The consequences of the 2008 crisis on Britain's Inflation Targeting ...

Revue Française de Civilisation Britannique French Journal of British Studies XXI-2 | 2016

Economic Crisis in the United Kingdom Today: Causes and Consequences

The consequences of the 2008 crisis on Britain’s Inflation Targeting Framework Les conséquences de la crise de 2008 sur le cadre britannique de ciblage de l’inflation Nathalie Champroux

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The consequences of the 2008 crisis on Britain’s Inflation Targeting Framework

The consequences of the 2008 crisis on Britain’s Inflation Targeting Framework Les conséquences de la crise de 2008 sur le cadre britannique de ciblage de l’inflation

Nathalie Champroux

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monetary policy, inflation targeting, interest rates

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politique monétaire, ciblage de l’inflation, taux d’intérêt

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09/10/2016

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The financial crisis that started in the summer of 2007 in both the United States and the United Kingdom represents a turning point in the economic history of most developed countries. What Alan Greenspan, former Chairman of the Federal Reserve, compared with a “once-in-a-century credit tsunami1” tipped the Western world into economic turmoil, thus wiping out several decades of economic stability. As the “Great Moderation”, or the “nice” decade,2 gave way to recession, many of the macroeconomic theories that had developed over the preceding fifteen years were called into question.

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In the United Kingdom, the systemic financial crisis that rolled out proved “unprecedented in scale3”. The subsequent recession lasted four quarters in a row in 2008-2009, with Gross Domestic Product (GDP) growth slumping to the record low of -5.2% 4 and unemployment rising to 7.5% in 2009 5. Growth then remained weak and sometimes negative6, while inflation peaked at 4.48% in 20117. Yet, the British authorities had reacted strongly, as soon as the signs of economic dysfunctioning had been recognized.

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Among all the measures that the British authorities enforced, this article examines the monetary policy response to the crisis. In particular, it seeks to understand whether, beyond the activation of unconventional practices, the crisis caused a major restructuring of the United Kingdom’s monetary policy framework. The first section describes how the framework was renewed in 1997. The second and third sections show how New Labour, and then the coalition Government, responded to the 2008 crisis and its

Revue Française de Civilisation Britannique, XXI-2 | 2016

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aftermath within the framework. The fourth section determines how the reform of monetary policy of 2013 altered the fundamentals of the framework and the fifth section places the reform in the context of the progress of monetary theories.

Britain’s Inflation Targeting before the Crisis 7

Since October 1992, British monetary policy has officially been dedicated to price stability, through a framework of inflation targeting (IT) first improvised by Conservative Chancellor of the Exchequer Norman Lamont. As the Treasury’s archives tend to show8, there were no alternative plans ready when the pound sterling had to leave the European Exchange Rate Mechanism on 16 September 1992. The Treasury’s only certainty was that a short-term reintegration of sterling into the mechanism was not an option. As for IT, it had been briefly examined and put away in December 1989, when it was legislatively introduced in New Zealand. Three years later, the strategy kept fairly new and not widely-spread. Although it had “intellectual roots9”, it was not solidly theory-backed10, and there were hardly any robust empirical studies to prescribe it. As a matter of fact, just three days before announcing its adoption by the Treasury, Lamont himself still declared that “he was not greatly attracted to having an inflation target11”. The British recourse to IT therefore resembled an improvisation forced by circumstances, a “pragmatic ‘art’”, to quote Emmanuel Carré12. Nevertheless, the monetary framework that Lamont established on 8 October 1992 already had the basic characteristics of genuine IT13.

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It was this existing IT framework that New Labour strengthened five years later, especially through the reform of the Bank of England. As soon as he became Chancellor in May 1997, Gordon Brown took everyone by surprise when he announced the Government’s intention to start proceeding to this reform14. In fact, Brown had secretly been preparing the reform for at least two years with Ed Balls15, from a project conceived in 1988 by Conservative Chancellor Nigel Lawson16. In the end, the reform was enacted in Parliament by the adoption of the Bank of England Act 1998 which did not only concern monetary policy, but also the supervision and regulation of the financial services industry 17 .

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Regarding monetary policy, the law confirmed that the objectives of the Bank of England were “(a) to maintain price stability and (b) subject to that, to support the economic policy of Her Majesty’s Government, including its objectives for growth and employment.” To realize these objectives, the Bank would comprise a new entity of nine members, a Monetary Policy Committee (MPC), enjoying complete operational independence in “formulating monetary policy” (i.e. setting the level of interest rates). The law also said that the Treasury would specify annually to the Governor of the Bank of England, “(a) what price stability is to be taken to consist of, or (b) what the economic policy of Her Majesty’s Government is to be taken to be.” Then, the Act of Parliament reinforced transparency and accountability, with an obligation to publish a statement each time the decision of an intervention was made, the minutes of the meetings and monthly reports, and with the surveillance of the MPC’s procedures by a Parliamentary “Oversight Committee”. A last section dealt with the Treasury’s “reserve powers”, that is to say the right to dictate operational actions to the Bank in “extreme economic circumstances”, with the prior approval of Parliament18.


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Whether the Chancellor would lose or gain power over monetary policy, as a result of the new legislation, was not straightforward. On the one hand, there was a move towards monetary policy de-politicization. The Government could no longer influence the setting of the Bank Rate according to short-term political considerations, the advantage being that it would no longer be held responsible for unpopular interest rate rises19. But on the other hand, the law left considerable discretion to the Government as it did not impose any restrictions on the Chancellor’s power regarding the definition of price stability. For example, the Bank of England Act 1998 did not mention inflation targets20. This means that IT can still be abandoned at any time today, in favour of another type of strategy, without any legislation change. In fact, the monetary policy framework can be modified very easily when the Chancellor requires so.

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In his new monetary policy framework, Brown refreshed the target for inflation, replacing the target range by a symmetrical point. The 1998 Budget also specified that even though the target was valid “at all times”, temporary deviations could occur. As a means of information and accountability, the obligation was introduced for the Governor to send an open letter to the Chancellor, should inflation be more than one percentage point higher or lower than the target. The letter should explain the situation and the MPC’s plan to reverse it21. There was a strong echo here to a provision already made in 1992 by Lamont, who had specified about his new IT policy: We have to acknowledge that events outside our control may take us temporarily outside the range. This could arise, for example, if there were a sharp movement in the terms of trade, particularly through commodity prices. If that occurred, the Government would have a duty to explain how this had arisen, how quickly it intended to get back within the range, and the means by which it would achieve this22.

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The framework then remained unchanged for five years. On 10 December 200323, two changes were introduced. First, the Chancellor announced the inflation target was now based on an internationally recognised measure, the Harmonised Index of Consumer Prices (HICP, renamed Consumer Prices Index or CPI), instead of the RPIX. The change induced the setting of a new target value, at 2%. Second, it was the start of the publication of the Chancellor’s remit for the MPC. Since then, the remits, and the letters that introduce them, have been the reference documents fixing the rules of the monetary policy framework.

