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The MPC's Puzzling Statement

New chief Mark Carney jumps the gun and gives "forward guidance" on Day One...
The BANK of ENGLAND's Monetary Policy Committee (MPC) was due to produce a view about the role of "forward guidance", writes Andrew Sentance – a former MPC member – on his Hawk Talks blog.
This view on forward guidance in monetary policy was due alongside the August 2013 Inflation Report. But the Bank of England's view has now been upstaged by its MPC statement today.
Today's statement was aimed at slapping down expectations of interest rate rises next year. They had come to be priced into the market curve before this week's MPC meeting, which ended with no change to policy. Making an MPC statement when there is no explicit change in policy is a rare event – I can only recall one when I was a member of the Committee. So today's is an important statement.
What did the MPC say? The key paragraph reads as follows:
"At its meeting today, the Committee noted that the incoming data over the past couple of months had been broadly consistent with the central outlook for output growth and inflation contained in the May Report.  The significant upward movement in market interest rates would, however, weigh on that outlook; in the Committee's view, the implied rise in the expected future path of Bank Rate was not warranted by the recent developments in the domestic economy."
There are a number of puzzling aspects to this MPC statement.
First of all, it represents a form of forward guidance – the MPC is saying they want to keep interest rates lower for longer than the market was expecting. This pre-empts the fuller statement on forward guidance which is due to be released alongside the August Inflation Report, but without the opportunity to explain in detail the MPC's thinking.
Second, the MPC is using its interpretation of very recent data to make judgements about policy over the next 1-2 years. How has the MPC become so confident that it can predict policy 1-2 years ahead on the basis of current economic indicators?
Experience teaches us that the economy is frequently subject to unexpected shocks, to which policy-makers need to react. A better way of providing  "forward guidance" is to link policy moves to the future path of the economy – but this was a step too far for the MPC in today's statement.
Third, we could be more confident about this type of forward guidance if the MPC's forecasting record had been more accurate in recent years. Unfortunately, the opposite has been the case. In particular, the MPC has consistently under-predicted inflation – its key target variable. And the negative reaction of the pound to the latest MPC announcement suggests that there may be more imported inflation in the pipeline over the next few months.
Mark Carney has jumped the gun. The media hype around his appointment was likely to make a "no change" decision disappointing. But this statement – a few days into his term as Governor – could be more problematic.
In the western world, central banks face a strategic problem, of exiting from emergency monetary policies put in place to deal with an extreme financial crisis from which we are now recovering. The challenge for Carney, Bernanke and their counterparts is to recognise and address this challenge. The longer they delay, by promising continued very low interest rates, the bigger the problem becomes for the future.

Now senior economic advisor to PricewaterhouseCoopers and part-time professor of sustainable economics at the University of Warwick in England, Andrew Sentance is a British business economist who from 2006 to 2011 served on the Bank of England's Monetary Policy Committee. Consistently calling for higher interest rates to combat rising inflation during his last 12 months in the role – and overwhelmingly outvoted each time – Dr. Sentance today shares his views on macroeconomic and monetary developments in his weekly blog, The Hawk Talks. His previous roles include senior economist at the Confederation of British Industry (CBI), chief economic advisor to the British Retail Consortium, and chief economist at British Airways.

See full archive of Andrew Sentance articles

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