The Bank of England's decision to keep interest rates at an historic low disappointed pundits who had been calling for tighter monetary policy in the face of economic recovery. That's good, because to take their advice would have been an act of madness.
Any interest-rate increase would have put the central bank out ahead of its counterparts in the U.S. and Europe in tightening, even though the U.K. is in no better shape. Real wages have been falling, inflation is decelerating and the country's economy is still smaller than it was in 2008. The U.K.’s third quarter growth of 0.8 percent may be encouraging, but it is just catching up with its peers.
Chris Giles at the Financial Times has argued that the Bank of England will have to raise rates soon, because recent job growth has been accompanied by low productivity -- a situation that could produce inflation unless the bank acts. The informal Shadow Monetary Policy Committee, which meets at a free-market think tank, has been calling for an interest-rate increase since February last year, when there was no recovery in sight.
What the policy hawks fail to recognize is how damaging a premature tightening could be. As Oxford Professor Simon Wren Lewis has noted, debt-service payments still occupy a large portion of households' budgets. In the absence of an adequate increase in income, even a small increase in interest rates could trigger defaults and foreclosures on a grand scale. Why would anyone intentionally precipitate such a crisis unless coerced by the prospect of rampant inflation?
The debate over the U.K.'s monetary policy may be an unintended consequence of the communication policy adopted by the Bank of England's new Canadian governor, Mark Carney. In August, just before the recovery began, he pledged not to consider tightening monetary policy until the unemployment rate had fallen to 7 percent -- a form of what central bankers call forward guidance. Now, a sudden output spurt, combined with poor productivity growth, has brought the economy close to that threshold much sooner than expected. As a result, expectations of an interest-rate increase are being encouraged by a policy that was designed to discourage them.
Some economists expect Carney to set a lower threshold. Rather than fiddle with the numbers, though, Carney should just keep pointing out that 7 percent was only the point at which he said he would start “considering” whether to tighten policy. Then he should stick his fingers in his ears and wait until the risk of inflation genuinely outweighs the risk of killing the recovery with a rate increase.
The day will come, in the U.K. and elsewhere, when the exceptionally stimulative monetary policies that central banks have employed since the recession can be abandoned. Hopefully, that will happen well before the next recession. We're not there yet.
(Marc Champion is a member of the Bloomberg View editorial board. Follow him on Twitter.)