Mervyn King’s speech to Welsh business people in Cardiff is a significant speech. It highlights a number of important ideas that must be considered if there remains any opportunity of returning to normal monetary policy.
Synopsis
He starts off by explaining the policy paradox: policy is directed in a way that does not match the long term growth path. The UK is seeing growth accelerate domestically as a result of policy but it is not, yet, addressing the long term problems such as more exports, less debt and a greater level of savings and investment.
He believes monetary policy is still effective. There are more gilts to be bought,the number of gilts in private hands is at record levels. Though rates may not change substantially, he believes further purchases can lead to lower risk premia for other asset classes, and so higher prices.
But he goes on to say that the right path must be rejoined. It cannot be put off forever. One such example is the investment in retail shopping space. King believes much of it is now obsolete and will never be useful again. Demand and output must now reflect this fact. He also highlights a lack of capital in the banking sector.
His final point goes to the definition of “good” and “bad” money creation. “Good” money creation can be defined as the money created to maintain price stability. “Bad” money is the money created by government to finance its fiscal expenditure. It is for this reason that he rejects the notion of the Bank of England squaring the debts of the Exchequer, as though they were the one entity.
Apart from removing the credibility of central bank independence, King highlights a similarly important reason to not undertake this policy: what does the Bank sell when it needs to tighten policy?
Conclusion
King’s speech is very important. It signals the start of a long and dangerous process. As such it suggests markets start behaving slightly differently. This fits with his Maradona Theory of Interest Rates – he’s setting expectations without necessarily changing policy. This means one way or the other the UK is beginning the process of long term structural adjustment and policy may be less concerned by short term cycles.
I would also argue that other policy makers need to start thinking about things this way. It’s not fair on coming generations to put off the structural adjustment in perpetuity. The structural adjustment must occur.
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