29 Sep 2015
Shadow Chancellor John O’Donnell said the party would review the mandate of the Bank of England with an eye to adding to its objective so that the British central bank doesn’t just target inflation, but also employment and economic growth, if it is successful at the next general election.
There is good reason to target both, as Linda Yueh, Adjunct Professor of Economics, London Business School explains: “One reason for the need to target both is the difficulty of pinpointing the relationship between inflation and unemployment. The Philips curve has become flatter, perhaps due to globalisation and external factors affecting prices more than before, so that there is a less pronounced relationship between inflation and unemployment.
“In this case, it may make sense to target both – provided that the target is clear and not a generalised second target around economic growth, which would be more likely to damage transparency.”
But this isn’t the BOE’s first facelift.
“Like other central banks, the Bank of England has already had a radical facelift in terms of its mandate”, Yueh explains.
“The relationship between price and financial stability had evidently broken down prior to the 2008 banking crisis. Low inflation masked the unsustainable build-up of credit in the U.S. and elsewhere, including the UK to some extent. So, the BOE and others have a new mandate to use macro-prudential tools to target financial stability whilst also maintaining the inflation target.”
The challenge is not the additional mandate, but the tools needed to execute it.
“There is also a coordination issue between the Financial Policy Committee and the Monetary Policy Committee”, says Yueh. “As that is being worked out, it may be a good time to adjust monetary policy still further if that means that central banks are better keeping up with the changing relationship between money, prices, growth and financial stability. The BOE has been at the forefront of the new paradigm for central banking in this respect, and it could continue to lead the way.”