Politics 7 August 2013 Bank of England: interest rates stay low til unemployment drops Mark Carney's Bank promises to fight the slack in the economy. Print HTML The Bank of England has released its quarterly inflation report, in which it assesses the state of inflation in the UK and lays out the risks ahead. August's release is particularly notable because it is the report in which the Bank promised to detail its plans for the role of forward guidance in British monetary policy. Forward guidance is the practice of revealing the rules by which the Bank plans to make decisions about policy, and is important because much of the intricacy of monetary policy involves managing expectations. For instance, if investors expect interest rates to rise when growth gets high, they may be wary of making investments, which will itself keep growth low. Therefore, by promising that interest rates would stay low in the event of growth, a central bank can boost the economy without resorting to more conventional tools. The inflation report reveals the forward guidance that the Bank has settled on. The key measure is unemployment. The Bank will not raise its base rate from 0.5 per cent "at least until the Labour Force Survey (LFS) headline measure of the unemployment rate had fallen to a ‘threshold’ of 7%". That is roughly equivalent to the Evans Rule (named after Chicago Fed President Charlie Evans) applied by the US Federal Reserve, which swears to keep the base rate under 0.25 per cent as long as unemployment remains above 6.5 per cent. The Bank's rule contains a few conditions beyond the unemployment threshold, however. Firstly, it only holds if the MPC thinks inflation is "more likely than not" to be less than 0.5 percentage points above the 2 per cent target 18-24 months ahead; secondly, the Banks must feel that medium-term inflation expectations remain sufficiently well anchored; and thirdly, the Financial Policy Committee (FPC, a separate body, albeit one with three overlapping members) must be sure that the rule does not pose a threat to financial stability. The MPC sums up the rationale for what will surely be known as the Carney Rule: In essence, the MPC judges that, until the margin of slack within the economy has narrowed significantly, it will be appropriate to maintain the current exceptionally stimulative stance of monetary policy, provided that such an approach remains consistent with its primary objective of price stability and does not endanger financial stability. The rule is extremely similar to the Evans Rule, but is a lighter touch: the unemployment threshold is higher, and the FPC oversight provides more opportunity for a "knockout" to be applied. Nonetheless, it is a radical change for UK monetary policy, since it represents the Bank of England claiming direct influence over the unemployment rate at the highest levels. Politically, the rule takes some of the steam out of the Government's attempts to present the economy as on the mend. Setting an unemployment threshold of 7 per cent means that the Chancellor can no longer present the UK's labour market as healthy, and will hopefully draw attention to the fact that unemployment has stagnated closer to 8 than 7 per cent for the past six months. It also lessens the ability of the Government to focus on recent increases in growth; as the Bank points out, while unemployment is this high, there is almost certainly slack in the economy, meaning growth could be higher. But accommodative monetary policy has to be accompanied by accommodative fiscal policy to be effective. There is much George Osborne could do to aid Mark Carney's attempts to fix the economy, but there is much else he could do to frustrate them. The burden is shared. Hopefully the Pushmi-pullyu can agree on what needs to be done. › Sea swims in England are all rocks, cliffs and shingle Alex Hern is a technology reporter for the Guardian. He was formerly staff writer at the New Statesman. You should follow Alex on Twitter. Subscribe More Related articles Leader: On capitalism and insecurity No economy is an island: why Britain's finances now depend on Europe Cabinet audit: what does the appointment of Philip Hammond as Chancellor mean for policy?