What is UK Monetary Policy?

Chris Giles argues that the Bank of England is guilty of “institutional dovishness”.   Simon Wren-Lewis is not so sure.  I think there are two very different questions which we care about here:

1) Are the goals of UK monetary policy “appropriate”?

2) Has the Bank of England set the “tools” of policy (e.g. QE, interest rates) correctly so as to achieve those goals?

I am not sure if Chris is arguing about (1) or (2).  The discretionary approach to the labour market data could be taken as evidence the MPC is changing the goals of policy in a more expansionary direction.  But the question of whether the Bank should raise rates now is more about (2).

Mr. Giles also says the Bank is “institutionally biased against higher interest rates”.  “The Bank” has argued, very forcefully, in favour of 2% inflation targeting.  I count in particular Mervyn King and Charles Goodhart.  I think it is correct to argue, hence, that the Bank is institutionally biased against higher (nominal) interest rates – but that is a thoroughly hawkish bias.  After all, the most hawkish central bank in the world (the Bank of Japan) also has the best record in the world for keeping nominal rates very low.

I would argue that the important institutional bias at the Bank is against monetary policy rules and in favour of discretion.  The independence of the “nine wise bankers” of the MPC to “make the right decisions” is what is being protected above all else.  The uncertainty around the “appropriate goals” for UK monetary policy is extremely helpful in protecting that independence.

Are the Bank targeting 2% inflation on the two year horizon?   Is it one year?  Or three years?   What about the “output gap”, or “spare capacity”?  Is it acceptable for the Bank’s forecast to show they expect to persistently undershoot the 2% target, as in February 2009 when the median CPI rate averaged just 0.8% across the forecast period?   If so, would it not also be acceptable for them to set policy such that they persistently overshoot the target?  What is the “institutional bias” shown in the February 2014 forecasts, where the median CPI rate across the forecast period averages… 1.9%?

Simon makes the case that deflation in Sweden shows what happens if monetary policy is tightened unnecessarily.  This gives too much ground to the hawks.  Was UK monetary policy “too tight” in, say, November 2008 or June 2010?  It is easy for the MPC to deflect this charge following the same logic as Simon: inflation was above target, and mostly stayed above target.  And then we can argue till the sun goes down about the output gap, because nobody “knows” for sure.

We are left with this vacuum of policy.  Is it right for the Bank to keep rates at 0.5% in March 2014?  I agree with Simon that it is right beyond any reasonable doubt.  The MPC should continue to duck and weave until inflation (by which I mean nominal GDP) “takes off”, and the more the chattering classes get annoyed by London house prices, the better.  It’s also right to dump the inflation target in favour of a clear rules-based policy regime.  Other opinions are also available.