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Ten years later, the assessment of the IT framework displayed gratifying results. Since the inception of IT at the end of 1992, until the improvement of the framework in 1997, average inflation as measured by RPIX was 2.7%. It decreased again down to 2.5% from 1998 to 200524. As measured by CPI, inflation was 1.5% on average between 1997 and 2007. Over this last period, the actual inflation rate never deviated by more than one percentage point from the targets, though it fell close to the lower alarm threshold of 1% of CPI in March, April and September 2004, and rose close to the upper alarm threshold of 3% of CPI in December 200625. The truth is inflation had already been decelerating even before the beginning of IT in 1992. But since then, stability had been remarkable, both in terms of inflation and GDP growth, hence the reference to the nice decade. The stability was probably enhanced by monetary policy, but not only26. At the beginning of 2007, a study made by the Bank of England experts reported that even if the IT framework and institutional arrangements could be praised, there were also many other factors at stake. Some factors were domestic but non-monetary, like the supportive fiscal framework. Some other factors were external, due to the integration into the world economy of


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emerging countries and to immigration. What now seems more crucial, with the benefit of hindsight, was the report’s list of worrying issues and threats, and the conclusion that the experts could not “guarantee that the next ten years [would] be so ‘nice27’”. In the end, this conclusion proved dramatically right.

The Monetary Responses to the 2008 Crisis under New Labour 14

British Governments and the Bank of England took numerous actions of a massive scale to pull the United Kingdom out of the financial crisis and subsequent recession. In the flow of interventions, it was rather difficult to distinguish clearly between monetary and financial (or banking sector) actions. It is therefore necessary to recall official definitions to avoid confusion. The Bank of England only lists under the appellation of “monetary policy operations” the setting of the Bank Rate, the injection of money directly into the economy by purchasing financial assets (Quantitative Easing) and Forward Guidance 28. The Treasury confirms, by not inventorying any of the former as a financial policy intervention. It also considers the Asset Purchase Facility established in 2009 as the concrete means to finance the Quantitative Easing programs29.

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The first monetary actions that were taken were the decreases in the Bank Rate, which commenced in December 2007 and ended in March 200930. These measures were therefore implemented under the leaderships of Gordon Brown as Prime Minister and Alistair Darling as Chancellor, former Prime Minister Tony Blair having resigned on 27 June 2007. The first wave, of three cuts by 0.25 percentage point each, occurred from December 2007 to April 2008 and reduced the Bank Rate down to 5.0%. For the lay public, it might have seemed paradoxical, because actual inflation31 was on an accelerating trend and exceeded 3% between May 2008 and February 2009. But the cuts in the Bank Rate were not responsible for the simultaneous acceleration of inflation, which was duly explained in the open letters that Governor Mervyn King (nominated in 2003) sent to Chancellor Darling. Rather, the MPC justified them by the risk of too low inflation in the medium term that accompanied the prevision of a sharp slowdown in economic activity32. The Committee proved right: Inflation was actually below 2% between June and November 2009, hitting a low of 1.09% in September. The second wave of cuts occurred between October 2008 and March 2009 and brought the Bank Rate down by 4.5 percentage points to 0.5%. The first reduction was part of one of the rare international concerted actions in response to the unexpectedly massive scale of the economic crisis33. Yet, the MPC justified it, and all the others that it decided, by the need to compensate for the risk of inflation undershooting the 2% target in the medium term. Among the risk factors, the Committee identified the domestic recession, which increased spare capacity and pushed wages and companies’ margins down, and the fall in energy and food prices. But it was not fully right this time: The actual inflation rate overshot the target by more than one percentage point throughout 2010, more than two percentage points throughout 2011, and still more than one percentage point from January to April 2012. The reasons for this overshooting are not the subject of the present paper, but let it be simply noted that the MPC blamed temporary factors like the increase in the standard rate of Value-Added Tax, the fall in sterling and the steep increases in import and energy prices.


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What should be highlighted is that the interest rate cuts which responded to the crisis situation remained within New Labour’s monetary policy framework. First, the Government did not use its reserve power to dictate the interest rate levels or the timing of change. Not only did the Chancellor let the MPC’s experts do their job, he also always endorsed the Committee’s operational decisions, whatever the situation. At each target overshooting, for example, he publicly expressed his agreement with the MPC’s justifications and forward-looking decisions34. Second, officially, the ultimate objective of monetary policy never stopped being the control of inflation. Helping with output was presented as a means to reach this objective, not the contrary. As a result, the remits did not encounter any modifications under New Labour. Only the Chancellor’s accompanying letters varied slightly, with the mention of the emergence of global challenges and some references to the Asset Purchase Facility.

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The Asset Purchase Facility (APF), launched on 29 January 2009, is an arrangement under which the Bank of England is authorized to purchase high-quality assets from the private sector, the list of which is validated by the Treasury. The primary idea was to help financial stability, by financing the purchases by the issuance of Treasury bills with low returns, that private investors would not wish to keep, but would use to buy other assets like corporate shares, thus bringing liquidity to the credit system. But in March 2009, the Chancellor also permitted the MPC to use the APF as a monetary policy instrument, with the financing of asset purchases through the central bank’s creation of money. This way of injecting money directly into the economy is known as Quantitative Easing (QE). The MPC announced its first wave of QE on 5 March 2009, for £75 billion of mostly government bonds (gilts), but also commercial paper and corporate bonds. It then extended the programme up to £125 billion on 7 May, £175 billion on 6 August and £200 billion on 5 November. In January 2010, the Bank of England started selling as well as purchasing corporate bonds in the secondary market. And in February, the Treasury allowed the Bank to continue to do so, but required the future purchases to be financed by the issuance of Treasury bills.

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Just like the manipulation of interest rates, QE was implemented within New Labour’s monetary framework and dedicated to IT. It was conceived as an alternative to the Bank Rate instrument, which could no longer be reduced further, whereas the urgency to support the recovery in nominal spending persisted. In the minutes of the meeting held in February 2009, which set the case for the use of APF for monetary purposes, the MPC repeated no less than four times that the unique motive was to meet the 2% inflation target, and insisted on the importance of diffusing this message when communicating about the MPC’s actions35. In his letter dated 3 March 2009, which officially authorized QE, Darling therefore confirmed the Committee’s objective of price stability36. In his following letters, “price stability” was simply replaced by “monetary stability37”. Since QE operations, financed by the APF, were just seen as a supplementary monetary instrument, on the same level as the Bank Rate, the MPC was accountable for any of its decision regarding this new instrument, through the existing system of publication of Inflation Reports and evidence to the Treasury Committee.

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Even if the exact effects of the Bank Rate cuts and the QE programmes on the United Kingdom’s economy cannot be accurately assessed, because all other things are never equal, all analysts agree the interest rate cuts were the thing to do and the crisis would have been deeper without QE38. Yet, at the beginning of 2010, with GDP growth still lower than 0.5%39 and inflation back to above 3%, the British population had no reasons to


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rejoice. In its discontent, the electorate blamed both the Conservative Party and New Labour, and on 6 May 2010, neither Party obtained the majority of seats in the House of Commons, which forced the formation of a coalition government.

The Conservatives’ Extension of Existing Responses 20

Throughout its mandate, the coalition Government was led by Conservative Prime Minister David Cameron, assisted by Liberal-Democrat Deputy Prime Minister Nick Clegg, while monetary policy was in the hands of Conservative Chancellor George Osborne. As seen before, it took over a context of high inflation. This context lingered for more than two years, while growth showed no signs of recovery. During this period, the coalition Government reinforced the measures implemented by its predecessors.

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Just after arrival in power, Osborne affirmed the Government’s commitment to maintaining price stability with the pursuance of the 2% inflation target, in his letter to the Governor dated 18 May 201040 and in the emergency Budget of June 2010 41. He confirmed this target in each remit for the MPC that he sent from March 2011. It should be noted that the first remit by the Conservative Government, which was faithfully replicated afterwards until 2013, showed few modifications from New Labour’s remits. Furthermore, these modifications were only related to the new Government’s beliefs and objectives, but not to monetary policy itself. For example, whereas the objective of the New Labour Government had been “to achieve high and stable levels of growth and employment42”, that of the coalition Government became “to achieve strong, sustainable and balanced growth that is more evenly shared across the country and between industries43”.

