The begin by noting that despite stressing that his comments were not levelled at any economy in isolation, with Carney set to take over the reigns at the Bank of England in 2013, they feel that it is hard not to deduce that he may ask for this very change in mandate when he arrives in London.
The UK inflation target was introduced in 1992 following the UK´s exit from the Exchange Rate Mechanism and current Governor King was one of the architects. Also, in an under reported speech given in October 2012, King said, “it is far too soon to bury inflation targeting.”
As King illustrated in that speech, UK inflation history, pre and post targets suggest that they have been extremely successful. King claims that inflation was the single biggest problem for the UK in the twenty years preceding the adoption of the target and that over the history of the target, it has averaged at 2.1%, practically the same as the inflation target.
However, they note, it is one thing to point to this occurrence, and quite another to credit this to inflation targets. All G7 countries had extremely favourable inflation experiences over the same time frame and not all of them had inflation targets. Moreover, even if inflation targeting is a helpful regime under which to credibly move to a low inflation state and build a low inflation reputation, that does not make it the only post transition policy that can be considered.
So whilst it may well be that for many developing or small countries an inflation target is a helpful policy tool, for much, if not all of the G7, they believe it is worth considering whether inflation targets have passed their policy ´best by´date.
However, despite King´s previous comments Carnell and Knightley suspect that he may be closer to Carney´s position than is maybe appreciated. Indeed, talks between King and the UK Chancellor of the Exchequer on modifying the BoE´s mandate have been going on for some time. They write, “For example, King’s Stamp lecture speech goes a long way in suggesting changes and modifications to the current system. And perhaps part of the reason this speech does not seem to have made many waves with the UK media is that it is a bit dense for public consumption.”
Nevertheless, they have summarised as follows:
Buried in language about “agents” long-term misconceptions about future incomes and prices is the notion that rigid inflation targets may be inconsistent with long term stability in asset prices and that in such circumstances, monetary policy is an ineffective ´mop´ for cleaning up the subsequent mess.
They believe that perhaps a little economic instability is a good thing. This is a view which is advocated by BoJ Governor Shirakawa and forms the idea behind recent books by Nassim Taleb. It is the belief that economic volatility can invigorate an economy over the long term. Furthermore, long periods of stability can lead to far more damaging crisis. In short, they write that monetary policy should not exist to try and smooth the business cycle out of existence. Claims by the ill fated former UK Chancellor Gordon Brown, to have eradicated the business cycle from Britain, now look not only incorrect, but ill-advised.
The final example King gives, which they feel is less relevant to the current debate, is that the monetary response to crisis can itself generate inappropriate risk taking, as yields fall and agents seek higher returns. This too can generate future crisis and unsustainable asset responses and perhaps what is exactly being seen in the US now, as house price growth has recovered to rates in line with disposable income, whilst monetary policy easily continues to be ramped up. They regretfully suspect that the seeds of the next disaster may already have been sown in the US.