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Carney Says Forward Guidance Can Make Monetary Policy Better

May 02, 2013

Mark Carney, who becomes Bank of England governor later this year after leaving Canada, said offering future policy guidance can help central banks respond to economic shocks or financial imbalances, a view that may be disputed by his future colleagues.

Guidance can influence longer-term interest rates and would be useful as long as the “bounds” on central-bank authority are clear, Carney said in a lecture yesterday at the University of Alberta in Edmonton.

“The scale of shocks now facing major advanced economies is stretching the conventional flexibility of inflation- targeting frameworks,” Carney said. “Guidance can crystallize boundaries on the degree of flexibility.”

Carney, who is leaving the Bank of Canada June 1 to take over the Bank of England a month later, cited his success with guidance when the Bank of Canada pledged in 2009 to hold its policy rate at the lowest possible level for a year. He also cited the Federal Reserve’s decision to implement “state- contingent” thresholds on unemployment for when interest rates will rise.

Chancellor of the Exchequer George Osborne last month introduced the first shake-up of the central bank’s remit in over a decade, formalizing powers that would give Carney greater flexibility on setting interest rates when he comes to London in July.

Forward guidance has been questioned by current Bank of England Governor Mervyn King, who has said it may hurt the credibility of monetary policy. Asked about possible opposition to guidance, Carney told reporters at a press conference he didn’t want to “prejudge” the debate.

Thresholds Discussion

“There is a discussion that we will have,” Carney said. “The Chancellor in his remit letter has asked for a perspective on thresholds in August, so we will, the Bank, through the Monetary Policy Committee, will provide views on that,” Carney said.

There are skeptics about guidance on the nine-member Monetary Policy Committee that Carney will lead. “Forward guidance, particularly if it’s associated with thresholds, in the British context, does have problems,” policy maker Martin Weale said in an April 18 interview.

Adam Posen, a former member of the Bank of England’s rate- setting Monetary Policy Committee, said at a Bloomberg Economic Summit panel in Washington that the discussion about guidance is “much fuss about nothing.”

“It’s more what central banks do than what they say,” said Posen, who is now president of the Peterson Institute for International Economics in Washington.

Too Far

In the lecture, Carney said there is risk that flexibility could be taken too far by central banks, meaning there’s a need to develop clear policy frameworks that can “play a critical role in building and preserving credibility.”

Carney also said there are a number of circumstances when it would be desirable to bring inflation back to target over a longer-than-normal horizon, such as when central banks need to promote adjustments to financial excesses or credit crunches.

“Monetary policy tactics, particularly communications, can play an important role in anchoring inflation expectations and retaining the credibility necessary for monetary policy to be effective,” he said.

“Guidance and state-contingent thresholds are examples of mechanisms to define the boundaries of flexibility.”

One scenario may be the need to tolerate inflation above target for a longer horizon in order to help an economy suffering from deleveraging or prolonged periods of weakness that is undermining productivity, he said. Monetary policy can also be used to “lean” against a build-up of excessive debt in an economy, Carney said.

Cyprus Bailout

Asked about the European Union’s bailout of Cyprus, which involved taxing deposits at Cypriot banks, Carney told reporters it’s important “to know in advance what the creditor hierarchy is.”

“The creditor hierarchy changed from one weekend to the next,” Carney said. “It wouldn’t appear, at least on that standard, that that constituted best practice.”

The text of the lecture didn’t mention the outlook for Canada’s economy or monetary policy. After the lecture, Carney told reporters that there may be more momentum in the economy than the bank had earlier thought.

To contact the reporters on this story: Theophilos Argitis in Ottawa at; Greg Quinn in Edmonton at

To contact the editor responsible for this story: David Scanlan at

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