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Concerning the MPC’s monetary policy operations themselves, while inflation accelerated throughout 2010 and 2011, Osborne accepted the Committee’s decisions to keep the Bank Rate close to the zero lower bound. In addition, he allowed for the rise in the amount of the APF available for QE interventions, up to £275 billion in October 2011, £325 billion in February 2012 and £375 billion in July 2012. As a matter of fact, the new independent economic analysis institution, the Office for Budget Responsibility (OBR), that the Conservatives had created44, always validated the MPC’s inflation previsions in the medium and longer-term. These previsions were that inflation would eventually return to the 2% target in the medium term, with a substantial risk of undershooting because the economy was still struggling.

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Indeed, the steady recovery experienced after the deep trough of the last quarter of 2008 suddenly came to a halt in the second quarter of 2010. From then on, and until the first quarter of 2013, GDP growth was very volatile, sometimes close to zero (in the fourth quarters of 2010 and 2011), sometimes even negative (in the second and fourth quarters of 2012), but never as high as 1%45. So it was certainly not the right time to prevent the MPC from practicing monetary ease. Actually, monetary ease – or “monetary activism” – was the counterpart to fiscal austerity in what the Chancellor later labelled the Government’s “economic strategy46”. Yet, the strategy was not presented as such. Rather, Osborne considered that the commitment of the Government to reduce the budget deficit created a fiscal credibility supportive of the recovery, and of price stability and so, in turn, allowed monetary policy to be loosened so as to stimulate the economy47.


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There was nevertheless a limit beyond which monetary policy could not be loosened further without risking to fuel inflation and disrupt the financial market structure too much for a smooth return to normal monetary policy in due course. This limit was apparently reached at the beginning of 2013. From November 2012, the MPC started debating over the merits of raising the APF by £25 billion, to £400 billion. At first, at the end of 2012 and very beginning of 2013, only one MPC member (David Miles) was in favour of this increase and voted accordingly. Then, from February to June 2013, two more members (the Governor and Paul Fisher) joined him. Their opinion was that more monetary stimulus was required in the light of the projections of modest recovery in growth and employment at home and the current euro-area turmoil, while there were nearly no risks of higher cost pressures48. Yet, six members persisted in their refusal of a higher APF. They argued that the economy was recovering, the previsions of below-target inflation in the medium term were not that robust, the past QE operations had not stopped delivering, the Funding for Lending Scheme (FLS) was helping, and all in all, the potential costs of higher APF outweighed the benefits. The growing disagreement was destabilising. This might partly explain why some of the interest rates the markets offered to households and businesses rose slightly in the spring and summer of 2013 49. The disturbing discussions went on even after Governor King had reached the end of his ten-year term in office and had been succeeded by Carney. But in the meantime, the Conservative Government had begun leading the MPC towards the research of other monetary instruments. With work still in progress in July 2013, the Committee voted unanimously against any changes in its operations until it had completed its study. In August, it opted for Forward Guidance instead, in the wake of the Bank of Japan, the Fed, the Bank of Canada and the European Central Bank50.

The Next Phase: The 2013 Monetary Policy Reform 25

Forward Guidance (FWG) is a form of communication dedicated to the management of expectations of future monetary policy. In theory, it consists in clarifying the authorities’ reaction-function so that market participants may know more acutely what to expect. In practice, the monetary authorities usually provide benchmarks (dates or macroeconomic indicator values) that must be reached before any change in monetary policy is even considered. In this way, they hope to encourage the markets to trustfully pursue constant reaction-functions consistent with constant monetary policy. In the United Kingdom, the MPC first implemented a “state-contingent51” form of FWG linked to a specific quantitative economic indicator. On 1 August 2013, the Committee adopted a proposal stating its intention “not to raise Bank Rate from its current level of 0.5% at least until [...] the unemployment rate [had] fallen to a threshold of 7%52”. As the unemployment rate approached the threshold, the message was reviewed in the Inflation Report of February 2014. The idea was that the MPC would “seek to close the spare capacity in the economy over the next two to three years while keeping inflation close to the target53”. Spare capacity was evaluated at broadly 1%–1.5% of GDP, but the pace at which it would be absorbed remained unclear54. What the markets had to expect, though, was that there were no Bank Rate rises scheduled as long as the spare capacity persisted, which could take years. And when these rises eventually came, they would be very fragmented and small. Apparently, this second form of FWG worked, because the statistics show that since


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2013, the markets have resumed their cuts in most of the interest rates they offer to households and businesses, and so have supported consumption and investment 55. 26

The MPC did not decide on its own to have recourse to FWG. The Chancellor was the instigator of the move which was part of a far broader plan designed to put the United Kingdom’s economy back on track. Indeed, at the beginning of 2013, the mid-term record of the Conservative Government was one of continuous sluggish and volatile GDP growth accompanied by high inflation. Consequently, Osborne, together with Chief Economic Adviser Rupert Harrison, decided to strike a blow at this faint echo of the stagflation scenarios of the 1960s and 1970s. The plan was revealed in the 2013 Budget and comprised four pillars. The first pillar was entitled “Monetary activism56” and included two sections, one about “Monetary policy” and the other about “Credit easing”. The first section presented the updated remit that Osborne was sending to the MPC57 and that he assimilated to a monetary “reform” in his Budget statement.

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In 2013, the move to the use of unconventional policy instruments, and especially FWG, attracted much media attention, for both style and substance reasons. Style, on the one hand, because in his Budget statement, Osborne chose to elaborate on FWG. He went so far as to quote the option of intermediate thresholds and the example of the Fed which was using the unemployment rate58. He thus gave the media plenty to speculate about. Style, still, with the newly appointed Governor, 47-year-old and charismatic Carney, who was frequently put in the spotlight even before taking office, and presented as the pioneer of the use of unconventional monetary instruments in Canada. Substance, on the other hand, since the final MPC’s announcement of the use of the 7% unemployment threshold was the most concrete and visible outcome of the strategy. Yet, FWG should not be regarded as the main feature of Osborne’s monetary policy reform. By 2014, the remit had to be modified because the decrease in unemployment caused the MPC’s first guidance to cease to apply. In the section dedicated to “Unconventional policy instruments”, the Chancellor reduced his advocacy to the mere statement that the use of FWG was left to the discretion of the MPC. Any reference to the “thresholds”, which had been written no less than three times in the updated remit of 2013, was erased. By contrast, what remained was the more general requirement of the creation of a solid governance and accountability system when unconventional interventions may affect credit risk or credit allocation. To illustrate this point, the Chancellor retained the examples of the APF and the FLS. So in the end, what the reform permanently brought in the area of unconventional policy instruments was a clarification of when they could be used and what governance change should accompany their implementation.

