The new Bank of England governor’s pledge to keep interest rates low until unemployment falls is a big innovation – and a signal to the British public to spend, writes Economics Editor Faisal Islam.
Mark Carney‘s first major policy move is a guidance batlamp – and one that he hopes you’ll see from afar.
That is why today he announced the biggest innovation to UK monetary policy since 1997.
It is why he announced that any rise in UK interest rates from their extreme lows of 0.5 per cent would, in the first instance, wait until unemployment fell below 7 per cent. If forecasts are right, this will not occur until 2016 or 2017.
Essentially he and the chancellor can now claim that rates will only go up if 750,000 jobs are created. Barring a most extraordinary dotcom-esque boom over the next two years, interest rates are now guaranteed at this ultra low level past the next election. They could well end up having been at this level for a decade or so.
Chancellor George Osborne is now nicely hedged for 2015: he either gets massive job creation, or low rate guaranteed into the future.
There are a number of escape clauses or “knockouts” that enable the bank to claim that it is sticking steadfastly within the current system. Mr Carney denied that temporarily the inflation target has been lifted to 2.5 per cent. The proof of this will be in the eating.
This innovation was first tried by the US Federal Reserve in the Washington, where “full employment” is part of the mandate. But here unemployment does not form part of Bank of England’s mandate. It has been chosen by the governor and his committee because it is easy to understand by the public.
“Lower for Longer” will now seep into the consciousness of the house-buying public, and the young person-employing small business. It is a like a beacon or a bat signal to everyone in the economy, not just bond traders and economic journalists, to increase demand for money and credit. Previous moves – cutting rates, and printing money – have focused on the supply of money and credit. This is meant to stir the animal spirits, and excite the investment.
Importantly Carney and his team brushed aside the notion (suggested by his predecessor) that this and other innovations such as the Help To Buy mortgage subsidies could cause a renewed borrowing bubble. In fact the picture mapped out by the accompanying inflation report is one of housing recovery first, followed by business recovery.
He acknowledged signs of recovery, but said this is not “escape velocity”, and that now is just the time to try something else out to confirm the recovery after a weak performance.
I asked him today if this was just a clarification of communication or an actual loosening of monetary policy. “Not a loosening?” I asked. “It’s more effective,” he shot back.
It’s an exercise in applied psychology. He hopes you are listening, and he hopes you go out and spend.