Bank of England’s Dilemma

February 17, 2010

To extend its asset purchases or not to extend them, that was the question that consumed the Monetary Policy Committee, according to minutes from its February 3-4 meeting.  In a “finely balanced” decision masked by the 9-0 unanimous vote to stop the asset purchase program for now, officials offered six reasons for leaving policy as it was and two reasons to have eased additionally.  Among the latter,

  1. Expanding quantitative monetary support might lift CPI inflation, which at present policy settings would otherwise be under target for most of the forecast horizon period, to its 2% target more quickly.
  2. Growth support also might mitigate damage that the recession is causing to Britain’s potential growth rate.

The six counter-arguments that persuaded policymakers to leave the asset purchase program at Gbp 200 billion were:

  1. The new quarterly projections of inflation over the coming three years do not suggest an especially big undershoot of the central bank’s target.
  2. Considerable uncertainty surrounds the baseline growth and inflation forecasts. Officials were reluctant to fine-tune policy based on a baseline forecast that carried such a large margin of error.
  3. When officials met early this month, CPI inflation exceeded the 2% target and was headed higher in the short term.  A risk of rising inflation expectations caused by that overshoot could be exacerbated if the Bank of England eased then.
  4. Enlarging the asset purchase program ceiling might spawn some asset price inflation.
  5. Reabsorbing spare capacity at an even faster pace because of additional monetary stimulus might prove inflationary.
  6. Officials remain unsure of the impact of quantitative easing, particularly since completion of the Gbp 200 billion of assets bought between March 2009 and January 2010 “had resulted in little immediate impact on market yields.”  By pausing the experiment in quantitative easing, officials would be better able to gauge the effects of cumulative monetary easing since September 2008.

Although policy was not eased, the tone of the minutes was pessimistic.  Officials on the committee held a spectrum of views on how much stimulus had been imparted by the central bank’s initiatives, and I imagine some of the debate boiled down to whether the stance of policy or its rate of change mattered most.  The group agreed that recovery would be weak, and one of the cited bright spots, a more stable labor market, might be getting reconsideration in light of today’s news of an unexpected jump in unemployment last month.  Another expressed concern, the need for budget consolidation — that is a tighter fiscal policy — likely would resonate even more strongly now than early this month. Related to that, the minutes make a very important observation with relevance to all economies.  The public sector is not alone with a balance sheet that has to be cut.  Private consumer and business debt are excessive, too. 

A concern was raised that undermines the whole view that inflation is more likely to undershoot than overshoot the central bank’s target of 2%.  It involves the possibility that inflation may not trend downward much in response to spare capacity “because of both longer-term structural developments in the economy since previous recessions and the impact of economic uncertainty on businesses’ pricing decisions.”  The Great Recession has changed so much that officials really do not know what to believe.  In all decision-making, one can do a lot worse in such circumstances than following the advice that “when in doubt, do nothing.”  Analysts are rightfully concluding that is would likely take an unambiguous significant deterioration in U.K. economic conditions and prospects to prompt an increase in the asset purchase program.

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.



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