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The monetary policy reform concerned two other areas. One was the flexibility of the framework and the second was the relationship between monetary stability and financial stability. As a matter of fact, these two areas were closely intertwined in the reform. First, the updated remit went further than the traditional acceptance of inflation target overshoots or undershoots due to exceptional shocks and disturbances. The reform actually acknowledged the responsibility of the MPC in the potential deviations, by saying that the Committee may “wish” to allow deviations. Then, two circumstances for these voluntary deviations were identified. The first was the consideration of “short-term trade-offs” between the need to return inflation to the target and the risk to cause undesirable volatility in output. The remit went on with the specific claim for clear explanations from the MPC about how the trade-offs influenced the Committee’s previsions and decisions. The second circumstance, though not exactly expressed in these


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terms, can be summed up by the consideration of trade-offs between the need to return inflation to the target and the risk to contribute to financial instability. The MPC was not to be the “first line defence” against the risks of financial instability: the Financial Policy Committee (FPC) was. But what the monetary reform stipulated was that each Committee should “have regard” to the policy actions of the other. To ensure this coordination, a last section was added to the remit, which announced overlap in membership of the two Committees, and required each of the institutions to include, inside their various accountability publications, explanations about how they had regard to the other’s actions. 29

The reform59 was not the total overhaul of monetary policy that was pressed by commentators and pressure groups like Positive Money, but that the Treasury’s thorough preparatory work had discarded. The preparation had taken the form of a review of no fewer than 62 pages, along which the Treasury had examined the performance of the British monetary policy framework and explored alternatives in the light of evolving monetary policies around the world. The option of an exchange of the CPI for another measure of inflation (like core inflation, nominal wage inflation and asset price inflation) had been analysed and rejected. So had the hypothesis of abandoning IT altogether for the alternatives of price level targeting, nominal GDP growth targeting or nominal GDP level targeting. In the end, the Treasury had concluded that the existing flexible IT framework had served the United Kingdom well and should be maintained60. This came as a disappointment for some who had hoped a lot more with Carney’s appointment as Governor of the Bank of England.

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When Osborne appointed Carney on 26 November 2012, he took nearly everyone by surprise, as Paul Tucker, the Deputy Governor of the Bank of England, had been seen as the prospective candidate. Carney had brilliant professional records in the fields of central banking and financial regulation: He was then Governor of the Bank of Canada and Chairman of the Financial Stability Board of the G20. As a foreigner, he was largely unknown by the British lay public, but he rapidly became the object of the press scrutiny. His general remark on the potential necessity, in extraordinary circumstances, to relinquish the IT framework in favour of a targeting of a nominal GDP level 61 therefore did not go unnoticed. That was what the self-called Market Monetarists, led by Danish economist Lars Christensen, had been recommending for some time62. There were proponents of nominal GDP targeting in the United Kingdom too, and they were sometimes quite insistent, like the Financial Times’s economic commentator Samuel Brittan63. So suddenly there were widespread speculation and arguments about whether Osborne would make the leap. But eventually, the Treasury concurred with the more conservative opinion of outgoing Governor King who strongly defended the IT framework 64. Therefore, British monetary policy is still subordinated to the priority to keep inflation low and stable in the long term, as defined by the target of 2% inflation in the medium term.

The 2013 Reform in the Dynamic of Monetary Theories 31

The 2013 monetary policy reform should be valued for the fact that it brought clarification in the Government’s position regarding two ongoing monetary policy debates, the first of which is the “rule versus discretion” debate. This debate opposes the


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value of a policy constrained by the strict respect of rules (such as the reduction of money supply aggregates to planned quantitative levels, or the stability of exchange rates at fixed levels in a monetary system), to that of a policy left to the entire discretion of the monetary authorities65. According to economists Finn Kydland and Edward Prescott, rules guarantee the time-consistency of a policy, that is to say long-term outcomes that correspond to the policy objective66. But discretion permits the authorities to adapt their response to destabilising events in order to smooth the effects they may produce. 32

In a now widely-quoted article, Ben Bernanke and Frederic Mishkin identified IT as a framework reconciling rule with discretion. The economists argued that, in practice, IT was not a strict rule, but a framework ensuring “constrained discretion”: The central banks actually dealt with short term issues like output and employment provided that did not affect their meeting of the long-term objective of stable inflation67. At the Bank of England, King did not think differently. When still Deputy Governor in 1997, he presented IT as a framework guaranteeing that central banks were not left with “unfettered discretion68”. Like Bernanke and Mishkin, he insisted on the fact that monetary policy had two components: an inflation target and a response to shocks. He explained that faced with a supply shock, the central banks were confronted with a trade-off between the volatility of inflation and the volatility of output, and their role was to properly choose which time horizon was the best to return inflation to target without too much damage on output. Adding to the works of John Taylor69, King stated that the optimal targeting horizon depended on the nature and persistence of shocks. For many supply shocks a two year horizon was reasonable. But when shocks were larger, there might be a need to extend this horizon. The goal of the Governor’s open letter, when the inflation target was missed, was to inform on this extension.

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In light of King’s discourse, it is obvious that the remit updated in 2013 simply officialised a situation that already existed regarding the dual component of monetary policy and the extent of the discretionary powers of the Bank of England. So in practice, there was nothing new. But the message had obviously not been understood previously. Indeed, the remits published before 2013 had been short on developments and explanations about discretion. That deficiency was of no consequence as long as there were no major crises. But since 2008, there was a growing need to complement the message, to explain why the MPC seemed gradually more focused on output than on inflation. Indeed, inflation deviations from target went on occurring without causing much official stir. At the same time, the emergence of operations concerted with the Government, like the FLS, gave the impression that the Bank of England was more and more required to support the Government’s objective for growth, rather than to maintain price stability. The misunderstanding of the true mechanism of monetary policy action added to the confusion of the markets and needed to be cleared up. As it turned out, the Government’s clarification about the trade-off between inflation and output volatility was often interpreted as a step towards more discretion.

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In reality, the main move towards more discretion was rather the positioning of the Conservative Government in a second debate called the “lean versus clean” debate. In this debate, the question is to decide whether monetary policy has a role to play in the prevention of asset price bubbles (leaning against the wind) or should only focus on restoring the macroeconomic situation back to normal if bubbles burst (cleaning the mess)70. This debate had long existed. In the United Kingdom, the “clean” side had arguably won the argument, with the definition of monetary policy written in the Bank of


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England Act 1998, even if some research revealed the MPC had actually responded to financial market volatility71. But the debate had naturally reopened with the financial crisis and its economic aftermath. At the Bank of England, outgoing Governor King was of the unshakable opinion that central banks should not use the Bank Rate for financial stability objectives72. But incoming Governor Carney was fuelling the debate. He believed that even if the prevention of financial bubbles was first a matter of micro- and macroprudential regulation and supervision, there might be a point at which monetary policy would be the last line of defence73. Eventually, the Conservative Government found a consensus. Osborne did not modify the objective of monetary policy by giving the MPC the role of ensuring financial stability. Rather, another committee, the FPC, was (re)created to deal with the latter objective. Nevertheless, the monetary policy reform of 2013 actually managed to link the two intertwined objectives of monetary and financial stability74. 35

As can be seen, the reform of the British monetary policy framework was embedded in the context of the progress of monetary theories in the light of a situation that was encountered worldwide for the first time. IT frameworks had never been confronted with such a large scale financial crisis. In the United Kingdom, the collapse of Barings in 1995 was now seen as a very small event. As for the hypothesis of the Bank Rates stuck at the zero lower bound, it had always been a “theoretical curiosity75”. In the end, the IT frameworks stood the test and their flexibility provided adequate responses, but the crisis had raised many interrogations in the fields of economic analysis in general 76 and monetary policy in particular. When economists did not ask for a scrap of IT altogether, they proposed the kinds of improvement that the British Conservative Government adopted77. Indeed, a worldwide recurring recommendation was that of spreading the use of FWG, with a clear statement about future policy intentions linked to specific economic conditions, whether these conditions were still anomalous or back to normal. Another repeated instruction was that of keeping monetary policy as a last line of defence, but securing coordination between monetary and macro-prudential policies78. A thorough comparison with the evolution of the IT frameworks in the major economies would allow for a better measure of global influences.

