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Carney’s (old) new normal

Summary:
There are many uses of the phrase “new normal” in economics these days. Usually, it is used to signify lower growth or a different type of growth than in the pre-crisis period. Mark Carney went onto the radio this morning to talk about the “new normal” in monetary policy. Interest rates would be materially lower in future than the 5 per cent rate widely seen as normal before the crisis. The Bank of England governor’s words have been widely reported as a big new statement of policy. Is this a new policy? No. Carney first talked about future interest rates being “well below historical norms” in his January speech at the World Economic Forum in Davos, which confirmed the BoE had ditched its original forward guidance linking interest rates solely to unemployment. The important passage was reported clearly in the FT at the time and is copied below. In February this year, David Miles, an external MPC member, devoted a whole speech to “the transition to a new normal for monetary policy”, in which he said that higher margins on mortgage lending, among other things, meant “the equilibrium policy rate [will be] as much as 2 per cent, and conceivably a little more, below what we used to think of as normal”. Did Carney make a commitment on the radio? No.

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Carney’s (old) new normalThere are many uses of the phrase “new normal” in economics these days. Usually, it is used to signify lower growth or a different type of growth than in the pre-crisis period. Mark Carney went onto the radio this morning to talk about the “new normal” in monetary policy.

Interest rates would be materially lower in future than the 5 per cent rate widely seen as normal before the crisis. The Bank of England governor’s words have been widely reported as a big new statement of policy.

Is this a new policy?

No. Carney first talked about future interest rates being “well below historical norms” in his January speech at the World Economic Forum in Davos, which confirmed the BoE had ditched its original forward guidance linking interest rates solely to unemployment. The important passage was reported clearly in the FT at the time and is copied below.

Carney’s (old) new normal

In February this year, David Miles, an external MPC member, devoted a whole speech to “the transition to a new normal for monetary policy”, in which he said that higher margins on mortgage lending, among other things, meant “the equilibrium policy rate [will be] as much as 2 per cent, and conceivably a little more, below what we used to think of as normal”.

Did Carney make a commitment on the radio?

No. He said that in the three-year time horizon of the BoE’s quarterly forecasts, both financial markets and the central bank have penciled-in interest rates rising to around 2.5 per cent. The governor then said

“We consider that as not inconsistent with returning the economy to full employment. “

That is far from a pledge to keep interest rates no higher than 2.5 per cent. In addition, Carney insisted he was offering no guarantees.

Will interest rates go above 2.5 per cent?

Yes, probably. A “new normal” of 2.5 per cent is not a ceiling, but an average. That is why the BoE is insisting that banks check new mortgage borrowers can afford mortgage rates of 7 per cent before lending to them.

Does this mean my mortgage rate will not rise higher than 2.5 per cent?

No. One of the reasons for the “new normal” being lower is that the interest rate gap between the BoE’s official interest rate and mortgage rates is expected to remain higher in future than in the past. Carney said banks would continue to pass the costs of tougher regulation to customers. In response, the BoE is likely to keep its interest rate lower so that the interest rates paid by borrowers is roughly right to keep demand and inflation under control.

Should I buy a house knowing interest rate rises will be “limited and gradual”, as Carney says?

That is your decision. Remember, less than a year ago the BoE thought unemployment would remain above 7 per cent until mid 2016 and the guidance therefore suggested interest rates would be stuck at 0.5 per cent at least until late 2016.

Now Carney is suggesting rates of 2.5 per cent in early 2017 are consistent with a stable recovery. Perhaps the new guidance will last longer than the old guidance. The past year has taught us all not to rely too much on central bank guidance.

Chris Giles
Chris Giles is the Economics Editor of the Financial Times. Before that he was a leader writer. He reports on international and UK economics and writes a fortnightly column on the UK economy.

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