In my previous post, I suggested that the best way to assess monetary policy is by comparing the target variable to the target. This is the only proper way to evaluate the stance of monetary policy. Interest rates and monetary aggregates might be useful guides, but they are only intermediate targets. An explicit target is also important because it helps to anchor expectations. As a result, I have been watching monetary policy in the U.K. closely. The Bank of England undertook quantitative easing while maintaining their explicit inflation target. In addition, they provided guidance as to their target for nominal income growth as well.
The reason that one should be interested in the Bank of England is because they are following a policy roughly consistent with those advocated by folks like me, David Beckworth, Scott Sumner, Bill Woolsey, and others: anchor expectations with an explicit goal — preferably for nominal income — and use quantitative easing when interest rates fall near zero.
As I alluded to in the previous post, inflation has been running at the top end of the target set by the Bank of England and today the WSJ reports:
Another quarter, another surprisingly strong U.K. growth figure. Growth of 0.8% in the third quarter smashed the consensus estimate, pitched at just half that level, and also demolished any thought that the Bank of England might move towards more quantitative easing at its meeting next week. The U.K. economy is looking resilient.
The U.K. economy has now expanded 2.8% in the last year, a little above the average for the pre-crisis decade of 2.6%. Encouragingly, growth is broad-based across services, construction and manufacturing; the latter has now racked up annual growth of 5.3%, the strongest year-on-year rise for 16 years, Barclays Capital notes. Despite concerns, service-sector growth held up at 0.6%, the same pace as the second quarter. Indeed, worries that the U.K. is experiencing a particularly bumpy recovery are starting to look overdone. That should help unlock corporate spending and hiring.
Investors hadn’t expected such strong growth: sterling shot up against the dollar and 10-year gilt yields rose more than 10 basis points as markets judged that more BOE bond purchases were a vanishing prospect. Of course, the fiscal tightening set out in last week’s comprehensive spending review may drag on growth in coming months. But there is no case for the BOE to be loosening policy now, with inflation stubbornly above target and nominal growth close to 6%; Citigroup notes this means that policy makers are above the trend growth rate of 5% that the BOE targeted in undertaking round one of quantitative easing.
In other words, the Bank of England has shown us that QE works.