The Limits of UK Monetary Policy
It didn’t take long for the hand-wringing about the limits of monetary policy to resurface. Chris Dillow wonders whether we are “approaching the limit of what QE can do“, and concludes that QE is “not enough” to raise real GDP.
Let’s consider the question of QE.
The Bank of England has a legal mandate to operate monetary policy such as to hit a 2% CPI rate. Have they been unable to hit it? In a sense. They have overshot it for the best part of seven years, three of those with interest rates firmly at the “zero bound”, one (and a half?) of those where fiscal policy was tightened – apparently – “too far, too fast”. So is monetary policy itself approaching a “limit”?
Did we suffer below-2% CPI inflation after hitting the zero bound? Yes, briefly during 2009, but the CPI rebounded after that.
Did we enter a deflationary slump after fiscal policy was tightened? Not obviously; the level of CPI grew 3.3% in 2010 as a whole, and 4.4% in 2011.
The only limit I see is on the number of different excuses the MPC can conjure up for the “temporarily” high CPI rate.
Various counterarguments to the above are often thrown around: the main one being that the VAT rate change “artificially” boosted the CPI rate in 2011, so that somehow “doesn’t count”. But the CPI rate is the Bank of England’s target, not CPI-CT or any other price index which ignores indirect tax changes. You could just as well blame them for failing to stabilize the price paid for Premier League footballers. They weren’t trying to do that, so don’t pretend that their behaviour would be exactly the same in a counterfactual where they had a different mandate.
The empirical evidence hardly falsifies the claim that QE is “enough” to keep CPI growing at around 2%, meeting the Bank’s legal mandate – even at the zero bound and in the face of fiscal tightening. Quite the opposite; doesn’t CPI growth of 4.4% in 2011 suggest the Bank were doing “too much”?
The real question is whether a 2% CPI target is sufficient to get the desirable rate of demand growth. To that we can say: no, evidently not. It is not QE which is providing deeply unsatisfactory macro outcomes, it is the inflation target itself – combined with a healthy dose of supply shocks.
Chris Giles writes that the Bank “must unleash more QE“. That is all very well, but expecting to get good outcomes from monetary policy like this surely requires a huge leap of faith. We are asking the Bank to do one thing (target 2% CPI inflation) and hoping they’ll do something completely different (ignore inflation and provide “enough” demand growth) – if we ask them loudly enough. What if they don’t listen to Mr Giles, and instead, say, the shrill voices of the liquidationists?
If we want really really really want faster nominal demand growth, then why do we not simply change the Bank of England mandate to target the desired path of nominal demand? And empower them to use whatever tools they see fit to hit the level: interest rates, QE, currency devaluation, whatever.