The Old Lady will soon have a new man—and he’s Canadian. In the summer, Mark Carney will take over as governor of the Bank of England (also known as the Old Lady of Threadneedle Street). The current head of the Bank of Canada—and “young, good looking and charismatic,” according to outgoing governor Mervyn King—Carney is an excellent choice who will shake up the tired Old Lady’s habits. Yet precisely what his arrival will mean for UK interest rates, quantitative easing and the pound is uncertain.
One thing can be predicted: the Bank’s communication of policy will be clearer. Across the Atlantic, this has become the norm. Early in the financial crisis the Bank of Canada committed itself to low interest rates. A policy statement from April 2009, for example, said that the benchmark interest rate could “be expected to remain at its current level until the end of the second quarter of 2010.” At the US Federal Reserve, Ben Bernanke is making ever more explicit the Fed’s expectations of the economy and the likely future path of interest rates. Such clarity is the opposite of King’s studied uncertainty. “We’re in no position to make any accurate forecasts of what will happen in the UK,” King said in August.
Any view the Old Lady expounds under Carney will depend too on the nine-member Monetary Policy Committee, of which four members are external to the Bank of England. While in the US and Canada the central bank heads are thought to dominate the direction of policy, the MPC is an unruly bunch. King was on the losing side of a 5-4 vote in the MPC as recently as June. Carney will have to adapt to working with the committee and if he can’t carry it, he is the one likely to compromise—because on his side of the Atlantic the boss must be seen to lead.
Precisely what the bank will aim for is also uncertain. At present the MPC’s target is a 2 per cent inflation rate. It has consistently missed this, with inflation mostly well above, and sometimes more than double, that level over the past few years—and currently at 2.7 per cent. Carney himself has mentioned the possibility of targeting a level of nominal GDP, rather than the inflation rate. This would mean that at times of recession, policy would tend to be more loose, actively aiming to achieve higher inflation.
Such a change would alter the bank’s mandate. How much it would alter policy-making is less clear. One of the reasons why UK inflation has been consistently above target is that the MPC has assumed high global commodity prices were causing inflation. It believed raising interest rates would simply deepen recession and ultimately cause deflation. To a degree, then, the future path of GDP growth has already been central to policy-making. The risk, however, in formally adopting a nominal GDP target might be that the Bank overreaches and inflation gets out of hand.
What about the pound? Much will depend on the attitude the MPC takes to quantitative easing (the creation of extra money by the Bank to assist growth). The Bank of England has printed £375bn (about a quarter of GDP) since 2009. The Bank of Canada, with a stronger economy, has not resorted to QE but has felt the effects of the Fed’s QE, which has weakened the US dollar and kept the Canadian one strong. Carney has pointed out that the “unspoken issue” with quantitative easing is that it tends to work in part through “the exchange rate channel”—that is, by devaluing the currency, and causing problems for trading partners. Carney may perhaps prove more sensitive to such concerns than King and more reluctant to press the QE button.
But that too will depend on whether or not the UK economy picks up in 2013. A relapse into recession would no doubt force Carney and the MPC to do something. Carney comes from a strong economy on the fringes of the global crisis to a comparatively weak one that has been at its centre. There are no easy solutions to the UK’s weak growth and dogged inflation. Carney may be clearer about his policy intentions but growth and volatile inflation could make his forecasts look foolish too. Just like her ex, the Old Lady’s fresh face is going to find her challenging.