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Yet, the embedding of the reform of British monetary policy in the global dynamic of the monetary theories does not detract the Conservative Government from its paternity. One can go so far as to put forward that the monetary policy reform was a truly Conservative move, and not only because it respected the principles set by John Major’s Government as of 1992. Indeed, it was an echo of the vision the Conservatives had of monetary policy when arriving in power in 1979, which was that of “monetary activism”. The first Thatcher Government had heavily relied on the Medium Term Financial Strategy (MTFS) to create the optimal stability conditions for economic growth, while trying on the other hand to cure the budget from its deficit and from debt evils79. In 2013, Cameron was strongly backing his Chancellor’s strategy of fiscal conservatism combined with monetary activism80. In both cases, the Conservative Governments had the same discourse: they said monetary stability was a pre-condition, but was not sufficient to ensure economic growth and employment. And in both cases, they seemed to put too much faith in the potency of monetary policy to restore growth. Furthermore, a rather Conservative approach may be recognized in the hands-on behaviour of Osborne regarding monetary policy. Even though the Government did not attempt to repeal the monetary policy sections of the Bank of England Act 1998 that ensured the operational independence of the MPC, the


11


Chancellor went as far as he could to intervene in the MPC’s work within the legal constraint.

Conclusion 37

The financial crisis of 2008 and the subsequent recession dramatically affected the economic and monetary conditions in the United Kingdom. Despite massive monetary responses, the consequences of the turmoil can still be felt eight years later, as several economic fundamentals are not back to pre-crisis levels. The crisis interrupted fifteen years of relative stability and growth, which had been accompanied by the constant implementation of IT, through a progressively consolidated monetary framework dedicated to price stability. Unsurprisingly, the financial and economic collapse called into question the validity of this monetary framework in terms of the prevention and correction of imbalances. As a consequence, the framework has encountered some alterations.

38

In March 2013, Chancellor Osborne detailed these alterations in an amended remit he sent to the MPC while presenting them as a true monetary reform in his Budget speech. First, the use of unconventional instruments by the Bank of England was officially authorised and the terms of the regulation of such a use were reaffirmed. Second, the scope of the discretion allocated to the Bank in the consideration of the trade-off between inflation volatility and output volatility was clarified. Third, supplementary discretion was granted in the context of more coordination between monetary and financial policies.

39

In light of the impressive scale of the financial and economic shock, the alterations brought to the monetary framework are relatively limited. Indeed, the essentials of IT have officially survived. One may argue that the Bank of England is claiming a focus on price stability whereas it is targeting growth and employment. But supporting the Government’s objectives for growth and employment is consistent with the Bank of England Act 1998, as long as this does not conflict with price stability. And in fact, since 2013, targeting growth and employment has served the objective of price stability, because the monetary easing that the former requires has also been needed to break the steady decelerating trend of inflation81.

40

The financial crisis of 2008 and its aftermath have therefore not completely disrupted the British economic and political consensus in favour of the IT strategy. This raises again the question of whether IT is not the end of monetary policy history82 – the final outcome of centuries of thinking and tests, that will continue to be modified and improved, but that will not disappear. The future will tell, but one may already wonder about what would happen if a situation of deep stagflation occurred again one day and opposed the objectives of price stability on the one hand and growth and employment on the other. So far, the resilience of the British IT framework does not seem to have been fully tested.

Appendix Figure 1: GDP growth, UK, 2003-2015

[Image non convertie] Source: Office for National Statistics


12


Figure 2: Short-term interest rates, UK, 2003-2016 41

[Image non convertie] Source: Bank of England

Figure 3: Inflation, UK, 2003-2016 42

[Image non convertie] Source: Office for National Statistics

43

Nathalie Champroux est Docteur en Études du Monde Anglophone de l’Université Sorbonne Nouvelle, Maître de conférences en civilisation britannique à l’UPEC et chercheur au CERVEPAS/CREW. Ses recherches portent principalement sur les politiques monétaires appliquées au Royaume-Uni.

BIBLIOGRAPHY ARESTIS Philip & MIHAILOV Alexander, “Flexible rules cum constrained discretion: a new consensus in monetary policy”, Working paper, No 053 (Henley Business School - University of Reading, October 2007). BANK OF ENGLAND , “Report: The Monetary Policy Committee of the Bank of England: ten years on”,

Quarterly Bulletin, Vol. 47, No. 1 (2007 Q1). BANK OF ENGLAND , Monetary policy trade-offs and forward guidance, Inflation Report (August 2013). BANK OF ENGLAND , The Bank of England Act 1998, the Charters of the Bank and related documents (July

2015). BERG Claes, “The Global Financial Crisis and the Great Recession: Causes, Effects, Measures and Consequences for Economic Analysis and Policy”, Paper presented at a Workshop on Monetary Policy, Macroprudential Policy and Fiscal policy at the Centre for Central Banking Studies of Bank of England 17 May-19 May 2011 (Bank of England, 23 May 2011). BERNANKE Ben & MISHKIN Frederic, “Inflation targeting: A new framework for monetary policy”, Working Paper, No 5893 (National Bureau of Economic Research, January 1997). CARNEY Mark, “Guidance”, Remarks at the CFA Society Toronto (Toronto, 11 December 2012). CARNEY Mark, “Monetary Policy After the Fall”, Eric J. Hanson Memorial Lecture at the University of Alberta (Bank of Canada, 1 May 2013). CARRÉ Emmanuel, “Une histoire du ciblage de l'inflation : science des théoriciens ou arts des banquiers centraux ?”, Cahiers d'économie Politique / Papers in Political Economy, N° 66 (2014), pp. 127-171.


13


CRESPO CUARESMA Jesús & GNAN Ernest, “Four Monetary Policy Strategies in Comparison: How to

Deal with Financial Instability”, Monetary Policy and the Economy (Oesterreichische Nationalbank, Q3 2008), pp. 65-102. DODGE David, “Our approach to monetary policy – inflation targeting”, Remarks to the Regina Chamber of Commerce, (Regina, 12 December 2005). FILARDO George & HOFMANN Boris, “Forward guidance at the zero lower bound”, BIS Quarterly Review (Bank for International Settlements, March 2014), pp. 37-53. FREEDMAN Charles & LAXTON Douglas, “Why Inflation Targeting?”, IMF Working Paper, Wp/09/86 (IMF, April 2009). GOODHART Charles et al., “Monetary targetry: Might Carney make a difference?”, VOX (CEPR’s Policy Portal, 22 January 2013). HM TREASURY , Review of HM Treasury’s management response to the financial crisis, PU1286 (House of

Commons, March 2012). HM TREASURY , Budget 2013, HC 1033 (House of Commons, 20 March 2013). HM TREASURY , Review of the monetary policy framework, CM 8588 (House of Commons, March 2013). KEEGAN

William, The Prudence of Mr. Gordon Brown (John Wiley & Sons, 24 September 2004).

