I’m not sure it would cut much ice with parliament’s Treasury Committee if I said I was voting not on the basis of what was going on in the economy right now but instead because of some guidance a few years ago by an earlier MPC. The interpretation of guidance and the potential costs of mistaking the conditional as unconditional I picked out a moment ago a couple of key bits of guidance by the MPC. There were several others. But all of them contained the message that the outlook for interest rates would be dependent on that for the economy and inflation at the time. However, I think it’s clear from the reaction to these episodes that the points we were trying to get across – including this critical point about conditionality – were not universally understood. One particular problem was that, in response to the September 2013 guidance, many commentators appeared to see the 7% unemployment threshold as a sufficient, not just a necessary condition for the tightening policy. We would apparently be “forced” to raise interest rates if unemployment fell below this level, whatever the outlook for inflation at the time. As for the general point about conditionality, it was only two days after the February 2014 Inflation Report that the BBC said: “What is forward guidance?
If it were possible to eliminate or reduce at least one source of unpredictability, wouldn’t that be a good thing? And since the MPC is in control of interest rates why can’t it just tell us what it’s going to do? The problem is that we can’t be sure. Interest rates are not an end in themselves. They’re a means of meeting our objectives: the stabilisation of inflation over the medium term and, subject to that, the stabilisation of economic activity. And because there are lots of unpredictable shocks hitting the economy, things that would otherwise (and often do) move output and inflation around, the appropriate path of interest rates is necessarily unpredictable as well. The skipper of a boat, adapting to a skittish wind, and interested in making the journey as smooth as possible, may have perfect control of the tiller. But that doesn’t mean she can tell you exactly which position it will be in at every point in the future. That will depend on the direction of the wind at the time. It’s not that monetary authorities are unconcerned about expectations of future interest rates. Quite the opposite: these expectations are central to the transmission of policy. We directly determine only one particular – and very short-term – interest rate (what commercial banks get paid on their overnight deposits, or “reserves”, at the central bank). But demand and spending depend more on longer-term interest rates. In the UK, around half of corporate borrowing has a maturity of three years or more.