There will be no rise in the UK interest rate until unemployment drops to 7%, Mark Carney has announced in his first Inflation Report as governor of the Bank of England. His move marks a decisive change of direction for the methods the Bank uses for gauging the nation’s economic health. Despite recent reports indicating a resurgent economy – with house prices rising and employers back on the hiring trail – Carney was at pains to point out: “This is the weakest economy on record, and those records go back more than 100 years.” For the Bank chief’s money, improvements will have to register at grassroots level for the interest rate to budge.
However, that strategic shift has angered some experts. Professor Philip Booth of the Institute of Economic Affairs said: “This is the most dangerous development in UK monetary policy since the late 1980s. Monetary policy should be designed to ensure that we have stable prices. The level of unemployment is mainly determined by a range of factors, such as labour market regulation, the benefits system, tax rates and so on. To try to use monetary policy to reduce unemployment when inflation is already above target is playing with fire, and could lead us down the road that we followed in the 1970s.”
Booth added: “This move also calls into question the independence of the Monetary Policy Committee and the Bank of England’s ability to fulfil its statutory duties.”
While prominent think tank the Adam Smith Institute welcomed the Bank’s change of tack as an “improvement”, it nonetheless said that Carney had left himself – and his organisation – at the mercy of guesswork. “Unemployment and inflation come from both aggregate demand (which the bank can control) and aggregate supply (which it has essentially no control over),” said the group. “Since neither of those numbers distinguish between changes in supply or demand, the Bank is still fumbling in the dark with its guesses over whether a change in inflation comes from demand (which means it should react) or supply (which means it shouldn’t). Uncertainty still reigns.”
However, British Chambers of Commerce director John Longworth said that, with the unemployment rate not about to dip anytime soon, business leaders will have a broadly stable platform on which to base their plans. “The introduction of a 7% unemployment threshold before the MPC considers tightening monetary policy will reassure business,” he said. “We agree with the committee that a decline in the unemployment rate to 7% is unlikely in the next few years, so it looks as though interest rates will remain low for quite some time. This will give businesses a much-needed confidence boost when looking to invest, as they know that any plans will not suddenly be derailed by a hike in interest rates. We are also pleased that Mark Carney has shown his commitment to the 2% inflation target, as we believe that higher inflation damages growth prospects.”
Longworth added: “While the governor made it clear that forward guidance is not a legal commitment and will ultimately depend on economic circumstances, it is still a positive development. However, we would like to have heard something more concrete about how the MPC plans to underpin the recovery. We would urge the BoE to use its balance sheet to further capitalise the British Business Bank or underwrite private investment in infrastructure projects, as this would help to secure the long-term economic future of the UK.”
Download the Inflation Report from the Bank of England’s website
Image of Mark Carney courtesy of the Wikimedia Commons, via Wikipedia