Opinion: Carney’s dismissal of using monetary policy to resist rising asset prices is 'vacuous'

It is vital that politically independent central banks should work within a political vacuum, rather than adjusting their monetary policy reasoning to avoid subsequent political controversy
Tim Young
Tim Young

Mark Carney, governor of the Bank of England (BoE), made this statement to the British parliament last week, when asked for his response to calls from a Bank for International Settlements (BIS) annual report for a normalisation of interest rates in developed economies:

It's an interesting report. A report that is made in a vacuum, though, the vacuum of Basel; in a world where a central bank does not have a mandate; a world where a central bank is not accountable to parliament and, through parliament to the people, to achieve specific targets... So, in effect, what the BIS would be recommending to the Bank of England, if you take the core of the recommendation, would be to further extend the time over which it would return inflation to target; beyond its forecast horizon [and] further than it ever has intended to do so... My basic point is this is an analysis that is outside the political reality and the political economic reality... central banks have mandates. We have a clear remit at the Bank of England. We take it very seriously.

I believe this was mistaken. On the contrary, concern about rising asset prices is justified within an inflation-prioritising monetary policy mandate. Asset prices can lead to a situation in which, if inflation threatens to breach its target on the upside, the central bank may feel compelled to accept that breach rather than precipitate a financial crisis by raising its policy interest rate and remove the interest rate support for elevated asset prices.

Carney's response as quoted above as well as the context in which they were made – to a parliamentary committee – may prove particularly revealing about his own approach to the job of BoE governor, and why he was appointed. When he talks about the "political reality" of "accountability to parliament and through parliament to the people", Carney seems to imply that when formulating monetary policy, the BoE's Monetary Policy Committee (MPC) should take account not just of the existing expression of the public will as previously laid down in the central bank's mandate and the more detailed remit set by the serving government, but also of the likely impact of the MPC's decisions on subsequent discussions when MPC members are held to account by parliament. This would be misguided.

What is supposed to take place when the central bank is operationally but not goal independent, such as is the case for the BoE, is that the MPC should make monetary policy in a political vacuum, apart from its existing mandate and remit. After explaining its decisions when called to account by parliament, the central bank should leave it to the politicians to consider whether in the light of that testimony they would like to adjust the central bank's remit or mandate.

If the politicians choose to amend the central bank's mandate, it is up to them to make the argument for it and to agree the adjustment in cabinet or parliament respectively. The politicians then have to take responsibility for that change and any reputational impact it may have. It would not be surprising if British politicians prefer the approach Carney hinted at; that he might use his MPC vote and influence to formulate monetary policy that, within the constraints of the mandate and remit, will meet the politicians' approval without them having to explicitly ask for it.

Even if this is not the case, contrary to Carney's suggestion that the BoE's inflation-prioritising mandate precludes the MPC from following the advice of the BIS to use monetary policy to lean against rising asset prices, the BoE's mandate provides ample room for such action. As I argued when a BoE employee myself, and afterwards in the Central Banking article, Why policy should take account of asset prices, if asset prices depend on the continuation of low interest rates to sustain their level, the political pressure on the central bank to keep interest rates low – if necessary by tolerating higher inflation – becomes irresistible. The implication is that, depending on what is driving them, asset price rises may well lead to inflation above its present target, albeit over a time horizon longer than the range of a typical central bank model forecast.

In my view, without being close to the one-percentage point leeway below its inflation target (a point beyond which an open explanatory letter to the chancellor of the exchequer is required) – let alone making the case for a trade-off between near-term downside breaches to prevent long-term upside target breaches – the BoE has allowed itself to get into a constrained position with house prices. Then, if for some reason, inflation seems set to rise sufficiently far above its present target within the MPC's forecast range, there is little scope for interest rate rises without precipitating a surge of mortgage defaults and repossessions.

Tim Young is a former Bank of England official and university lecturer in finance and economics.

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