KING Mervyn, “Changes in UK monetary policy: Rules and discretion in practice”, Journal of Monetary Economics, Vol. 39 (1997), pp. 81-97. KING Mervyn, “The Inflation Target five years on”, Lecture at the London School of Economics

(Bank of England, 29 October 1997). KING Mervyn, “Finance: A Return from Risk”, Speech to the Worshipful Company of the International Bankers at Mansion House (Bank of England, 17 March 2009). KING Mervyn, “Twenty years of inflation targeting”, The Stamp Memorial Lecture, London School of Economics (Bank of England, 9 October 2012). KING Mervyn, “Speech at the CBI Northern Ireland Mid-Winter Dinner, Belfast” (Bank of England, 22 January 2013). KYDLAND Finn & PRESCOTT Edward, “Rules Rather than Discretion: The Inconsistency of Optimal Plans.” Journal of Political Economy, Vol. 85 (1977), pp. 473-91. LAMONT Norman, Letter to John Watts (8 October 1992). LAWSON Nigel, The View from Number 11 (Corgi Books, 1992). MISHKIN Frederic, “Monetary policy strategy: Lessons from the crisis”, Working Paper, No 16755 (National Bureau of Economic Research, February 2011). MONETARY POLICY COMMITTEE , “Minutes of Monetary Policy Committee Meeting” (Bank of England)

(19 December 2007); (20 February 2008); (23 April 2008); (18 February 2009); (19 June 2013); (14 August 2013); (21 May 2014). OSBORNE George, “Budget 2013: Chancellor’s Statement” (House of Commons, 20 March 2013). JOYCE Michael et al., “The United Kingdom’s quantitative easing policy: design, operation and impact”, Quarterly Bulletin (Bank of England, 2001 Q3), pp. 200-212. TAYLOR

John B, “Discretion versus policy rules in practice”, Carnegie-Rochester Conference Series on

Public Policy, Vol. 39 (1993), pp. 195-214.


14


WOODFORD Michael, “Monetary Policy Targets After the Crisis”, Paper presented at the Rethinking

Macro Policy II: First Steps and Early Lessons Conference Hosted by the International Monetary Fund (Washington, April 16-17 2013).

NOTES 1. G REENSPAN Alan testifying to the House Oversight and Reform Committee of the Congress, in “Financial crisis ‘like a tsunami’”, BBC (23 October 2008). 2. The “non-inflationary consistently expansionary - or “nice” – decade” was an expression first used by the Governor of the Bank of England Mervyn King in a speech delivered on 14 October 2003 at the East Midlands Development Agency/Bank of England Dinner in Leicester. 3. HM TREASURY, Review of HM Treasury’s management response to the financial crisis, PU1286 (House of Commons, March 2012), p. 19. 4. Real GDP growth rate.

OFFICE FOR NATIONAL STATISTICS ,

“Long-term profile of Gross Domestic

Product (GDP) in the UK”, ˂http://www.ons.gov.uk/ons/rel/elmr/explaining-economicstatistics/long-term-profile-of-gdp-in-the-uk/sty-long-term-profile-of-gdp.html˃[25 September 2015]. 5. Annual average rates calculated from monthly figures measuring change over the last three months. OFFICE FOR NATIONAL STATISTICS , “Table 9: Unemployment by age and duration: People duration of unemployment by age (seasonally adjusted)”, A01: Summary of labour market statistics, Excel sheet 3015Kb (15 July 2015), ˂http://www.ons.gov.uk/ons/taxonomy/index.html? nscl=Unemployment+Rates#tab-data-tables˃[25 September 2015]. 6. Quarter-on-quarter GDP growth. OFFICE FOR NATIONAL STATISTICS , Statistical Bulletin: Gross Domestic Product Preliminary Estimate, Quarter 2 (Apr to June) 2015 (TSO, 28 July 2015), p. 5. 7.

TRIAMI MEDIA BV ,

“Table: average inflation Great Britain (CPI) - by year”, inflation.eu, Utrecht,

˂http://www.inflation.eu/inflation-rates/great-britain/historic-inflation/cpi-inflation-greatbritain.aspx˃[25 September 2015]. 8. See the page ˂http://webarchive.nationalarchives.gov.uk/20130304161249/http://www.hmtreasury.gov.uk/foi_introduction_of_inflation_targets_2005.htm> [25 September 2015]. 9. On these “roots”, consisting of the acknowledgment of the absence of long run trade-offs between output and inflation and the recognition of the time-inconsistency problem, see F REEDMAN Charles

and LAXTON Douglas, “Why Inflation Targeting?”, IMF Working Paper, Wp/09/86

(IMF, April 2009). 10. See CARRÉ Emmanuel, “Une histoire du ciblage de l'inflation : science des théoriciens ou arts des banquiers centraux ?”, Cahiers d'économie Politique / Papers in Political Economy, N° 66 (2014), pp. 127-171. 11.

HM TREASURY ,

room,

HM

“Inflation and monetary policy”, Minutes of a meeting held in Chancellor’s

Treasury

at

4.20

PM

on

Monday,

5

October

1992,

p.

4,

˂http://

webarchive.nationalarchives.gov.uk/20130304161249/http://www.hm-treasury.gov.uk/d/ foi_dis_6_cx_metting_051092.PDF>[25 September 2015]. 12. In his study of the origins of inflation targeting in New Zealand, Emmanuel Carré exposes and contradicts the various theories of the science of monetary policy that are said to underlie the phenomenon of inflation targeting, by showing that the latter was a pragmatic creation of the central bankers, and so had hardly any theoretical foundations at first. See C ARRÉ Emmanuel, “Une histoire du ciblage de l'inflation : science des théoriciens ou arts des banquiers centraux ?”, op. cit. 13. On these characteristics, see F REEDMAN Charles & L AXTON Douglas, “Why Inflation Targeting?”, op. cit.


15


14. See B ROWN Gordon, “Statement from the Chancellor” (House of Commons, 6 May 1997), ˂http://webarchive.nationalarchives.gov.uk/20090905044043/http://archive.treasury.gov.uk/ pub/html/chxstatmt/st70506.html>[25 September 2015]; and B ROWN Gordon, “The new monetary policy framework”, Letter from the Chancellor to the Governor [6 May 1997]. 15. On the whole preparation of the reform of the monetary framework, see

KEEGAN

William, The

Prudence of Mr. Gordon Brown (John Wiley & Sons, 24 September 2004), Chapter “In central banks we trust”, pp. 151-172. 16. The bill that New Labour proposed in 1997 seemed copied from Lawson’s plan, which had been confidentially discussed in 1988, but rendered public in 1992. Cf. L AWSON Nigel, “Minute to the Prime Minister (An independent central bank)” (25 November 1988), in L AWSON Nigel, The View from Number 11 (Corgi Books, 1992), pp. 1059-61. 17. See “Bank of England Act 1998”, in BANK OF ENGLAND, The Bank of England Act 1998, the Charters of the Bank and related documents (July 2015), Chapter 11, Part I, pp. 20-50. There was also a Part III dedicated to the “Transfer of supervisory functions of the Bank to the Financial Services Authority”, to be found in article 162 of SI 2001 No. 3649, and the Financial Services Act 2012. 18. “Bank of England Act 1998”, in BANK OF ENGLAND, The Bank of England Act 1998, the Charters of the Bank and related documents (July 2015), Chapter 11, Part II: Monetary policy, pp. 50-55. 19. When New Labour came to power, the British economy was overheating and there was a need for more restrictive monetary policy. Brown increased the Bank base rate once, and then quickly gave operational independence to an interim MPC which had to assume the next five increases. 20. Brown announced his project of a new monetary policy framework in a letter and in statements dated 6 and 20 May 1997. The Bank of England Act repeated the terms of the documents word for word, except for the reference to inflation targets which had noticeably disappeared. For comparison, see BROWN Gordon, “The new monetary policy framework”, Letter from the Chancellor to the Governor (6 May 1997), § 4. 21. HM TREASURY, Budget 98: New Ambitions for Britain, The Financial Statement and Budget Report (House of Commons, March 1998), pp. 17-18. 22. L

