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Bank of England's bright forecast a little premature


Mark Carney

Mark Carney


Mark Carney

It is, as the baseball legend Yogi Berra put it, "like déjà vu all over again". The Bank of England's Inflation Report again acknowledges that the economy is growing much faster than it thought, and the governor, Mark Carney, again asserts that interest rates won't go up any time soon and when they do, it won't be by much. OK, maybe "asserts" is unfair, let's say "guides".

The new bit of guidance, that bank rate will be "materially below the 5% set on average" before the financial crisis, should be taken with the same scepticism as the bank's forecast last year as to when unemployment would reach 7%, the trigger point for an increase in rates. And yes, I know that was expressly intended not to be a trigger, but that was what the markets jumped on as the likely moment when rates would start to move.

The basic point here is that the governor and the members of the MPC have no idea what level interest rates will need to be in three or more years' time. None.

If that seems a bit harsh, consider this: could any member of the MPC have conceived in the summer of 2007 when rates were 5.75% that in less than two years' time they would be 0.5%?

Actually it is perfectly plausible that rates will be somewhat lower in the future than they have been in the boom years of the decade to 2008. There are a number of reasons why. For a start, governments around the developed world will seek to hold down their borrowing costs.

The posh expression is 'financial repression'; the more honest, 'cheating less-sophisticated savers'. Households, lured into the borrowing spree, are still paying down debts, so you don't need higher rates to curb their borrowing. Companies, suddenly squeezed by the banks, will be careful about getting into hock again. And banks themselves have been forced to pare down lending by capital and other requirements.

But that is only a guess. It is, conversely, quite possible that we may be in the early stages of another bubble in property and other asset prices. If that proves right, expect the asset prices to feed into current prices over the next three years. So, if inflation at a consumer level goes back to, say 4%, we may very well need rates above 5% to curb it.

The reassertion of the importance of the inflation rate is welcome, but remember that the experience of the past decade has taught us about the huge cost of over-loose monetary policies, even when on the official measures inflation looked acceptable. There is an argument that one could use regulation over the supply of credit, rather than the price of credit, to stop bubbles occurring. But regulating the supply of credit, rather than its cost, creates distortions that damage the financial system in other ways.

The bank expects that growth will be around 3% a year through to the end of 2016, with the obvious possibilities that it might be higher or lower.

But let's assume that this will turn out to be broadly right. Trend growth is 2.25%, maybe a little more. What will three years of above-trend growth do to our attitudes about working, saving and spending? It may be that any latent animal spirits will be crushed by higher taxation, for the scale of the spending cuts necessary to eliminate the deficit look daunting. There may have to be higher taxes after the election. There may be some further economic shock out there.

But if we do get three years of above-trend growth we are going to feel pretty chipper. The party will be going good and the task of the central banks will be to take the punch bowl away.

Experience of the past decade has taught us about the huge cost of over-loose monetary policies

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