This week 10 central banks took policy decisions with seven banks maintaining rates while three cut rates (Australia, Romania and Jordan) but the Bank of England’s decision to settle on unemployment as a guide to future policy decisions dominated global monetary policy.
Reams of newspaper articles were written about the decision of the Bank of England (BOE) and its new Governor Mark Carney to pick a 7 percent jobless rate as a threshold for a possible change in monetary policy as part its new tool of forward guidance.
Flanking the unemployment threshold, the BOE added three conditions, including high inflation and financial instability that would “knock out” the unemployment threshold.
The BOE’s decision was interesting for three reasons.
Firstly, because it shows how unemployment has replaced inflation as the main concern of public policy. Secondly, it illustrates the growing role of financial stability in policy frameworks. Thirdly, it seeks to tackle uncertainty over how the economy’s supply capacity will evolve as demand improves.
Normally, an economy’s spare capacity rises following a recession but there is evidence that since 2009 the spare capacity within U.K companies has narrowed and productivity growth has been weak.
“That suggests that companies’ ability to produce output – and so the supply capacity of the economy – may have been eroded in recent years,” the BOE said.
The BOE really doesn’t know how much of the unusually weak growth in productivity is directly due to a lack of demand and how much is due to problems in banks and consumers’ uncertainty.
The danger facing the UK, and other advanced countries, is that a recovery in demand after years of extraordinarily easy monetary policy could quickly overwhelm supply and boost inflation, a scenario that evokes the inflationary threat of the 1970s.
Some of the concern over continued quantitative easing by major central banks stems from this uncertainty over how supply will adjust to an eventual rise in demand.
In a lecture in Basel this June, Raghuram Rajan, appointed this week as the next governor of the Reserve Bank of India (RBI), made the point that the growth capacity of industrial countries has been declining for decades. But this has been masked by debt-fuelled demand and only structural reforms will improve the capacity for future growth.
It is within this context of uncertainty that the BOE believes explicit forward guidance can enhance the effectiveness of monetary stimulus.
“First, it provides greater clarity about the MPC’s view of the appropriate trade-off between the horizon over which inflation is returned to the target and the speed with which output and employment recover. Second, it reduces uncertainty about the future path of monetary policy as the economy recovers. And third, it delivers a robust framework within which the MPC can explore the scope for economic expansion without putting price and financial stability at risk,” the BOE said.
Apart from the BOE, Australia’s served up the main shift in policy this week with a widely-anticipated rate cut, the Reserve Bank of Australia’s eight rate cut since embarking on an easing cycle in October 2011 as it adjusts to a slowdown in mining investments.
The seven central banks that left rates on hold this week include Russia, which signaled that it is moving closer to a rate cut, Japan, Korea, Serbia, Peru, Uganda and Uzbekistan.
Through the first 32 weeks of this year 24.5 percent, or 76, of this year’s 310 policy decisions by the 90 central banks followed by Central Bank News have led to rate cuts, marginally up from 24.3 percent last week and 24.1 percent the previous week.
Central banks in emerging markets have been aggressive in cutting rates this year, accounting for almost one-third of all rate cuts, while less than one-tenth of this year’s rate cuts have come from developed market central banks. That figure, however, does not capture the quantitative easing by major central banks, such as the
Bank of Japan which embarked on a new more aggressive phase of quantitative easing in April.
But central banks from countries that fall outside the MSCI classification, i.e. countries with less developed capital markets and economies, have been responsible for the largest share of rate cuts, accounting for 41 percent of all rate cuts. This illustrates the widespread lack inflationary pressures from weak global demand.
LAST WEEK’S (WEEK 32) MONETARY POLICY DECISIONS:
| COUNTRY | MSCI | NEW RATE | OLD RATE | 1 YEAR AGO |
| UGANDA | 11.00% | 11.00% | 17.00% | |
| ROMANIA | FM | 4.50% | 5.00% | 5.25% |
| UZBEKISTAN | 12.00% | 12.00% | 12.00% | |
| AUSTRALIA | DM | 2.50% | 2.75% | 3.50% |
| JORDAN | 4.75% | 5.00% | 5.00% | |
| JAPAN | DM | N/A | N/A | 0.10% |
| KOREA | EM | 2.50% | 2.50% | 3.00% |
| SERBIA | FM | 11.00% | 11.00% | 10.50% |
| PERU | EM | 4.25% | 4.25% | 4.25% |
| RUSSIA | EM | 8.25% | 8.25% | 8.00% |
Next week (week 33) four central banks are scheduled to hold policy meetings, including Armenia, Georgia, Indonesia and Sri Lanka, which moved its policy review meeting to Aug. 16 from this week when it was tentatively scheduled.
| COUNTRY | MSCI | DATE | RATE | 1 YEAR AGO |
| ARMENIA | 13-Aug | 8.00% | 8.00% | |
| GEORGIA | 14-Aug | 4.00% | 5.75% | |
| INDONESIA | EM | 15-Aug | 6.50% | 5.75% |
| SRI LANKA | FM | 16-Aug | 7.00% | 7.75% |
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