Mark Carney relishes being a radical in a conservative job. As Bank of Canada (BoC) governor, when the global crisis began, Carney aggressively kicked open the liquidity gates in the G7’s most structurally sound economy and most stable banking system. One month after his appointment, Carney led the decision to cut the overnight rate by 50 basis points in March 2008, as his market instincts rightly judged a global crisis was nigh, even as price-stability fears prompted ECB rate hikes in July that year.
And when policy rates hit the effective lower bound in Canada, in a precursor to the Federal Reserve's “open-mouth” communication policy, Carney opted for a non-standard monetary tool: the “conditional commitment” in April 2009 to hold the policy rate for at least one year. This was the first time in Canadian monetary history that such explicit forward-rate guidance was deployed.
Fast-forward to mid-2009: output and employment bottomed out, buttressed by monetary stimulus. Carney’s global reputation as a trail-blazing governor, who perceives monetary affairs through a market-based prism, took centre stage.
Carney then led the charge to re-tool the BoC’s mandate. Even though Canada benefits from a clean banking system, 21 years of strongly anchored inflation expectations and steady economic expansion, though still weak at 2% year-on-year, Carney incurred the wrath of price-stability puritans by leading the push to hard-wire a “financial stability” objective in the BoC’s inflation-targeting framework in late 2011.
This framework, for the first time, includes the possibility of a "flexible" approach in determining the time-horizon when its 2% target will be achieved. In other words, interest rates can be used to stabilize domestic financial conditions even when inflation deviates from target and, to assuage financial-bubble fears, could be hiked in a counter-cyclical fashion to prick bubbles.
Although Carney’s hawkish rhetoric is well-known – a product of the domestic environment, and the fact that inflation expectations have been locked in at 2% since roughly the mid-90s – Carney told Euromoney earlier this year that inflation-targeting puritanism was dead. He said: “We are not part of the caricature of inflation-targeting regimes, which has been described as a mechanistic, dogmatic-based approach to monetary policy.”
London calling
However, Canada is not the UK. A huge sovereign debt burden, fears of a liquidity trap, the prospect of a triple-dip recession and questions over the central bank’s independence will greet Carney’s tenure, from July.
While the governor’s status as Financial Stability Board chair provide some clues to his views on UK banking supervision, the gulf between the Bank of England (BoE) and BoC – both in terms of their mandates and economic challenges – meant the market was unclear just how radical the BoE could become under governor Carney when the news of his appointment was announced.
Until this week.
Carney – who has also touted the theoretical allure of price-level targeting – generated global shock and awe on Wednesday with the suggestion that the central banks, faced with liquidity-trap fears, could abandon their inflation-targeting regimes in favour of nominal GDP targets. This speech saw Carney swimming with the intellectual tide in the US, given the Federal Reserve’s adoption on Wednesday of a new policy stance that explicitly targets unemployment.
In a clear break with the current BoE governor Mervyn King’s legacy of an inflation-targeting framework, Carney made it clear G7 central banks should consider more radical measures to buttress sagging growth, such as keeping rates on hold for an extended period of time, numerical targets for unemployment, or scrapping inflation targets entirely, until nominal growth reached a given level. “If yet further stimulus were required, the policy framework itself would likely have to be changed,” he said.
And the bombshell: “For example, adopting a nominal GDP level target could in many respects be more powerful than employing thresholds under flexible inflation targeting." He cautioned the benefits of any regime change “would have to be weighed carefully against the effectiveness of other unconventional monetary policy measures under the proven, flexible inflation-targeting regime”.
Even though King has overshot the inflation target for the past seven years, and embarked on radical policy tools to buttress sagging growth, Carney’s monetary radicalism, and calls to consider a regime shift, endows King with a sense of conservatism, by contrast.
However, this is no-road-to-Damascus conversion to monetary liberalism. In countless speeches in recent years, Carney has paid lip service to the BoC inflation target and, instead, passionately waxed lyrical about the opportunity for central banks to broaden their mandates to counter the cycle, and the power of communication as a chief tool in the monetary arsenal, given intensifying real economy-financial linkages in G7 markets.
