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Change on the way at the Bank of England?

I have always liked the pragmatic approach to economics of the Financial Times Economics Editor Chris Giles, whose balanced pieces are a useful corrective to the doctrinally-driven work of most economists. His recent article in the Financial Times included this sensible comment on the most recent speech by Sir Mervyn King, Governor of the Bank of England, which I think was a significant milestone on the road towards what increasingly looks like a coming change in emphasis in UK monetary policy.

On Tuesday evening, Sir Mervyn King completed his slow conversion from being an activist on what economists call the “demand side” to a “supply side” pessimist. Where the Bank of England governor once saw monetary policy as a simple tool to reinvigorate spending and bring the level of output back to its previous trend, his speech indicates he now sees the pre-crisis period as infected by unsustainably overexposed bank lending and “unsustainable paths of consumption”.

Forget fiscal policy and the government’s many growth plans – Britain’s most important economic debate focuses on whether Sir Mervyn is right. He might be a lame duck with only five months of his term left to run, and his views on the remit of monetary policy are far less interesting than those of Mark Carney, his successor. But his four-year volte-face represents the crushing of hope and bitter experience of the UK’s post-crisis period.

There is no escaping the fact that the outlook for the UK economy looks particularly uninspiring. It seems inevitable that the UK will lose its AAA sovereign debt rating this year. In a world where every country is looking to drive down its currency, we face an an appealing combination of limited growth and stubborn inflation. The next Governor, Mark Carney, who takes over in the summer,  has every incentive to adopt more unconventional monetary policy measures. By acknowledging the limited success of what has happened since 2008, the current incumbent is doing no more than pave the way for this new approach. In Chris Giles’ words:

The governor’s new outlook is depressingly pessimistic. But it fits the facts, and it is logical and coherent. I worry, however, that it is too defeatist. Trying to do more with monetary policy – through additional quantitative easing and other measures – seems to offer limited risks and the potential to find that we might live in a better world than Sir Mervyn describes.

Unfortunately I rather fear that the risks of doing more, far from being limited, are real and substantial. Central bankers the world round are looking to adopt new ways to use monetary policy to kick start economic growth. Short term that is positive for risk assets, but longer term there are good reasons to fear the consequences. What we are surely seeing unfolding before our eyes is the intellectual route map with which the world’s policymakers rationalise their way towards a world of higher inflation, the only electorally acceptable way to work through the global debt crisis.

Written by Jonathan Davis

January 27, 2013 at 8:29 PM