I don’t view today’s announcement by the Bank of England as being a major change in monetary policy. The inflation target of 2% remains in place and the tools with which the Monetary Policy Committee (MPC) can hit it (interest rates and quantitative easing) stay the same. It is an example of the dynamics of intervention – when existing methods are seen to have failed they get tweaked, and augmented, as opposed to replaced.
This isn’t to say that there’s nothing new. The Bank of England’s introduction of forward guidance with an explicit unemployment threshold is a new way of achieving their goals. The Federal Reserve has previously done the same, albeit it has a dual mandate that makes unemployment data already part of monetary policy. The fact that the MPC plans to keep interest rates low for as long as unemployment remains above 7% places more weight on this particular indicator. Whilst it’s true that it isn’t targeting unemployment directly, there is an incentive to use monetary policy to boost output, and boosting output might be expected to lower unemployment. To the extent that the MPC want to exit from historically low interest rates, they will want to use monetary policy to improve labour market figures.
And therein lies the problem. Only this week we’ve seen the problems with having a narrow focus on unemployment figures. One of the surprises of the ‘recovery’ is the fact that employment has held up reasonably well. We now hear people saying that the use of zero hour contracts means it’s the wrong type of employment. The more policymakers search for indicators of genuine improvements in well-being, the more obvious the problems of central planning become.
There is also the very real danger that by committing to low interest rates for even longer than previously thought the MPC is itself dampening the recovery. Forward guidance takes monetary policy even further down the wrong track. It needs to focus on broader indicators, not narrower ones. It needs to be focused on market forecasts, not official statistics. The real problem is the missed opportunity to reform the monetary regime.