Finn Poschmann, vice-president of research at CD Howe Institute – a Canadian public policy think-tank in Toronto – and a rare Canadian critic of Carney’s monetary flexibility, said: “Every speech made by Carney begins with a nod to the inflation target's importance but the subsequent words have pointed in the other direction, at least since 2009. If the transatlantic tide flows toward NGDP [nominal GDP targeting], the evidence to this point is the governor will swim with it.”
According to people familiar with the matter, Carney was said to be impressed by Federal Reserve Bank of Chicago Charles Evans’s speech in November in Toronto, where he reiterated his call for explicit jobless targets to anchor US monetary policy, a stance ultimately adopted by the Fed this week.
Evans is a fan of what is known as “modern macroeconomic theory”, as advanced by Michael Woodford at Columbia University, who famously delivered an influential speech to the annual meeting of G7 central bankers in Wyoming in August. This speech touted the virtues of forward-rate guidance, citing Carney’s successful mid-crisis monetary measures, as well as NGDP regimes.
In an under-reported February speech to the US Monetary Policy Forum in February 2012, posing the question “would targeting the nominal GDP level be superior?” to a flexible inflation-targeting regime, Carney made it clear NGDP regimes could be considered when rates are at the lower-bound, rather than during conventional business cycles.
He said: “When stuck at the zero lower bound, there could be a more favourable case for NGDP targeting in providing additional stimulus and better facilitating the deleveraging process in the aftermath of a financial crisis ... NGDP-level targeting may thus merit consideration as a temporary unconventional monetary policy tool. But NGDP targeting does not, in our view, amount to a complete policy framework.”
The market has largely greeted Carney’s appointment, raising expectations about his tenure, with nominal GDP still 16% below its pre-recession trend. Nevertheless, the jury is out on to what extent Carney will seek to prosecute this cause both within the BoE and Treasury.
NGDP targeting
After the speech, BoE markets director Paul Fisher poured cold water on Carney’s more radical proposals, suggesting forward-rate guidance was unnecessary given current lower-bound market rates, risked BoE politicization and that the employment rate in the UK was harder to estimate.
On Thursday and Friday, UK chancellor of the exchequer George Osborne – responsible for approving any shift in the monetary policy framework – set a high bar for shifting the monetary regime, but did not rule it out.
The BoC’s governing council structure means the interest rate decision is for Carney alone, but the governor has made it clear he would respect the primus inter pares environment within the UK monetary policy committee. Nevertheless, his actions at the BoC and FSB level lay bare his leadership instincts and battle-ready disposition.
Carney’s recent speeches suggest he, in principle, advocates a one-off departure from inflation targets during periods of slow activity. However, in his February speech, he made it clear he favoured this objective is entrenched within the central bank’s mandate to bestow political legitimacy, boost market expectations about the transparency of monetary policy while generating higher growth expectations.
“Even if nominal GDP targeting proves to be a step too far, [Carney is likely to pursue less-radical measures such as] numerical thresholds for inflation and unemployment that must be met before policy is tightened,” in a nod to the Fed, analysts at Capital Economics said.
Simon Hayes, UK economist at Barclays Capital, added Carney was headed for a showdown with his BoE counterparts. “The BoE MPC has shied away from giving firm rate guidance, citing concerns that this guidance ultimately might not prove credible and runs the risk of holding the BoE to an inappropriate monetary stance but Carney is less convinced by this,” he said.
Analysts at ING added: “Carney does not appear to be shackled by convention and is prepared to consider imaginative alternatives.” The analysts reckon Carney could advocate further QE aggression, “coupled with other policies designed to weaken the currency, perhaps negative deposit rates,” and delay rate hikes, with a Reuters poll, conducted before Carney's speech this week, forecasting the first rate hike in April 2014. The jury is out on whether the BoE under Carney will adopt an explicitly flexible inflation-targeting framework, a more ambitious nominal GDP-targeting agenda, articulate empirical thresholds to anchor monetary policy, pursue QE in an ever-aggressive scale, or a combination of such measures.
For the price-stability puritans, the outcome is more certain. “The lack of political fallout over failure to meet current price-stability target means easy money triumphs in public over uneasy inflation outcomes,” concludes Poschmann at the CD Howe Institute.
In other words, the bond market’s preferred monetary policy mix for rebalancing – a decently sloping yield curve to generate credit growth and a relatively loose monetary stance subject to strict inflation targets – won’t be in vogue under BoE Carney, if UK output remains stagnant.