AMONT

Norman,

Letter

to

John

Watts

(8

October

1992),

˂http://

webarchive.nationalarchives.gov.uk/20130304161249/http://www.hm-treasury.gov.uk/d/ foi_dis_7_john_watts_081092.pdf> [25 September 2015]. 23. See HM TREASURY, The strength to take the long-term decisions for Britain: Seizing the opportunities of the global recovery, Pre-Budget Report, CM 6042 (House of Commons, December 2003), pp. 15-17. See also BROWN Gordon, “Change to Monetary Policy Remit – June 2003”; B ROWN Gordon, “Remit for the Monetary Policy Committee – December 2003” and Inflation

Target

–December

2003”,

HM TREASURY ,

“Annex: The New

˂http://www.bankofengland.co.uk/archive/Pages/

digitalcontent/historicpubs/remitletters.aspx˃[25 September 2015]. 24. Four-quarter inflation rates. Figures from BANK OF ENGLAND, “Report: The Monetary Policy Committee of the Bank of England: ten years on”, Quarterly Bulletin, Vol. 47, No. 1 (2007 Q1), p. 26. 25. It actually rose to 3.1% in March 2007. This was the first time the Governor had to write an open letter to the Chancellor to justify the situation and his strategy. CPI rates in TRIAMI MEDIA BV, “Table: average inflation Great Britain (CPI) - by year”, op. cit. 26. On the MPC’s decisions from 1997 to 2007 and subsequent performance, see

CHAMPROUX

Nathalie, “La stabilisation de l’économie par la politique monétaire”, in E SPOSITO Marie-Claude, Le renouveau de l’économie britannique (Economica, 2007), pp. 35-50. 27. BANK OF ENGLAND, “Report: The Monetary Policy Committee of the Bank of England: ten years on”, op. cit., pp. 24-38. 28. See the electronic site of the Bank of England, ˂http://www.bankofengland.co.uk/ monetarypolicy/Pages/default.aspx˃[25 September 2015].


16


29. HM TRESAURY, Review of HM Treasury’s management response to the financial crisis, PU1286 (House of Commons, March 2012), Annex B: Policy Interventions, p. 57. 30. For a comprehensive view of Bank Rate cuts, see Figure 2, Appendix, infra. 31. For a comprehensive view of inflation fluctuation, see Figure 3, Appendix, infra. 32.

MONETARY POLICY COMMITTEE ,

“Minutes of Monetary Policy Committee Meeting 5 and 6

December 2007” (Bank of England, 19 December 2007);


“Minutes of

Monetary Policy Committee Meeting 6 and 7 February 2008” (Bank of England, 20 February 2008); MONETARY POLICY COMMITTEE ,

“Minutes of Monetary Policy Committee Meeting 9 and 10 April

2008” (Bank of England, 23 April 2008). 33. The Fed, the European Central Bank, the Bank of England, the Bank of Canada, Sveriges Riksbank, and the Swiss National Bank all decided to cut their short-term interest rates at the same time and to officially present the move as an international coordinated action in a single statement released simultaneously in the six countries, as well as in Japan, which expressed its support. See CHAMPROUX Nathalie, “British and American monetary policies convergence: structural coincidence or transatlantic mutual influence?”, in G ROUTEL Anne,

COSSU-BEAUMONT

Laurence, PAUWELS Marie-Christine & P EYRONEL Valérie (eds.), Revisiting the UK and Ireland’s Transatlantic Economic Relationship with the United States in the 21st Century, Beyond Sentimental Rhetoric (Palgrave MacMillan, 2016). 34.

DARLING

Alistair, “CPI Inflation”, Reply from the Chancellor to the Governor (17 June 2008);

(15 September 2008); (16 December 2008); (24 March 2009). 35.


“Minutes of Monetary Policy Committee Meeting 4 and 5

February 2009” (Bank of England, 18 February 2009). 36. D ARLING Alistair, “Asset Purchase Facility”, Letter from the Chancellor to the Governor (3 March 2009). 37. D ARLING Alistair, “Extending Asset Purchase Facility”, Letter from the Chancellor to the Governor (6 August 2009); (5 November 2009). 38. See J OYCE Michael et al., “The United Kingdom’s quantitative easing policy: design, operation and impact”, Quarterly Bulletin (Bank of England, 2001 Q3), pp. 200-212. 39. For a comprehensive view of GDP growth, see Figure 1, Appendix, infra. 40. OSBORNE George, “CPI inflation”, Reply from the Chancellor to the Governor (18 May 2010). 41. HM TRESAURY, Budget 2010, HC 61 (House of Commons, 22 June 2010), p. 14. 42. DARLING Alistair, “Remit for the Monetary Policy Committee – March 2010” (24 March 2010). 43. OSBORNE George, “Remit for the Monetary Policy Committee – March 2011” (23 March 2011). 44. The Conservatives created the OBR in December 2009 when still in opposition and officialised the existence of the public, but non-departmental, institution in May 2010. 45. Trends from OFFICE FOR NATIONAL STATISTICS , Statistical Bulletin: Gross Domestic Product Preliminary Estimate, Quarter 2 (April to June) 2015, op. cit. 46. OSBORNE George, “Budget 2013: Chancellor’s Statement” (House of Commons, 20 March 2013). 47. See, for example, OSBORNE George, “CPI inflation”, Reply from the Chancellor to the Governor (18 May 2010); (14 February 2012). 48.


“Minutes of Monetary Policy Committee Meeting 5 and 6 June

2013” (Bank of England, 19 June 2013). 49. As far as loans granted by UK banks and building societies (excluding central bank) were concerned, the effective rate on the stock of households’ unsecured personal loans increased between April and May 2013, from 7.70% up to 7.77% for outstanding loans, and from 6.94% up to 7.20% for new loans. The effective rate on private non-financial corporations’ loans increased from February to April 2013, from 3.09% up to 3.12% for outstanding loans, and from 2.58% up to 2.86% for new loans. After a decrease down to 3.10% and 2.41% respectively by June, these two rates on PNFCs’ loans rose again and were 3.12% and 2.77% respectively by August 2013. See BANK


17


OF ENGLAND,

“Effective interest rates: May 2013”, Statistical release (Bank of England, 1 July 2013)

and “Effective interest rates: August 2013”, Statistical release (Bank of England, 30 September 2013). 50. For details about the various forms of FWG implemented by these central banks, see F ILARDO George & HOFMANN Boris, “Forward guidance at the zero lower bound”, BIS Quarterly Review (Bank for International Settlements, March 2014), pp. 37-53. 51. BANK OF ENGLAND, Monetary policy trade-offs and forward guidance, Inflation Report (August 2013), pp. 21-22. 52.


“Minutes of Monetary Policy Committee Meeting 31 July and 1

August 2013” (Bank of England, 14 August 2013). 53. BANK OF ENGLAND, Inflation Report (February 2014), p. 7. 54.


