More of the same. That promised to be the flavour of the government’s economic policy in 2013, confirmed by the Chancellor’s third austerity Budget in October. Then all of a sudden George Osborne revealed that this year will bring not one, but two, bold experiments. At the end of November, he announced that the Canadian Mark Carney will become the Bank of England’s first foreign governor. A fortnight later, he endorsed Carney’s suggestion that the UK should consider ditching its 15-yearold policy of targeting low and stable inflation.
The reaction to both reforms was wholly positive. Britain, it seems, is once again setting the pace when it comes to monetary policy and the Chancellor has been transported back to the days when he enjoyed a reputation for combining tactical nous with economic strategy. Unfortunately, the two changes suffer from profound inconsistency.
Up until the late 1980s monetary policy was an unscientific business. Its objectives were obscured by a shifting fog of political pri - orities, and its implementation was the subject of interminable disputes between rival schools of economists, even as central bankers carried on regardless.
In the early 1990s, everything changed with the introduction of an ingenious framework for monetary policy – the “New Keynesian” theory of the macroeconomy – which promised a truce between the warring academic factions. To those who believed in managing demand, it conceded that proactive monetary policy could affect the economy. To the supply-siders, it delivered clear limits to this effectiveness, and the wholesale adoption of other neoclassical ideas and techniques.
More importantly, it offered a simple but rigorous framework for the practical business of central banking. According to the new theory, the goal of policy was straightforward. It was “monetary stability”, defined as low and stable inflation; central bankers need focus on nothing else. And with this new goal, the process of policymaking was demystified, too. It should be in the hands of techno - crats, not politicians.
An international best practice of an inflation target pursued by an independent central bank was enthroned. In 1997, the Labour government introduced the system to the UK. In 1998, the eurozone did the same when the European Central Bank was established. The US Federal Reserve alone persisted with its idiosyncratic commitment to stabilise both employment and inflation.
It is in the ascendancy of this New Keynesian science of monetary policy that the ultimate origins of Carney’s appointment are to be found. If monetary policy is a technical subject, and central banks are independent, one should employ the best technicians in the job, regardless of nationality. That is why a non-political Monetary Policy Committee was formed in 1997, and why it had a couple of non-Brits on it from the start. It was only a matter of time until the best candidate for the job of governor should prove not to be a UK national.
From the mid-1990s to the mid-2000s, it seemed that the new gospel would indeed deliver the economy into the promised land. It was what Mervyn King called the “Nice” decade – ten years of Non-Inflationary, Constant Expansion. There did seem to be nothing more to economic stability but low and stable inflation, and the independent Bank had achieved it.
But then came the crash. Instability had not, it turned out, been banished after all. The Bank of England had just squeezed the balloon in one place and reinflated it in another. It had achieved monetary stability, at the price of financial instability. Asset prices, balance sheets, credit spreads and liquidity, it transpired, were just as important as inflation. The problem was that they appeared nowhere in the New Keynesian theory, and hence had been no part of the independent central bank’s job.
The financial policymakers themselves realised immediately what this meant: the New Keynesian framework had failed.
With his approval of Carney’s radical proposals to abandon simple inflation targeting in favour of an additional emphasis on growth, Osborne has shown that he no longer believes monetary stability alone will cure Britain’s post-crisis hangover.
What the experts seem not to have explained to the Chancellor, however, is that with the unravelling of the New Keynesian consensus the rationale for the revolutionary doctrine that monetary policy is non-political has evaporated as well. Gone are the halcyon days in which serious people could blithely sustain the belief that the job of the governor of the Bank of England is to solve a mathematical problem of how to minimise inflation – and that we should therefore choose the best mathematician for the task.
The monetary policies that Carney is mooting will have serious distributional consequences. As Britain’s pensioners are already discovering, holding interest rates near zero for an indefinite period of time is a means of transferring wealth from their generation to the next. And the incoming governor has rightly predicted that, in the near future, the Bank may need to do even more to reduce the UK’s mountain of debt.
Yet these intensely political decisions will be in the hands of an unelected official – and the government will escape responsibility for them. The Chancellor has consigned the New Keynesian idol of monetary stability to the scrapheap. And yet he still worships solicitously at the shrine of the independent central bank.
We have seen how foreign technocrats in charge of politically charged decisions have gone down in Ireland and Greece. The only difference in the UK’s case is that we have appointed the technocracy ourselves. Does Osborne think that, when reality bites, Mark Carney’s reception will be any different?
Felix Martin is a macroeconomist and bond investor. His book, “Money: the Unauthorised Biography”, will be published by the Bodley Head in June