Central Bankers: A blind guide dog

by Michael Roberts

‘Forward guidance’ is the central bank buzz-word.  Three of the top four central banks in the world have now officially adopted it.  And the fourth has already made it very clear where its monetary policy is going.  Forward guidance is an attempt by the leading central banks to indicate more clearly what monetary policy will be for a reasonable period ahead along with the conditions for sustaining it. It aims to allow households, businesses and financial markets to know what to expect in central bank base rates for the foreseeable future.  In the current environment of low growth, high unemployment and an overhang of capacity, central bankers hope that forward guidance will exert downward pressure on long-term interest rates as economies recover.

Following their December 2012 meeting, US Federal Reserve policymakers announced their new policy of ‘forward guidance’. The Federal Open Market Committee (FOMC) said it forecast that a target range for the federal funds rate of 0-0.25% will be kept for as long as the unemployment rate remained above 6.5%, inflation between one and two years ahead rose no more than 50bp above the FOMC’s target of 2% a year, and longer-term inflation expectations remained ‘well anchored’. The FOMC reckoned that this meant the federal funds rate would be unchanged at least through mid-2015. The thresholds for unemployment and inflation were not trigger points for an immediate change of policy, but points when the FOMC would consider its options.

More recently, the European Central Bank has adopted its variation on ‘forward guidance’. In July, its governing council said it expected to keep its refinancing and deposit rates at present levels ‘for an extended period of time’, assuming it was right in its forecast of subdued inflation, weakness in the Eurozone economy and low credit growth.

And only last week, the Bank of England (BoE) joined the party, when its new governor, Mark Carney, former governor at the Bank of Canada, made his first monetary statement and announced that the BoE would introduce forward guidance too. The BoE followed the Fed, as usual, in almost exactly the same terms of guidance. It pledged to keep its base rate at its lowest level in its 300-year history until unemployment falls to 7% from its current level of 7.8%. How long would that take? The UK’s Monetary Policy Committee (MPC) reckoned that that unemployment ‘knockout’ target would not be reached until mid-2016 after the creation of about 750,000 more net jobs. However the MPC couched that guidance with some caveats. If the annual inflation rate looked like staying at 2.5% or higher in the medium-term, or if inflation expectations were out of control, or if the policy was threatening financial stability, then interest-rate policy could change earlier.

The reality is that ‘forward guidance’ from central banks is to the blind capitalist investor is being done by blind guide dogs.  Neither Bernanke nor Carney have any idea where unemployment, GDP growth and inflation will be next year, let alone in two or three years time.  The efficacy of this new policy is thus shot through with holes.

Forward guidance is really an addition to quantitative easing (QE), the policy of the central bank buying financial assets, like government or corporate bonds and printing the money to do so.  The idea is that with interest rates already near zero, the only way for the central bank to stimulate the capitalist economy is to boost the quantity of money rather than lower its price (interest rate).  But QE is based on a fallacy that increasing supply of money can lower its cost or price, in other words, the price of money can be set exogenously to the transactions made by banks and other lenders and borrowers of money and credit.  Actually, the demand for money is endogenously, by the decisions of capitalists to invest and consumers to buy (see my posts, http://thenextrecession.wordpress.com/2013/06/26/the-failure-of-qe-2/  and http://thenextrecession.wordpress.com/2012/08/25/qe-uk-banks-and-the-economy/).

While investment remains low and consumption is muted, the demand for more money is low.  So all that happens to this supply of ‘liquidity’ is that it flows into the purchase of financial assets and property, the unproductive sectors of the economy.  So the stock market is booms and house prices inflate, while the real economy stays weak.  A recent paper by Vasco Curdia and Andrea Ferrero at the Federal Reserve Bank of San Francisco (Efficacy of QE) found that the Fed’s QE measures from 2010 had helped to boost real GDP growth by just 0.13 percentage points and the bulk of this ‘boost’ was thanks to forward guidance, namely convincing investors that interest rates were not going to rise.  If that factor had been left out, the US real GDP would have risen only 0.04 per cent as a result of QE.

So if QE continues and interest rates are kept low until 2016 as Carney and Bernanke plan, then any boom will take place in property and the stock market not the real economy.  Already we have seen a sharp rise in home prices in both the US and the UK in the last year.

The UK’s consumer price inflation has always been higher than in the rest of Europe, partly because the UK is a rentier, service economy, with monopoly companies in many key sectors, which have pricing power, while pro-capitalist governments have raised indirect tax rates in many sectors, like travel, insurance, energy.  The inflation figure for July is just out at 2.8 yoy, down slightly from 2.9% yoy in June.  That’s still way higher than Carney’s target of 2% a year.  Factory gate inflation rose at its fastest pace in six months and further rises look set to come, with manufacturers crude oil input costs rising at their most rapid rate in over a year.

Even more significant is the move up in house prices.  The Royal Institution of Chartered Surveyors’ monthly survey pointed towards the biggest rise in house prices since 2006 and official data showed house prices rising faster than inflation at an annual 3.1%.  House prices in London were racing along at 8.1%.

And this is at a time when UK average earnings from work are rising at just 1% a year.  Indeed, wages in the UK have seen one of the largest falls in the European Union during the economic downturn.  Average hourly wages have fallen 5.5% since mid-2010, adjusted for inflation.  That is the fourth-worst decline among the 27 EU nations. Across the European Union as a whole, average wages fell 0.7%.  Only Greek, Portuguese and Dutch workers have had a steeper decline than the UK in hourly wages.  The Institute for Fiscal Studies said that a third of British workers who stayed in the same job saw a wage cut or freeze between 2010 and 2011 amid a rise in the cost of living. “The falls in nominal wages… during this recession are unprecedented,” the IFS said.

So with the biggest fall in real incomes in a generation, what does the UK’s new governor do?  He announces ‘forward guidance’ that will mean higher house prices and bigger speculative profits for the stock market.  After doing so, Carney had a weekend off in upper-class Oxfordshire, the British version of the US east coast Hamptons.  Apparently, according to news reports, Carney is a clubbable, “very social” man who mixed “among the movers and shakers” of Canadian society.  Now he has joined the so-called Chipping Norton Set — the group of powerful friends who live in Oxfordshire, including UK PM David Cameron and members of the international media mogul family, the Murdochs.  Carney is married through his wife Diana into a family of British aristocrats.  Diana is apparently “an outspoken economist who has written about the need to rebalance global wealth towards the poorest!”  economist who has written about the need to rebalance global wealth towards the poorest”!  A senior UK government source described Carney as “the perfect Davos man” — referring to the annual gathering of decision-makers in the Swiss ski resort where contacts and smooth-talking oil big deals.

So the Fed and the BoE will continue with useless ‘forward guidance’ that will only fuel a credit boom for the rich, while inflation and house prices spiral for the rest of us.  It’s the rich leading the blind.