“Minutes of Monetary Policy Committee Meeting 7 and 8 May

2014” (Bank of England, 21 May 2014), pp. 10-11. 55. As far as households are concerned, the average interest rates on unsecured loans (£10,000) decreased, from nearly 7% down to slightly more than 4%, between 2013 and the beginning of 2016. The rates on two-year fixed-rate mortgages (75% loan to value) also decreased, from about 3% down to less than 2%, over the same period (See BANK OF ENGLAND, Inflation Report (November 2015), chart 2.4, p. 14). For 2013-2014, households’ consumption growth remained resilient, by 0.6%. So did private sector business investment growth, by 1.1% (Ibid., Table 2.B p. 12), while interest rates on lending to SMEs tended to decrease from 2013 onward (See BANK OF ENGLAND, Credit Condition Review (Q3 2015), chart 3.3, p. 14). 56. The other three pillars were “Deficit reduction”, “Reform of the financial system” and “Structural reforms”. See HM TRESAURY, Budget 2013, HC 1033 (House of Commons, 20 March 2013), p. 16. 57. OSBORNE George, “Remit for the Monetary Policy Committee – March 2013” (20 March 2013). 58. OSBORNE George, “Budget 2013: Chancellor’s statement” (House of Commons, 20 March 2013). 59. An overview of the 2013 updated remit would not be complete without a mention of two other changes. A new timing for the open letter process was set. And the list of the four pillars of the Government’s economic strategy was copied into the section describing the Government’s objectives. But these are relatively minor changes compared to the elements of the monetary policy reform exposed in the present analysis. 60. See HM TRESAURY, Review of the monetary policy framework, CM 8588 (House of Commons, March 2013). 61. CARNEY Mark, “Guidance”, Remarks at the CFA Society Toronto (Toronto, 11 December 2012). 62. See, for example, C HRISTENSEN Lars, “Market Monetarism – The Second Monetarist Counterrevolution”,

(13

September

2011),

˂https://thefaintofheart.files.wordpress.com/2011/09/

market-monetarism-13092011.pdf˃[25 September 2015]. 63. Note that Brittan defended a target of nominal GDP growth. See explanations in G OODHART Charles et al., “Monetary targetry: Might Carney make a difference?”, VOX (CEPR’s Policy Portal, 22

January

2013),

˂http://www.voxeu.org/article/monetary-targetry-might-carney-make-

difference˃[25 September 2015]. 64. See K ING Mervyn, “Speech at the CBI Northern Ireland Mid-Winter Dinner, Belfast” (Bank of England, 22 January 2013). 65. For an overview of the debate in neoclassical and then New Keynesian literature, see A RESTIS Philip &

MIHAILOV

Alexander, “Flexible rules cum constrained discretion: a new consensus in

monetary policy”, Working paper, No 053 (Henley Business School - University of Reading, October 2007). 66. K YDLAND Finn & P RESCOTT Edward, “Rules Rather than Discretion: The Inconsistency of Optimal Plans.” Journal of Political Economy, Vol. 85 (1977), pp. 473-91.


18


67. B ERNANKE Ben &

MISHKIN

Frederic, “Inflation targeting: A new framework for monetary

policy”, Working Paper, No 5893 (National Bureau of Economic Research, January 1997). 68. KING Mervyn, “The Inflation Target five years on”, Lecture at the London School of Economics (Bank of England, 29 October 1997). Also read about the various econometric models of the tradeoff between rules and discretion in KING Mervyn, “Changes in UK monetary policy: Rules and discretion in practice”, Journal of Monetary Economics, Vol. 39 (1997), pp. 81-97. 69. TAYLOR John B, “Discretion versus policy rules in practice”, Carnegie-Rochester Conference Series on Public Policy, Vol. 39 (1993), pp. 195-214. 70. On this debate, and the question of which kind of bubble can be prevented according to the nature of assets, see MISHKIN Frederic, “Monetary policy strategy: Lessons from the crisis”, Working Paper, No 16755 (National Bureau of Economic Research, February 2011). 71. See

CRESPO CUARESMA

Jesús &

GNAN Ernest,

“Four Monetary Policy Strategies in Comparison:

How to Deal with Financial Instability”, Monetary Policy and the Economy (Oesterreichische Nationalbank, Q3 2008), pp. 65-102. 72. See K ING Mervyn, “Finance: A Return from Risk”, Speech to the Worshipful Company of the International Bankers at Mansion House (Bank of England, 17 March 2009); “Twenty years of inflation targeting”, The Stamp Memorial Lecture, London School of Economics (Bank of England, 9 October 2012). 73. See C ARNEY Mark, “Monetary Policy After the Fall”, Eric J. Hanson Memorial Lecture at the University of Alberta (Bank of Canada, 1 May 2013). 74. On the financial stability aspect, see in the present book the article by ESPOSITO Marie-Claude. 75. CARNEY Mark, “Monetary Policy After the Fall”, op. cit. 76. See BERG Claes, “The Global Financial Crisis and the Great Recession: Causes, Effects, Measures and Consequences for Economic Analysis and Policy”, Paper presented at a Workshop on Monetary Policy, Macroprudential Policy and Fiscal policy at the Centre for Central Banking Studies of Bank of England 17 May-19 May 2011 (Bank of England, 23 May 2011). 77. For other kinds of proposals, see The Economist, “Monetary policy after the crash”, 21 September 2013, ˂http://www.economist.com/news/schools-brief/21586527-third-our-seriesarticles-financial-crisis-looks-unconventional˃[25 September 2015]. 78. See

MISHKIN

Frederic, “Monetary policy strategy: Lessons from the crisis”, op. cit.; and

WOODFORD Michael,

“Monetary Policy Targets After the Crisis”, Paper presented at the Rethinking

Macro Policy II: First Steps and Early Lessons Conference Hosted by the International Monetary Fund (Washington, April 16-17 2013). 79. See C HAMPROUX Nathalie & SOWELS Nicholas, “The Monetary and Fiscal Policies of Early Thatcherism and the Legacy of the Medium Term Financial Strategy”, in ESPIET-KILTY Raphaelle (ed.), L’héritage du thatchérisme, Review Observatoire de la société britannique, La Garde, No 17 (November 2015), pp. 135-159. 80. See

THOMSON

Ainsley, “Cameron Backs ‘Activist’ Monetary Policy”, The Wall Street Journal (11

October 2010). 81. In fact, as regards inflation only, more monetary easing should have been implemented, in 2013 and 2014 at least. Indeed, the CPI growth rate, which had been falling regularly since July 2013 (with the exception of a small rebound in July 2014), reached 0% at the beginning of 2015 and has been fluctuating around this zero value ever since. See

BANK OF ENGLAND ,

Inflation Report

(February 2016), chart 4.1, p. 26. 82. On the debate of whether IT is the outcome of monetary theories and practices, or “the end of monetary policy history”, see the enlightening remarks by C ARNEY Mark, “Monetary Policy After the Fall”, op. cit., as well as the initial balanced view of D ODGE David, “Our approach to monetary policy – inflation targeting”, Remarks to the Regina Chamber of Commerce, (Regina, 12 December 2005).


19


ABSTRACTS This article demonstrates the extent and limits of the consequences that the 2008 financial crisis and the subsequent economic recession had on Britain’s monetary policy framework. It shows that, beyond the activation of unconventional practices, the crisis caused a reform that was not a complete overhaul of the framework. The bases of the framework dedicated to inflation targeting, that the Conservatives set in the 1990s and that New Labour consolidated at the end of the decade, have been maintained. The value of the reform nonetheless resides in the clarification of the principles of the flexibility of the system and in a move towards a better coordination between monetary and financial policies. The reform is thus embedded in the global progress of monetary theories. L’article démontre l’étendue et les limites des conséquences que la crise financière de 2008 et la récession économique qui a suivi ont eues sur le cadre de politique monétaire britannique. Il montre que, au-delà de l’activation de pratiques non-conventionnelles, la crise a entraîné une réforme qui n’a pas été une refonte totale du système. Les bases du cadre consacré au ciblage de l’inflation, telles qu’elles ont été instaurées par les Conservateurs dans les années 1990, puis consolidées par les Travaillistes à la fin de la décennie, ont été maintenues. La valeur de la réforme réside néanmoins dans le fait qu’elle clarifie les principes de la flexibilité du système et avance dans la direction d’une meilleure coordination entre les politiques monétaire et financière. La réforme s’inscrit ainsi dans l’évolution générale des théories monétaires.

AUTHOR NATHALIE CHAMPROUX Université Paris Est Créteil


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