I promised to come back to Mr Carney’s “forward guidance” and Nottingham speech. I needed to undertake a long detour via Syria, given the run of news and the business before the Commons.
Mr Carney inherits a monetary policy badly damaged by successive misjudgements of his predecessor and Bank of England team. They first allowed too much money and credit in circulation. They failed to raise interest rates soon enough, and failed to work with the FSA to rein in banking excesses prior to 2008. They then held interest rates too high for too long and assisted in squeezing the banks too hard, creating the worst crash of the last 80 years. Some of us warned about both these mistakes in good time, to no avail.
He inherits a monetary policy that is at last beginning to create enough money to finance a recovery. It relies heavily on the money created by the central Bank and given on easy terms to the banking system. The banking regulatory side of the Bank of England is still applying the brakes to the commercial banks, necessitating the continuation of extraordinary monetary policies. These mean ultra low interest rates, which damage savers, and a greatly expanded Bank of England balance sheet. The failure to split up RBS and to get all the semi nationalised banks back into shape more quickly has delayed rccovery and required more extraordinary Bank of England measures. I would have preferred them to fix the banks rapidly and do without the extra money printing.
If you take the monetary base at the beginning of 2008, the UK’s monetary base has now increased fivefold. The US is almost the same, with a fourfold increase. Japan’s has merely doubled, but they plan another doubling from the end of last year. All these countries have resorted to money printing to offset the weakness of the commercial banking systems. The total amount of money amongst the leading advanced countries has ballooned from $3trillion to $8trillion. The reason that has not caused a runaway inflation is the weak state of many commercial banks and the new extra tough controls placed upon them to stop them creating money and credit.
Mr Carney issued forward guidance to say interest rates will not go up soon, and probably not before 2016. The markets meanwhile have ignored his advice, and have driven government borrowing rates up. The 10 year cost of money for the government is now 2.99%, compared to a low of under 1.5%. It has risen more than 1% or 100 basis points since Mr Carney’s arrival in the UK. It rose above 3% yesterday.
The markets are doing this because the extra printed money is beginning to boost asset prices, and may in due course feed through into higher inflation as the banks mend. Mr Carney has responded by saying he will take banking action to stop another asset bubble. He wants to keep people believing interest rates will stay very low, so they commit to more spending and to investing in riskier ventures. I think he is right to argue that official interest rates will not go up for a couple of years. It is important for the strategy to work that the markets come to believe him. He will later need to demonstrate the ability to fine tune through banking regulation to avoid a real assets bubble. There is already a bond bubble, created by official interventions in the main global bond markets.