The Bank of England’s new governor, Mark Carney, has adopted a 'forward guidance' policy, but just how much stability does such a strategy really provide for the economy?

Is a central bank more effective if we know how its managers are thinking and what its next moves are likely to be? It is fashionable to think so and the announcement by the Bank of England’s new governor, Canadian Mark Carney, that the UK central bank will provide forward guidance puts it on a par with the Federal Reserve in the US and the European Central Bank.

As things stand, forward guidance in the UK is being used as a way of telling markets that even though the economy seems to be picking up, the Bank of England is in no hurry to reverse its loose monetary policy by raising interest rates from the current 0.5%  level.

I am unconvinced the markets had any different expectations before this was formally consumed into a 'forward guidance' policy. For so long now, commentators have been saying that the UK’s recovery is weak and atypical and that care needs to be taken not to snuff it out.

In fact, the new forward guidance policy, by introducing several caveats, gives so much wiggle room that the markets may end up plotting out numerous alternative scenarios and acting upon these.

For example, there is a commitment to keep interest rates low until unemployment falls below 7%, which is not expected until mid-2016. But with unemployment at 7.8% it could easily breach that threshold before mid-2016, and as it gets close, armed with the 7% mantra, how will markets react? Remember how they reacted when Federal Reserve chairman Ben Bernanke gave them the 'forward guidance' that quantitative easing had to end one day (hardly a revelation).

In the UK situation, forward guidance has introduced three 'knock-outs' (from the policy link with unemployment) in the case of rising inflationary expectations and prospects of asset bubbles. This is now starting to get complicated – one market reaction to Mr Carney’s announcement was that it was a green light for buy-to-let mortgages and rising housing prices, all of which could lead to knockout number three (asset bubbles) in a rapid space of time.

Economic confidence comes from a lot of different sources, only one of which is monetary policy. Without doubt, central banks need to be credible and flexible to achieve their aims. The trend of independence for central banks, free from political interference, which began in the 1990s, arguably did more than anything else for this cause.

But central bank credibility (in the US, UK and euro area) has taken a knock as policy-makers meekly stuck to their narrow remit of inflation targeting at a time when asset bubbles were building and banks became too risky.

Mr Carney’s governorship will be judged a success not by the nature of his forward guidance, but by his courage to take tough decisions in the face of opposition from both politicians and markets.

Brian Caplen is the editor of The Banker

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