Carney said the unemployment target could be abandoned should the bank's internal analysis show GDP growth was the cause of a rise in prices of more than 2.5% in two years' time.That's odd. How are we supposed to know whether a given change in GDP "caused" a given change in prices? What does that mean anyway? In a lot of macro theories, we think of exogenous shocks as driving endogenous variables - which are typically GDP, prices, etc. I guess you could write down a theory where GDP is exogenous, but that doesn't look like anything that serious macroeconomists take seriously. But what if you could write down such a theory? Then Carney seems to be saying that there might be things causing inflation other than GDP, and if those come into play, he's not going to get bent out of shape about it. More simply, I think we should interpret Carney as saying that he's going to tolerate inflation above 2.5% if he thinks the real side of the economy is weak. Forward guidance is a surefire way to confuse anyone, but Carney made this more confusing than it needed to be.
Wednesday, August 7, 2013
Forward Guidance in the U.K.
Mark Carney's first major move as Governor of the Bank of England was to adopt what looks like a replica of the Fed's forward guidance policy, with some potential QE in the mix as well. As with the Fed, there are some contingencies associated with this: