Advertisement

Forward guidance: Mark Carney moves the goalposts

Bank of England governor Mark Carney has replaced the emphasis on unemployment with a broader focus on nurturing the recovery.

Bank of England governor Mark Carney has been forced to ditch his forward guidance' policy. Last summer, he warned the nation that he would only consider raising interest rates once unemployment had fallen to 7%.

At the time, that level seemed laughably distant yet a rapid rebound in the UK economy has seen the jobless rate plunge so fast that it is already nearly at 7%.

Advertisement - Article continues below

So this week, Carney replaced the emphasis on unemployment with a broader focus on nurturing the recovery. The Bank will monitor spare capacity' the amount of slack in the economy which determines how fast it can grow without generating inflation. The Bank also revised up its official estimate for 2014's GDP growth from 2.8% to 3.4%.

What the commentators said

However, the worry is that by putting much more emphasis on the output gap', or spare capacity, the Bank is replacing the unemployment rate "with an even more unpredictable, and much less observable, economic concept", said Capital Economics.

The output gap is notoriously difficult to measure in real time, and estimates of its size range from near-zero to around 6% of GDP. It is crucial to the inflation outlook, however.

If it is small, it means demand in the economy is close to matching supply, so growth cannot continue much longer without causing upward pressure on inflation. But if it is large, there is still plenty of capacity sitting around that was left idle in the recession, and the economy can grow into it without inflation rising.

Output-gap pessimists, such as Fathom Consulting, reckon the recession destroyed a lot of capacity as opposed to simply leaving it idle so the economy's productive potential was shrunk.

As MoneyWeek has noted, studies suggest that recessions following financial crises tend to wipe out a lot of capacity, as all the lousy investments caused by loose credit are killed off.

Fathom is worried that inflation will soon be back and interest rates won't rise nearly fast enough to tame it, fuelling the housing bubble and causing a "sterling crisis". Another boom and bust disaster "is all too possible", said Allister Heath in City AM. We will find out who's right about the output gap in 2016 or 2017.

Advertisement
Advertisement

Recommended

Beyond the Brexit talk, the British economy isn’t doing too badly
Economy

Beyond the Brexit talk, the British economy isn’t doing too badly

The political Brexit pantomime aside, Britain is in pretty good shape. With near-record employment, strong wage growth and modest inflation, there is …
17 Oct 2019
The truth about Boris Johnson’s “New Deal” package of infrastructure spending
UK Economy

The truth about Boris Johnson’s “New Deal” package of infrastructure spending

The prime minister promised a package of Rooseveltian proportions to grow the economy out of its Covid-19-induced torpor. Just how impressive is it re…
11 Jul 2020
UK house prices go into a gentle decline
House prices

UK house prices go into a gentle decline

Halifax’s house price index shows that UK house prices declined for the fourth month in a row in June.
9 Jul 2020
Rishi Sunak: buy a house, do it up and then go for a meal
UK Economy

Rishi Sunak: buy a house, do it up and then go for a meal

The chancellor has been on a spending spree. Will it help?
9 Jul 2020

Most Popular

An economics lesson from my barber
Inflation

An economics lesson from my barber

On reopening his shop after lockdown, Dominic Frisby’s barber doubled his prices. It’s all part of the post-Covid inflation process – and we’re going …
8 Jul 2020
What gold, bonds and tech stocks have in common
Stockmarkets

What gold, bonds and tech stocks have in common

"Risk off" or "safe haven" assets such as gold and government bonds have been doing well lately. But so have riskier tech stocks. That seems to defy c…
10 Jul 2020
Three ideas for Lloyds Bank's new boss
UK stockmarkets

Three ideas for Lloyds Bank's new boss

The Black Horse needs whipping into shape. A change at the top provides a great opportunity, says Matthew Lynn.
12 Jul 2020