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.
What's happening in monetary policy and macroeconomics.
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:
Posted by Stephen Williamson at 7:40 AM
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It's actually even softer than the Fed's conditional threshold forward guidance: the low interest rate environment is going to be abandoned should inflation not only be forecasted to be too high BUT also driven by GDP.ReplyDelete
I was thinking about the other case: inflation is high, but Carney claims it's not caused by GDP. Either way, it's not a conditional statement that bears any weight, as whether the inflation was "caused by GDP" or not is in Carney's mind.Delete
Agree. I guess the Fed would just reduce its forecast of inflation should it run above 2.5% at an inopportune point in time...no one would knowDelete
The UK has seen significant changes in indirect taxes and exchange rates (price level shocks) - and they don't really talk about core inflation over there.ReplyDelete
So I suspect he is really trying to say "if our conditional forecasts indicate that core inflation will rise above 2.5%pa in a two-year horizon we will drop the UR condition and tighten". He is using "due to GDP" so he can turn around and rule out changes due to exchange rate depreciation, commodity price spikes, or future changes in VAT.
It's impossible to observe directly what's "causing" the inflation, and core inflation measures have always been suspect, which is why central bank inflation targets are usually specified in terms of headline measures. Central bank promises which are conditional on things that can't be directly observed (e.g. we will or will not respond to inflation that is or is not caused by this or that) aren't good for much.Delete
Agreed - I was more just trying to figure out where he could have been coming from, rather than trying to justify anything :)Delete
From what I can tell, Carney never said those words - you're just quoting a media article. Or am i missing smin?ReplyDelete