Bank of England no longer at the ZLB
I didn’t expect to be writing this post so soon! The Governor of the Bank of England announced yesterday that interest rates are no longer at the Zero Lower Bound. This was a rather under-the-breath “Oh, and by the way” announcement, which is kind of funny given how much some economists have staked on the significance of the ZLB. From Carney’s letter to Osborne, my emphasis:
There are risks to the outlook in both directions. To the downside, the fall in near-term inflation could be more persistent than the Committee currently expects. Global activity could continue to disappoint, or if low inflation were to depress inflation expectations, it could become self-reinforcing. In that case, the MPC would need to provide more support to return inflation to the target over the appropriate horizon.
Were these downside risks to materialise, market expectations of the future path of interest rates could adjust to reflect an even more gradual and limited path for Bank Rate increases than is currently priced. The Committee could also decide to expand the Asset Purchase Facility or to cut Bank Rate further towards zero from its current level of 0.5%. The scope for prospective downward adjustments in Bank Rate reflects, in part, the fact that the UK’s banking sector is operating with substantially more capital now than it did in the immediate aftermath of the crisis. Reductions in Bank Rate are therefore less likely to have undesirable effects on the supply of credit to the UK economy than previously judged by the MPC.
In choosing to hold rates at 0.5%, the MPC is choosing to set rates above the new, lower, actual ZLB. The Bank of England is no longer at the ZLB.
The good news is that now the Bank is off the ZLB, reality-based Keynesians will return to talking about UK macro policy in terms of conventional monetary policy and will go quiet about the need to use fiscal policy to control AD. Right? No more talk of building schools to create jobs. We are seeing today the Bank’s preferred path for output and inflation. It leads to 2% inflation and zero output gap. We know, that if the Bank wanted a different path for output and inflation they can use the conventional tools of policy. If you think that path is not optimal, it is either because the Bank has the wrong target, or that you believe they are making a conventional policy error. Either way, no need to talk about fiscal policy.