Ashburton’s Tristan Hanson wonders if Bank of England could do more

Tristan Hanson, head of asset allocation and multi-assets at Ashburton says that the Bank of England has limited room to move on policy, and that the government will have to consider fiscal rather than monetary changes to help boost growth.

It has been speculated that George Osborne, chancellor of the Exchequer, may announce a change to the Bank of England’s (BoE) remit when he announces the UK budget on 20th March, ahead of Mark Carney’s arrival as the new governor of the BoE in July.

Possible options for a revised mandate could include (i) abandoning inflation targeting with a switch to a target for nominal GDP growth; (ii) giving the Bank a more explicit ‘dual mandate’ of inflation and growth; (iii) targeting a price level rather than the rate of change of prices (the inflation rate); or (iv) maintaining the inflation target but with additional flexibility. The suggestion, therefore, is that the Bank has been constrained by its mandate and could have done more to boost growth with limited negative consequences. But is this true?

Aside from the early days of the crisis in 2007 when it was slow to react, the Bank has in fact pursued an extremely flexible form of inflation targeting. The CPI inflation rate has been above the 2% target in 54 of the past 60 months.

During which time, the Bank has (via QE) purchased £375bn of UK gilts, equivalent to 30% of the stock of outstanding gilt issuance or 24% of last year’s GDP. On a relative basis, this is more aggressive than the Federal Reserve’s net purchases of US treasuries, agency debt and MBS which since 2008 amount to $2,375bn or 15% of GDP. Furthermore, the BoE expects inflation to be above target for the next two years and yet the committee was split on voting for more QE last month. Perhaps the Bank could have done even more QE, but under no circumstances is this strict inflation targeting.

The potential options for change contain several drawbacks. A nominal GDP target might imply that an outcome of 5% inflation and 0% growth is as desirable as 3% growth and 2% inflation, when it is clearly not.

Targeting the level of prices rather than the inflation rate would be confusing to the public and could create uncertainty. A more explicit dual mandate would change little in practice – the Bank is already more focused on stimulating growth than inflation.

A revised communications strategy with more emphasis on forward guidance would perhaps be the least risky option. However, when considering any possible change, it should be recognised that outside of crisis situations, in the long-run there is little that monetary policy can do to raise potential growth other than the positive contribution of keeping inflation low and stable, as the ECB has long argued with some justification.

The Bank is limited in what more it can do. If the government demands more growth, it should also look to its policies for taxes, spending and financial regulation to achieve a better outcome.

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