The Bank of England Monetary Policy Committee was not designed to achieve consensus, and cracks are appearing again after a period of harmony.
The second phase of forward guidance put labour market spare capacity at the heart of policymaking, and MPC members are at odds over how much slack there is. As Andy Haldane, who becomes chief economist on June 1 says, the divisions are likely to harden the closer the exit from the extraordinary stimulus is.
Each MPC member votes to set interest rates at the level he, or she, believes is consistent with hitting the inflation target.
As the BOE states in its description of the committee: “The MPC’s decision is made on the basis of one-person, one vote. It is not based on a consensus of opinion.”
The minutes for the March 5 and 6 MPC meeting were an exception to the rule in recording no disagreements among members, and some differences of view duly re-emerged in April.
MPC members are sensitive to any charges of group think.
Haldane, at his confirmation hearing at the Treasury Committee Wednesday, was asked about the odd harmony on the committee. With Bank Rate at just 0.5% and no-one pushing for more stimulus through quantitative easing, Haldane suggested the appearance of consensus was unsurprising.
“One very mechanical reason why that might be is that interest rates are on the floor, and they can’t go through the floor,” Haldane said.
“I think there are conjunctural reasons why there is an appearance of uniformity, homogeneity. I think, however, there are already signs of some differences of views across the committee on some issues,” he added.
The prime disagreement is over “how much spare capacity do we think there is in the UK economy right now.”
“That … is the fulcrum of the second phase of forward guidance. We have already heard from various speeches that different members of the MPC have somewhat different judgements on what the right number for spare capacity might be,” he said.
“We have also heard a degree of dissent about how useful forward guidance might be. As we come close to the point where we begin the process of unwinding this extraordinary monetary stimulus the scope for disagreement, I think, is likely to pick-up,” Haldane added.
The divide over the amount of spare capacity is easy to quantify. In the BOE’s February Quarterly Inflation Report the estimate was labour market spare capacity was in a 1% to 1.5% range, but by March Governor Mark Carney and MPC member Martin Weale were already estimating it respectively at a little above and below that range.
“I personally would be at the upper end of that range and … at the margin, given the most recent employment report, it would be probably be slightly higher than 1.5%,” Carney said.
Weale promptly came out with an estimate putting labour market slack at just 0.9%. The disagreements centre on how to treat the under-employed and the self-employed: are, for example, people who say they want to work more hours going to keep saying this if pay rates accelerate and/or their partners find work as unemployment continues its precipitous decline?
MPC member Ian McCafferty in notes from a presentation, issued Tuesday, set out why observers shouldn’t place great weight on the 1% to 1.5% range – which is simply a central estimate.
“If we were to take a one standard deviation range of each of the components of labour market slack, and sum the lower and upper estimates of each, we would reach a range estimate for the level of slack of between nought and 2.5%,” he said.
McCafferty noted the clash between the BOE’s assumptions on slack and its own agents’ report which found evidence of skill shortages and recruitment difficulties in some sections of the labour market, such as engineering, IT and management.
Other private sector surveys, such as the Recruitment and Employment Confederation one, showed permanent salaries rising at their fastest rates since July 2007 and a steepening decline in job candidate availability.
Rather than taking Carney’s view there is still plenty of slack around in the labour market, with the jobless rate at 6.9% and the economy growing above trend, it’s possible to construct an argument the amount of slack may be slender and disappearing fast.
McCafferty said with all the uncertainty around slack it was equally important to look at directly observable indicators, such as pay deals and corporate pricing.
He warned against taking taking false comfort from the current apparent lack of upward price pressures.
“At this stage of the recovery, it appears that the early supply chain pricing environment remains benign. But turning points are hard to predict and can be quite abrupt, and, in light of the revival in pay – which after all makes up companies’ main input cost – we must not be complacent,” he said.
In Phase Two forward guidance, activated now the jobless rate is below 7%, the MPC said when rate hikes did come they were likely to be gentle and gradual.
The hawks on the committee, however, can turn the sense of this apparently reassuring statement upside down.
Theory says if a central bank is late tightening, waiting until spare capacity is largely used up and inflation pressure mount, it will have to tighten more aggressively.
So to ensure rate hikes are gradual the MPC may need to start early – and the debate among analysts is whether the first hike, which will almost inevitably come in a Quarterly Inflation Report month, will be as soon as this November or, as most believe, in February or May next year.
“A gradual trajectory for rates can be ensured only if the first rate rise is not held back, such that we start the normalisation process before the economy reaches effective capacity constraints, so that inflation expectations and pressures are kept well in check,” McCafferty said.
The first dissenting votes in favour of tighter policy on the MPC may not be that far away and, as Haldane says, the disagreements are likely to intensify as the stimulus exit looms.