Monday 18 February 2019

Dan White: ECB is odd man out over unemployment

The decision by Bank of England to link interest rates to jobless figures follows that of the Federal Reserve

Dan White

NEW Bank of England governor Mark Carney's promise that he won't raise interest rates until British unemployment falls below 7 per cent, leaves the ECB as the odd man out among the world's major central banks in not linking interest rates to the health of the wider economy.

When UK Chancellor of the Exchequer announced last November that Mr Carney, who had earned his spurs as head of the Canadian central bank during the 2008 financial crisis, was to succeed Mervyn King as boss at the Bank of England, it was clear that major change was on the way at the Old Lady of Threadneedle Street.

Quite how much change became clear last Wednesday when, breaking with the impenetrable gobbledygook favoured by his predecessors, Mr Carney stated in plain English that, barring a sudden, unexpected upsurge in inflation, the Bank of England would not raise official UK interest rates until the unemployment rate falls below 7.0 per cent.

With the British unemployment rate currently standing at 7.8 per cent, analysts are predicting that the UK would have to create at least a net 750,000 new jobs between now and the end of 2016 before the Bank of England would raise its official interest rate from the current all-time low of just 0.5 per cent.

Just for good measure, Mr Carney also promised that the Bank of England would leave its stock of quantitative easing (i.e.

printing money) unchanged at its current level of £375bn — the equivalent of about a quarter of British GDP. He further pledged that QE would be increased if necessary.

Mr Carney's remarks came just three weeks after Fed chairman Ben Bernanke explicitly linked the future path of US interest rates with unemployment when he told Congress that the US jobless rate would have to fall below 6.5 per cent before he would consider increasing interest rates. US unemployment currently stands at 7.6 per cent.

In fact, the link between Fed interest rates and US unemployment is even more explicit than Mr Bernanke's remarks would suggest.

Following its lamentable performance during the Great Depression, Congress explicitly wrote maximising the level of unemployment as well as maintaining price stability into the legislation, dictating the factors which the Fed must take into account when setting interest rates.

Last week's comments from Mr Carney would seem to indicate that the UK is also moving towards a twin-track monetary policy where employment levels as well as likely inflation expectations must be taken into account when setting interest rates.

The change has been even more dramatic in Japan where prime minister Shinzo Abe ran on an explicitly reflationary economic programme in last December's general election in which he won a landslide victory. When the Bank of Japan objected to his policies — dubbed Abenomics — Mr Abe made it explicitly clear that it was he rather than the Bank which called the shots, threatening to introduce legislation stripping the Bank of Japan of its independence.

A suitably-chastened Bank of Japan quickly realised the error of its ways and is now, we happily report, an enthusiastic supporter of Abenomics.

What the Bank of Japan episode shows is that central bank independence — a fetish much loved by many in the ECB and the German Bundesbank — is a convenient myth.

The reality is that the only independence that central banks really enjoy is the freedom to make and implement decisions which elected politicians know in their hearts of hearts need to be made — but for which they are reluctant to pay the price at the ballot box.

Even the much-vaunted independence of the mighty Bundesbank has on occasion been more apparent than real. In 1990, in the run-up to German independence, the then West German Chancellor Helmut Kohl decided, over the strenuous objections of then Bundesbank boss Karl- Otto Pohl, to convert East German marks into D-marks at a hugely favourable one-for-one exchange rate. Mr Pohl resigned in a huff the following year.

More recently Axel Weber quit as Bundesbank president in 2011 when German Chancellor Angela Merkel refused to back his opposition to the ECB's purchases of the government bonds of peripheral Eurozone members.

So where does all of this leave the ECB, which is now the only one of the world's leading central banks that doesn't link its interest rate decisions to employment levels as well as inflationary expectations? Average Eurozone unemployment rate now stands at an all-time high of 11.9 per cent, much greater than in either the US or the UK. However, the jobless rates are even higher in the Eurozone periphery, over 26 per cent in both Spain and Greece, 17 per cent in Portugal — and "only" 13.5 per cent in Ireland.

Recent developments in the UK and the US will make it even more difficult for the German-led hawks on the ECB's governing council to push up interest rates any time soon. That's not enough. With a whole generation being threatened by the scrapheap of unemployment, ECB president Mario Draghi must, like his Fed and Bank of England counterparts, be mandated to explicitly target unemployment when setting interest rates.

Online Editors

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