages may not rise for years. That would be more honest – and a lot more useful as well.
As governor of the Bank of Canada, Carney hit on the forward guidance wheeze back in 2009. In the wake of the financial crisis, he not only slashed interest rates, he also promised Canadians that they would stay at those low levels for a long time to come. The policy is credited with having helped Canada steer its way through a global recession largely untouched. And its success helped secure Carney’s reputation as one of the world’s smartest central bankers, playing a big part in getting him the transfer from Ottawa to London.
Whether it really made much difference is open to debate. Canada was helped just as much by high commodity prices, the conservatism of its banks, and the fact Canadians carried on borrowing and spending more enthusiastically than any other nation, as it was by anything the central bank said. Still, Carney believes it worked – and looks determined to try something similar here.
There is nothing inherently wrong with giving forward guidance. If businesses and households know what could happen to interest rates one, two or three years out, it is easier for them to plan ahead. If we’d all known in 2009 that rates would be 0.5% for four or five years – and were not just an ‘emergency’ – we might have responded differently. The problem is, it needs to be the right kind of guidance.
What Carney should be telling people is this. First, interest rates of 0.5% are an aberration. They haven’t been this low for the last 300 years – and it will probably be another three centuries before they hit these levels again. At some point, rates will inevitably rise, and that will be very painful for many borrowers. You should be doing some maths on your mortgage, or your buy-to-let investment, or your business loan, on the basis that interest rates are 5% and making sure you can still afford the repayments. If not, you need to start doing something about it – before it is too late.
Second, don’t assume that interest rates are under the control of the Bank of England. We can set the base rate, but we can’t control what a lender will actually charge. Even if we say the base rate is going to stay at these levels for several years, the market may decide differently – and, as we’ve learned many times, the market usually wins. So plan on rates rising whatever the Bank does.
Third, the British government is hopelessly in debt – and has hardly even begun the task of getting its finances under control. It has the biggest deficit in the developed world, and is getting away with for it now – but probably won’t forever. At some point, it will have to radically cut back on what it does. It has promised you a range of benefits, from pensions, to healthcare, to education for your children, and now, most recently, support for buying a house. The chances are it won’t be able to deliver on most of those promises. You should expect to have to pay for them yourselves – and you need to start planning how to do so now.
Fourth, Britain has been running a huge trade deficit for two decades. This means we consume more than we produce. That is not sustainable either. We will need to consume less and produce more. The most likely way of achieving that is through a sustained fall in sterling’s value. It will make everyone feel poorer, and it will push up inflation as well – but it might bring the economy back into balance.
Finally, the growth of the last two decades was based mainly on debt. People borrowed a lot of money, and spent it, and that made them feel richer. But the only real source of rising wealth is productivity growth, and there has been scant evidence of that in the last few years. We won’t be able to reinflate the debt bubble, and even if we knew how to it would not be a good idea. But without rising debt, real wages are unlikely to rise nearly as fast as they did in the past and may not grow at all. You will have to work harder, save more and spend a bit less – and none of that will be much fun.
That kind of guidance might be unpopular. It isn’t what people want to hear. But it would be a lot more useful than promises of low interest rates for another two years – and it might actually allow people and businesses to start planning sensibly for the years ahead.