There was an intriguing article in Wednesday’s US print edition of the Wall Street Journal. It was called, “UK is set to change its guidance on rate policy“. The article explains how the UK treasury has gotten itself into a little communications difficulty. Mark Carney, the governor of the Bank of England, and the Monetary Policy Committee, had suggested in August that interest rates would remain low for some time. The bank also communicated that no rate change would be considered until the national unemployment fell below 7%. In November the unemployment rate fell to 7.1% as the UK economy improved rapidly in the second half of 2013.
The original guidance was given to help business and consumers assume a stable monetary environment. When consumers and business leaders expect interest rates to increase, we may hold off with some investment vehicles. With higher rates, capital returns on savings will ncrease, so we may delay investment in order to seek a higher return once the rates increases. And since the economy and it’s current recovery is beholden to, among other things, flighty investment cycles, anything that could slow investments might actually slow the recovery. This is therefore a catch-22 situation.
The explicit targeting of specific metrics, and the communiocation of such targets, has been the bedrock of financial forward guidance since it started. I have in my hand the UK’s 1992/3 Financial Statement and Budget Report that made up what was then known as the Medium Term Financial Strategy (MTSB). This was an innovation that started in 1980 by Margaret Thatcher’s government, with Sir Geoffrey Howe (Chancellor of the Exchequr). This innovation was isntrumental in providing forward guidance to interst rates and inflation targets the business leaders could euqally use in their medium term business strategies.
The value of “forward and public guidance” however has been discouinted. This often takes place when the mesures targetted start to lose their impact. Thatcher’s government targetted one of the many forms of money supply as a means to predict inflationary pressures. However, in some periods, inflation rates changed in directions that were contrary to the targetted money supply. This does not mean forward guidance is wrong; it means our understanding of the drivers of the economy need updating.
So forward guidance and the communication this entails is therefore very important. Just a few months ago the US stock market gyrated markedly when the outdoing Fed Chairman, Ben Bernanke, signaled the start of ‘tapering’. So whispers and words can a market make.
Interestingly before we had forward guidance the market still moved when news percolated through the economy. With forward guidance it seems the historical erratic nature of those moves have gone, only to be replaced with a different set of gyrations. Presumably it is all for the better….
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