Deputy governor of the Bank of England (BOE), the central bank, said Tuesday that he had been following a pragmatic probing approach to monetary policy and that the Bank's new forward guidance policy fitted that approach.

Paul Tucker told the annual conference of the Association of Financial Markets in Europe (AFME), "The Monetary Policy Committee's (MPC) forward guidance provides an articulated framework for a probing approach to policy, without a change in our preferences on inflation."

Tucker's public defense of the forward guidance policy was supported by another speech Tuesday by a fellow MPC member, who also defended forward guidance.

Tucker said that the MPC, which sets the bank rate, faced a trade-off between fears of high inflation on the back of a series of stimuli and fears of stagnation which could affect the medium-term prospects for the economy.

He said, "In the UK, the core challenge lies in balancing two medium-term risks -- to the economy's productive capacity and to price stability. Concretely, the longer the weakness in activity, the greater the erosion of the economy's capital resources and the damage to the skills and capabilities of our labor force."

Tucker said the MPC has needed to provide monetary stimulus not only to contain the short-term economic weakness but, even more important, to reduce its longer-run costs -- social and economic.

"But we cannot do that at the expense of price stability -- or, more technically, of allowing medium-term inflation expectations to drift away from the target of 2 percent. Were the anchor to slip, our ability to support recovery would be undermined," Tucker said.

Tucker said the MPC was faced with a problem of over-capacity in the economy and the unusual post-recession situation of relatively good job figures.

Tucker said the rise in unemployment, while inflicting a terrible cost on those directly affected, has been a lot smaller than anyone would have expected given the weakness in output.

"This means that productivity has fallen over recent years, leaving it some 15 percent below current estimates of its pre-crisis trend path -- in sharp contrast to the U.S.. Let's be clear: we do not understand why productivity has been so weak. And that means that we are highly uncertain about the amount of slack in the economy currently and prospectively," he said.

Tucker said his approach to policy over the past two years has been to provide stimulus, pause, check on the effect and apply again if necessary; and he added that this was consistent with the new policy of forward guidance now adopted by the BOE under new governor Mark Carney.

Tucker said he was not in favor of maintaining low interest rates longer than was prudent. Advocates of that approach would do so, he said, because that would provide additional stimulus to an already-running recovery.

In a separate speech at Northumbria University Tuesday, fellow MPC member David Miles argued that while recent improvements in economic data are welcome, the slack in the economy generated by several years of underperformance means that people should not expect monetary policy to quickly return to normal.

Miles explained that with forward guidance the MPC is sending a simple message: provided inflationary pressures do not head in the wrong direction, monetary policy will not be tightened until the recovery is sufficiently strong and sustainable to make a meaningful dent in unemployment.

Miles argued that it is important to distinguish between the economy returning to more normal growth rates and the economy being back at a more normal level of economic activity. Endi

Go to Forum >>0 Comment(s)