Mark Carney quick to stamp his authority on BoE

When Mark Carney makes a likely return to Canadian shores in 2018, it is possible that the Bank of England's main interest rate will not have budged from 0.5 per cent - the lowest level in the institution's 319-year history.

The BoE's decision to follow the US Federal Reserve's lead and promise to keep interest rates low until the UK economy adds what, according to the Monetary Policy Committee's current thinking, is likely to be around three quarters of a million jobs, could leave rates low for the duration of his five-year term.

Interest rates have already been at 0.5 per cent since early 2009. The BoE's commitment to keep monetary policy ultra loose until unemployment falls to 7 per cent, so long as price and financial stability are maintained, already implies rates will remain on hold for at least another three years - way past the mid-point of the governorship of Mr Carney.

The MPC, which for the first time on Wednesday unveiled a forecast for unemployment, does not expect the joblessness rate to fall from its current level of 7.8 per cent to 7 per cent until mid-2016. But it is easy to imagine a scenario where rates stay at 0.5 per cent for longer than this.

The Office for Budget Responsibility, the UK's fiscal watchdog, said in March that unemployment would stay above 7 per cent until 2017. Mr Carney was also quick to point out that unemployment, at that level, was still unacceptably high.

"Seven per cent is merely a 'way station' at which the MPC will reassess the state of the economy, the progress of the economic recovery, and, in that context, the appropriate stance of monetary policy," he said.

In its inflation report, the BoE made clear that an unemployment rate of around 6.5 per cent is more consistent with an economy that has returned to full health. In the longer run, it believes unemployment should fall as low as 5 per cent. That implies further forward guidance, rather than rate hikes, could follow once unemployment hits 7 per cent.

The MPC has opted to focus on unemployment because it believes it is the best measure of what is known in economists' parlance as "slack", which measures the difference between the level that growth is at and what it could be if the economy were operating at full capacity.

"There are one million more people unemployed today than before the financial crisis; and many who have jobs would like to work more than they currently can. The weakness in activity has also been accompanied by exceptionally weak productivity," Mr Carney said. "It is for these reasons that the MPC judges there to be a significant margin of slack in the economy, even though the extent of that slack, particularly the scope for the productivity rebound, is very uncertain."

As uncertain a measure of slack as it might be, former policy makers agreed that the current MPC's choice to make its forward guidance conditional on unemployment rather than another economic variable was wise.

Charles Goodhart, a founding member of the MPC, said: "One of the advantages of using unemployment is that it's a lot clearer than nominal GDP for operational purposes. It's not always getting revised."

"Carney has been bold. This guy's an operator. He's dominating the committee . . . He's stamped his authority on UK policy very quickly," said Sir John Gieve, a former deputy governor at the Bank of England. "Unemployment's the right thing to choose. It moves quite gradually, it is a definitive number, it isn't often revised and it's easy for the public to understand."

As well as making monetary policy easier to understand, the focus on unemployment could improve its relations with the public by allowing the BoE to do more to stress its role in supporting growth.

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Mr Carney said on Wednesday: "There is understandable relief that the UK economy has begun growing again. But there should be little satisfaction. Much is at stake as we seek to secure this recovery and return inflation to target.

"A recovery in productivity driven by demand would mean faster growth in real incomes. Such outcomes would represent real improvements in the lives of people across the nation."

Relatively high inflation, coupled with poor wage growth, has hit British workers in recent years. For a workforce that has seen an appreciable decline in real wages in recent years, the new governor's sentiments are likely to be warmly welcomed.

The BoE's decision to link monetary policy to the rate of joblessness means the Labour Market Survey will now face a higher degree of attention than before.

Simon Wells, economist at HSBC, said: "From now on, BoE watchers will be scrutinising this unemployment projection every quarter, in order to predict the outlook for monetary policy.

"The Bank seems to think that it takes so long for unemployment to fall because there is plenty of scope to grow via increased productivity, and from part-time workers moving back to full-time jobs."

The BoE's actions on Wednesday will also place renewed focus on a question that economists in both the UK and the US have spent years trying to answer: what constitutes full employment?

The question is important for monetary policy because, if unemployment is higher than it could be, then there is slack in the economy, which means central bankers should do more to boost demand. The BoE made clear on Wednesday that the so-called "equilibrium" rate of unemployment changes over time.

"The factors shaping the labour market in the long run include the extent to which potential employees are aligned with vacancies in terms of skills, location and occupation as this determines how long it might take those companies to fill those vacancies," the BoE said.

"Labour market flexibility - in terms of hiring and firing, and in offering people the option of part-time working or self employment - affects people's willingness to work and companies' willingness to offer jobs. And the influence of trade unions has an effect on wage bargaining power." The benefit regime also plays a role.

As the new governor acknowledged on Wednesday, such factors are beyond the scope of monetary policy. The rate of unemployment consistent with medium-term price stability was, he said, "a rate that monetary policy can do little to affect".

More of the responsibility for the long-term rate of unemployment lies with government than the UK's rate-setters. But Mr Carney will hope that the MPC can do enough to help create jobs to ensure that he gets to hike rates at least once before his time at the BoE is up.

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