Bank of England’s next governor Mark Carney: a radical in a conservative job

Sid Verma
Published on:

Carney's likely bid to reshape the UK's monetary framework, or at least push for more-aggressive easing, stems from his long-standing views that monetary activism can temper liquidity-trap fears, echoing the US Federal Reserve.

Mark Carney relishes being a radical in a conservative job. As Bank of Canada (BoC) governor, when the global crisis began, Carney aggressively kicked open the liquidity gates in the G7’s most structurally sound economy and most stable banking system. One month after his appointment, Carney led the decision to cut the overnight rate by 50 basis points in March 2008, as his market instincts rightly judged a global crisis was nigh, even as price-stability fears prompted ECB rate hikes in July that year.

And when policy rates hit the effective lower bound in Canada, in a precursor to the Federal Reserve's “open-mouth” communication policy, Carney opted for a non-standard monetary tool: the “conditional commitment” in April 2009 to hold the policy rate for at least one year. This was the first time in Canadian monetary history that such explicit forward-rate guidance was deployed.

Fast-forward to mid-2009: output and employment bottomed out, buttressed by monetary stimulus. Carney’s global reputation as a trail-blazing governor, who perceives monetary affairs through a market-based prism, took centre stage.

Carney then led the charge to re-tool the BoC’s mandate. Even though Canada benefits from a clean banking system, 21 years of strongly anchored inflation expectations and steady economic expansion, though still weak at 2% year-on-year, Carney incurred the wrath of price-stability puritans by leading the push to hard-wire a “financial stability” objective in the BoC’s inflation-targeting framework in late 2011.

This framework, for the first time, includes the possibility of a "flexible" approach in determining the time-horizon when its 2% target will be achieved. In other words, interest rates can be used to stabilize domestic financial conditions even when inflation deviates from target and, to assuage financial-bubble fears, could be hiked in a counter-cyclical fashion to prick bubbles.

Although Carney’s hawkish rhetoric is well-known – a product of the domestic environment, and the fact that inflation expectations have been locked in at 2% since roughly the mid-90s – Carney told Euromoney earlier this year that inflation-targeting puritanism was dead. He said: “We are not part of the caricature of inflation-targeting regimes, which has been described as a mechanistic, dogmatic-based approach to monetary policy.”

London calling

However, Canada is not the UK. A huge sovereign debt burden, fears of a liquidity trap, the prospect of a triple-dip recession and questions over the central bank’s independence will greet Carney’s tenure, from July.

While the governor’s status as Financial Stability Board chair provide some clues to his views on UK banking supervision, the gulf between the Bank of England (BoE) and BoC – both in terms of their mandates and economic challenges – meant the market was unclear just how radical the BoE could become under governor Carney when the news of his appointment was announced.

Until this week.

Carney – who has also touted the theoretical allure of price-level targeting – generated global shock and awe on Wednesday with the suggestion that the central banks, faced with liquidity-trap fears, could abandon their inflation-targeting regimes in favour of nominal GDP targets. This speech saw Carney swimming with the intellectual tide in the US, given the Federal Reserve’s adoption on Wednesday of a new policy stance that explicitly targets unemployment.

In a clear break with the current BoE governor Mervyn King’s legacy of an inflation-targeting framework, Carney made it clear G7 central banks should consider more radical measures to buttress sagging growth, such as keeping rates on hold for an extended period of time, numerical targets for unemployment, or scrapping inflation targets entirely, until nominal growth reached a given level. “If yet further stimulus were required, the policy framework itself would likely have to be changed,” he said.
And the bombshell: “For example, adopting a nominal GDP level target could in many respects be more powerful than employing thresholds under flexible inflation targeting." He cautioned the benefits of any regime change “would have to be weighed carefully against the effectiveness of other unconventional monetary policy measures under the proven, flexible inflation-targeting regime”.

Even though King has overshot the inflation target for the past seven years, and embarked on radical policy tools to buttress sagging growth, Carney’s monetary radicalism, and calls to consider a regime shift, endows King with a sense of conservatism, by contrast.

However, this is no-road-to-Damascus conversion to monetary liberalism. In countless speeches in recent years, Carney has paid lip service to the BoC inflation target and, instead, passionately waxed lyrical about the opportunity for central banks to broaden their mandates to counter the cycle, and the power of communication as a chief tool in the monetary arsenal, given intensifying real economy-financial linkages in G7 markets.