GDP surprising on the upside; sales trading up; sterling on a rocket — the British economy’s looking pretty good at the moment.
Unless you govern the Bank of England.
Here was Governor Mervyn King’s written testimony before the Treasury Committee on Wednesday, for instance.
Speaking on the risks of deflation from increasing the national savings rate – versus the risks of already-high inflation becoming baked into future inflation expectations – to say nothing of financial volatility, the Governor had this to say (emphasis ours):
The MPC faces a difficult challenge in balancing those risks. To do so, we judge that at present it is right to keep our foot firmly on the accelerator in order to stimulate the economy. As you would expect, there is a debate about quite how hard we should be pressing on the accelerator. In the months ahead it may be that the MPC judges that the inflation outlook warrants pushing down even harder or that we should ease back somewhat. The debate is about the appropriate degree of stimulus, not about applying the brakes.
Of course, there will come a point when we will certainly need to ease off the accelerator and return Bank Rate to more normal levels. I look forward to that time because it will probably be a signal that there is a smoother drive ahead, with the economic outlook improving in a durable way. But I fear there is some considerable distance to travel before we can begin to use the word “normal”.
First — it’s worth asking if this actually is what the debate should be about. As Monument Securities’ Stephen Lewis argues, ahead of next week’s MPC meeting:
[High G2 GDP growth] will not necessarily lead MPC members to temper their pessimism on Q3 growth but it does raise a presentational problem for those who would favour further policy easing. How could they justify taking that risk when GDP is progressing so far above forecasters’ expectations?
…in the light of price trends up to 2010Q1, nominal GDP in the first half of this year could have grown, in annualised terms, from the second half of 2009 at well over the 5% rate that is consistent with sustainably meeting the inflation target. Mr Trichet is fond of saying that price stability is the only needle on the ECB’s compass. It might seem the Bank of England had no needle on its compass at all, if it resorted to monetary easing when inflation was well above target, and likely to stay there at least to the end of 2011, and when output was, to all appearances, growing robustly.
While on the supposed danger of inflation expectations…
As for the MPC’s upside risk, inflation expectations, the committee is inclined to attach more weight to long-term expectations than to short-term. This is on the seemingly reasonable grounds that economic agents are less likely to react to expected increases in inflation they believe will be temporary than to those they think will be permanent…
The MPC’s emphasis on the long term may be misplaced, however. The wage/price spiral of the mid-1970s was not set in motion by rising long-term inflation expectations in the late 1960s but by short-term worries engendered by inappropriate policy responses to price shocks. In this regard. Keynes’s perception that the long term is no more than a succession of short terms is apposite.
Second — imagine the toys being chucked out of prams in the US if Fed chair Ben Bernanke had been quite as forthright as Governor King in his rather somnolent recent testimony to Congress.
Although of course, it sounds like Bernanke has inspired the BoE here — the earlier Bernanke, writing in 2004 on the virtue of a strategy of cautious warning in central bank expectations management, that is.
Extra points for the extended metaphor, however, Mr King.
Related link:
Further from El-Erian on Bernanke and sliding stock markets – FT Alphaville