Sir Mervyn King attacked proposals to ditch the Bank’s inflation target in favour of a growth target based on ‘wishful thinking’
Sir Mervyn King has launched a thinly disguised attack on his successor as Bank of England governor, deriding proposals to ditch the central bank’s inflation target in favour of a growth target based as “wishful thinking”.
King warned that policies designed to meet a growth target – a strategy backed by the incoming governor, Mark Carney – was unrealistic and for “dreamers”, signalling a rift with the man due to take over in Threadneedle Street in the summer after being lured by George Osborne from his post as Canada’s central bank chief.
The warning shot comes as Britain faces the prospect of a triple-dip recession and the possible loss of its AAA credit status.
King told an audience in Belfast: “To drop the objective of low inflation would be to forget a lesson from our postwar history. In the 1960s, Britain stood out from much of the rest of the industrialised world in trying to target an unrealistic growth rate for the economy as a whole, while pretending that its pursuit was consistent with stable inflation.
“The painful experience of the 1970s showed that this illusion on the part of policy-makers came at a terrible price for working men and women in this country. The battle to bring inflation expectations down was long and hard, and involved persistently high levels of unemployment,” he said.
“Wishful thinking can be indulged if the costs fall on the dreamers; when the costs fall on others, it is unacceptable. So a long-run target of 2% inflation should be an essential part of our macroeconomic framework.”
Figures on Friday are expected to show the UK economy shrank in the last three months of 2012 after a collapse in exports and consumer spending. Last week’s big freeze may be enough to end Osborne’s hopes of a quick recovery in the first months of this year, plunging Britain into its third official recession since the financial crash.
Higher public sector borrowing in December and the likelihood that the chancellor will fail to meet his annual borrowing targets could jeopardise the UK’s much-coveted AAA rating.
Carney floated the idea in a speech last year that central banks should devise policies to meet a healthy level of growth rather than fixate on inflation.
The governor-elect dropped a strong hint that he would favour more vigorous action to boost the UK economy if growth remained subdued when he takes over in June.
In a speech that appears to have upset King, Carney said central banks should be prepared to downgrade their inflation targets in the event of sluggish growth and instead set themselves the task of raising national output.
The speech was warmly greeted by many economists who have become frustrated at the lack of action at the Bank of England in the past three years.
A battle between the bank governor, often referred to as Britain’s most powerful non-elected official, and his successor is likely to make uncomfortable reading in the Treasury, which could be forced to take sides.
Osborne needs the central bank to pump funds into the economy to prevent a deep recession that would most likely follow steep cuts in public spending planned for the next six years.
Until now Osborne has kept faith with both men, telling parliament last month that he wanted to retain inflation targeting while also welcoming Carney’s less conservative stance.
However, the Treasury appeared to side with the governor after his speech. A spokeswoman said: “The chancellor has made clear [that] there [are] no plans to change the current monetary policy framework and agrees with the governor that keeping inflation under control is of vital importance.”
King was chief economist at the central bank in the 1990s when it was made independent by the then chancellor Gordon Brown. He devised the 2% inflation target, which he points out has recently been adopted by the US Federal Reserve and the Bank of Japan.
In an admission that reforms would be necessary, he said the Bank of England could follow the lead set by the Fed and signal to consumers and businesses how long interest rates will stay low. The Fed chief Ben Bernanke said last year that US base rates of 0.25% would remain for the next two years or until unemployment fell below 6.5%.
King has voted against increasing the size of the bank’s main lending programme, known as quantitative easing, arguing that a scheme offering high street bank’s direct loans should be allowed to work.
But the funding for lending scheme has come under attack from opposition MPs for bypassing small and medium-sized businesses. The latest lending figures show most loans went to homeowners to re-fiance their mortgages.
Adam Posen, a member of the bank’s monetary policy committee for three years until last summer, told MPs that he was in favour of more aggressive action to stimulate growth during his tenure, but was frustrated by a majority who voted for more limited measures.