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Wednesday, July 02, 2003

Central Bankers to the Rescue?

A heartfelt welcome for Mervyn King, and some reflections from the Economist:

Will the new men make a difference?

Mervyn King took over as governor of the Bank of England this week; sometime later this year a new head of the European Central Bank will be appointed; and Alan Greenspan’s current term as Fed chairman ends in 2004. Does any of this matter in the real world?

IT IS hard not to be impressed by the hushed air of grandeur at the Bank of England. Pink-coated footmen still attend the governor and other senior officials in the quaintly named parlour (offices to you and me). Mervyn King has long wanted the top job, and on Tuesday July 1st he at last joined the select group of men who have ruled that historic institution.

With inflation low, and Mr King’s predecessor, Sir Edward George, unusually well-known and generally popular, the new governor has taken over at a time when the bank is well-regarded. But Mr King has already said that he thinks the next few years will be a more difficult time, as the government caps the growth of personal consumption in order to finance public spending. The new governor is prepared to endure more criticism in a period of greater austerity. But if belts do have to be tightened, how far will the bank be to blame? Do central banks really have that much impact on people’s lives?

The question is worth asking, because Mr King has taken over in London at a time of turbulence—both for the world economy and for central bankers............
In part, the contribution that central bankers make depends on the powers they have. One reason for the Bank of England’s current popularity is that a period of unusual stability—by the standards of the British economy—coincided with the decision of the incoming Labour government to give the bank control over setting interest rates in 1997. The government gives the bank an inflation target; it is then up to the Monetary Policy Committee (MPC), comprising Bank insiders and some external appointees, to deliver inflation as near that target as possible.

With some modest tinkering with interest rates, the MPC has been remarkably successful at meeting the objective set for it. Some economists, though, reckon that this is more a reflection of the underlying stability of inflation in the British economy than anything the Bank of England has done. They note, for instance, that inflation has been reasonably close to 2.5%—the current target—for the best part of ten years, long pre-dating the establishment of the MPC.........

In spite of questions about the Fed’s handling of the boom years of the late 1990s, Mr Greenspan is still generally regarded as having done a good job. That view might change if the economy fails to regain momentum this year or, worse, if deflation becomes more of a worry. Doubts persist, though, about the extent to which monetary policy in a large economy should be dominated by one man. Pressure in America for a more detailed framework is likely to grow. Meanwhile, if Mr King is right about a bumpier ride for the Bank of England in the coming years, he will be grateful that the MPC is there to share the blame.
Source: The Economist

I think Mervyn King is right about the bumpy ride, and I think he understands only too well the principal pre-occupation: the housing boom. This really seems to be given such importance that it figured as one of the principal arguments as to why this was not the right time for UK euro entry. My feeling also is that he is probably the most economically intelligent of the new generation of central bankers. A quick google around the topic "Mervyn King Debt Deflation" will among other things turn up this paper . Whether this intelligence will serve for anything depends on the answer you give to the question at the head of the Economist article. I had the nerve to write to him once saying I thought his watch at the BoE might turn out to be the most difficult one since the time of Montagu Norman. I hope I'm wrong, but that is still my opinion. Welcome aboard Mervyn.

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