The Bank of England may have made some mistakes, but there was little anyone could do to prevent the financial tempest.
At least, that’s the view of MPC committee member Kate Barker, who gave her valedictory speech at the National Institute of Economic and Social Research on Monday night.
And here is the hand-washing case for the defence:
Firstly, it is unclear how much higher UK interest rates would have needed to be to have kept the expansion of credit and debt to an acceptable level (not least as there is considerable uncertainty about what that level might be). It seems likely that interest rates might have needed to be substantially higher, in real terms, to have had any noticeable effect. In this case, CPI inflation could well have seen an extended period below target. (The CPI was in any case below target for the first 18 months after the change to CPI from RPIX as the key inflation measure.) There would in these circumstances have been a risk of a damaging loss of credibility in the inflation targeting regime – although it would clearly have had to be weighed against the (as yet uncertain) costs of the subsequent crisis.
Secondly, and more significantly, it is not clear that this policy would have tackled effectively the major problem of banks’ misjudgement of risks and expansion of financial sector balance sheets. At the margin, it might have led to a little more caution among financial institutions, but unless policymakers had been prepared to shock the economy into a period of slow growth it seems unlikely that the financial crisis would have been wholly averted. However, modestly higher Bank Rate might have had the merit of discouraging households and firms from increasing their own debt levels, and therefore left the economy somewhat more resilient in the face of the crisis.
Thirdly, action only in the UK might have had limited effect on what has proved to be an internationally widespread crisis whose roots lie to a significant extent in the excess of savings in Asian countries and consequent excess of capital inflows into the US and Europe.
In any event, the BoE might not have been able to stop the storm but its response was the correct one, says Barker.
QE, for example, has worked:
However, there are grounds for optimism from recent data that the recovery is broadly on track. GDP in the fourth quarter of 2009 is now estimated to have grown by 0.3% with growth in consumer spending. Household balance sheets have already been strengthened. Employment trends have remained surprisingly robust, and firms’ employment intentions continue to recover from the low point early in 2009 in the bulk of the business surveys. I don’t think it is yet possible to be confident in the pace of recovery, and still expect the path to be bumpy. But some of the severe downside risks have diminished.
So, pats on the back all round.
Barker does at least acknowledge that not everything is rosy:
Credit conditions also remain a concern. The cost of credit for households remains high relative to Bank Rate, and there is still evidence from smaller firms that credit is either difficult to obtain or unacceptably costly. Banks’ own funding has become a little less costly, but the major UK banks still face a considerable funding challenge over the next few years, as well as uncertainty about how much capital they will be required to hold in the longer-term.
But on balance, the BoE passed this test with flying colours, she says:
Since the summer of 2007, life on the MPC has certainly felt very challenging. It may well be some time before all the lessons for the conduct of monetary policy can be fully appreciated. However, the MPC’s framework has overall proved to be resilient during the crisis and capable of making substantial responses to events. I am sure that this will remain true.
Related links:
Markets await MPC view on quantitative easing – FT
Threadneedle tumbleweed – FT Alphaville
Inflating the output gap at the BoE – FT Alphaville
Monetary policy – from stability to financial crisis and back? – Kate Barker, Bank of England