We have been stimulating the economy with historically extreme levels of monetary policy for a long time and a variety of headwinds (including the problems in the euro area, a tightening of credit conditions, the drag on activity from fiscal consolidation, and a squeeze in household real incomes resulting from the fall in productivity and higher energy and commodity prices) have all contributed to limit the effect of that stimulus. What seems to have happened in 2013 is that at least some of those headwinds were perceived to have diminished, allowing the policy stimulus to come through and the resulting growth has generated the renewed consumer and business confidence which reinforces demand. We are very conscious that the headwinds have not gone away: much of Europe and some other parts of the world continue to struggle for sustained growth; fiscal consolidation in the UK (and elsewhere) is likely to continue for a while to come; and the financial sector still needs some rebuilding. Indeed, the official production and construction data released earlier this month were rather disappointing, reminding us that strong growth from here on is by no means guaranteed. But to varying degrees perhaps the very worst of the storms may be behind us. Just a tailing off in some of their negative impacts may have been sufficient to allow the economy to start growing again. Interest rates and forward guidance So why aren’t we moving to tighten policy straight away, why did we issue forward guidance around monetary policy?
That guidance should help to give confidence to businesses and households and help to support demand growth. By reducing uncertainty about our reaction function, guidance should also have helped to counteract the pressure in financial markets to price in the chance of a rapid increase in Bank Rate. We chose unemployment as the threshold indicator not because it was ideal – far from it – but because other indicators were all less attractive. Of course, no sooner had we announced a policy linked to the unemployment rate than it began to fall unusually precipitously. But what is there not to like about sharply falling unemployment? After all, getting the economy back to a medium-term path quickly, allowing policy to normalise, would be a good thing? Right? Well, falling unemployment is undoubtedly a good thing for the individuals who are back in work and on many other social counts. It could only be a purveyor of the dismal science who found rapidly falling unemployment disappointing! Yet, in order to see rising living standards on average, it is crucial to see rising output per head (i.e. rising productivity) – which ultimately drives real national income per head and hence how well off we are as a country. So we need to see rising employment accompanied by even faster growth in output.