THE Bank of England increase in its official rate paid on commercial bank reserves to 4.75 per cent was regarded as a surprise and treated as hot news. So, however, was the decision of the US Federal Reserve not to change rates, even though that was expected. The increase in rates announced by the European Central Bank (ECB) was equally expected but was written off as something in the pipeline.
I will resist the temptation to engage in a philosophical disquisition on what counts as news. Clearly, however, these central banks have different outlooks. The ECB is a traditional sound-money anti-inflation policymaker. The US Fed is, as usual, giving priority to the domestic economy in spite of the huge balance of payments deficit and even indicators of rising domestic cost pressures.
The Bank of England could claim to be regarded as the most hawkish of the three, as its real interest rate is about 2.0 per cent (depending on how it is measured) compared with less than 1.0 per cent for the US and about 1¼ per cent for the ECB. Fortunately, as a result of the Bank's operational independence, there is now no hate figure such as Margaret Thatcher or Tony Blair to act as a scapegoat.
The Bank does not seem quite so hawkish when it is remembered that even 2.0 per cent is at the lower estimate of normal or equilibrium short-term rates and that UK broad money growth has taken off in the past three years to reach a rate of some 13.5 per cent per annum, which far exceeds that of both the US and the euro area. Someone at the Bank of England has clearly intervened to see that the money supply is taken seriously, however unreliable it is as a short-term policy indicator, and however difficult it is to interpret the increased monetary holdings of "non-bank financial firms".
One way of making sense of these different moves is to ask what a world monetary authority might do. A clue is provided by a report from the Centre for European Policy Studies entitled A World out of Balance? It accepts that there was an incipient surplus of world savings two or three years ago at the time of the deflation scare, but this has been more than offset by the injection of liquidity which has still to be withdrawn from the world economy.
Its most controversial message is that the concentration of all central banks on a parochial view of the outlook for prices and growth is a mistake. It even has a section entitled "The curse of the domestic Phillips curve", the tool for bringing these things together. It advocates instead a triple emphasis on internal balance, asset prices and the balance of payments. I am not sure about the last, as on a world level the balance of payments problem disappears. As the philosopher and political economist David Hume remarked more than two centuries ago, we might worry about the balance of payments between English counties, except that long experience has made us relaxed about the matter.
The inadequacy of the conventional domestic labour market analysis is seen in the discussion surrounding the British interest rate decision. In its recent statement, the Bank pointed to a large number of factors showing that economic activity was speeding up, perhaps to above the trend growth of the economy in which there was little or no spare capacity. The main dissent came from those outside commentators who emphasise the unemployment figures, which have tended to rise. But so has the number of people at work. The solution to this paradox is almost certainly the increase in immigration from new members of the European Union, whom we were wrongly assured would not be coming here in large numbers. But if you take together the increased possibilities of migration and the ability of emerging economies to fill any increase in demand with a stream of products at low prices, the old analysis in terms of unemployment, wages and prices no longer applies, at least as a guide to domestic overheating.
Is there then overheating at the level of the world economy? The upward pressure on commodity, oil and gold prices all suggest that there is. These are muted in their impact on final consumer prices by international trade flows and the migration of workers. Even so, the upward movement of many domestic asset prices not included in official inflation indices is now making people suspicious of the latter.
One reader suggested to me that central banks should be sued for misleading the public. It would, however, be difficult to sue the Bank of England as its inflation index is laid down for it by the chancellor of the exchequer. A former director of the World Bank admitted to me that neither measuring inflation nor formulating monetary policy was easy. But: "It is the arrogance by which the central banks tell us how good they are at it that really kills us."
Meanwhile, the best chance both of stemming asset price inflation and of reducing world "imbalances" lies not in any policy moves, but in the cooling off in the US housing market that is now beginning.
FT Syndication Service