Mark Carney on inflation, housing bubbles and how he shook up the Bank

Besides the Q&A session with British MPs this morning, there was a written part to Mark Carney’s job interview. For you reading pleasure, we’ve uploaded the entire 45-page document here. Below is a selection of intriguing and Canada-relevant bits.

Mark Carney on Mark Carney:

I have experience in risk management in the private sector and crisis management in the public sector. In Canada, I was part of a team, which rapidly assessed the risks and instituted an effective, coordinated response to the global financial crisis, despite Canada’s deep integration with the U.S. economy and financial system.

(…)

Serving as Governor of the Bank of England will mark the pinnacle of my career. I am a strong believer in the value of public service, and I firmly believe that this responsibility offers me the opportunity to contribute where I can make the greatest impact.

On asking for a shorter term (five rather than the customary eight years):

At the end of a five-year the term, I will have served as a Governor of a G7 Governor central bank for over a decade. In my experience, there are limits to these highly rewarding but ultimately punishing jobs. Second, the five year term has advantages given the ages of my children and the disruption that is involved in moving schools and countries.

On shaking things up at the Bank of Canada:

… I believe I know how to lead, when to delegate and how to forge consensus. My experience as Governor of the Bank of Canada demonstrates a willingness and ability to implement significant organisational change. I manage an organisation of about 1,200people across six offices, four time zones and in two official languages. Upon becoming Governor, I initiated a major reorganisation of our four policy departments, clarified the lines of responsibility of senior policy-makers, streamlined and delegated operating management.

With the Senior Deputy Governor, I led a process to re-engineer the Bank’s administrative and support services. As a result of that process, the Bank has achieved ongoing annual savings of $15 million and reduced staff by 7 per cent.

Since becoming Governor, our employee satisfaction has increased and we were for the first time recognised as a Top 100 employer in Canada. We have now held that position for the past 3 years running. I believe this reflects an enhanced focus on workplace environment, clearer lines of authority, the opportunity for greater personal initiative and a sustained focus on internal talent management and development.

 I have a track record of attracting and retaining senior external talent to public life including leading academics, several managing directors from the financial sector and senior IMF staff. Since becoming Governor, the Chiefs of our four main policy departments have been developed and then internally promoted. We have instituted and extended a comprehensive talent management strategy for the top 50 employees.

On the occasional need to tolerate above- or below-target inflation, at least temporarily:

 There are, broadly speaking, three sets of circumstances under which it may be desirable to return inflation to target, from above or below, over a horizon that is somewhat longer than usual.

First, the unfolding consequences of a shock could be sufficiently large and persistent that a longer horizon might be warranted in order to provide greater stability to the economy and financial markets. Stability considerations could lead the Bank to accommodate over a somewhat longer period, for example, the inflationary consequences of an unusually large and persistent increase in oil prices, or the disinflationary consequences of a severe global slowdown, including the possible constraints of the zero lower bound on interest rates.

Second, through a longer targeting horizon, monetary policy can also promote adjustments to financial excesses or credit crunches. For instance, there could be situations where, even though inflation is above target, ongoing monetary policy stimulus and a somewhat longer horizon to return inflation to target would be desirable in order to facilitate the adjustment to broad-based deleveraging forces that are unfolding.

Third, as the Bank of Canada has observed, the optimal inflation-targeting horizon will vary with the evolution of the risks to the outlook. Shocks to the economy, both observed and prospective, are inevitably subject to a degree of uncertainty. In some situations, risks to the inflation outlook could be skewed to the downside. In these cases, a balance must be struck between setting monetary policy to be consistent with the most likely outlook and the need to minimize the adverse consequences in the event that downside risks materialize. This would warrant a more stimulative setting for monetary policy than would otherwise be desirable in the absence of the downside risks. However, if the downside risks fade away rather than materialize, the resulting stronger inflationary pressures would merit returning inflation to target over a longer horizon. The opposite would be true under circumstances where risks to inflation are skewed to the upside.

In short, changing economic circumstances could demand some flexibility in the horizon over which the Bank seeks to restore inflation to target.

On the flip side, a tighter monetary policy that allows inflation to run below target for a longer period than usual could help to counteract pre-emptively excessive leverage and a broader build-up of financial imbalances. In recent months, the Bank of Canada has used such guidance to reinforce macroprudential measures implemented by the Government of Canada. By indicating that some tightening of monetary policy may be necessary, a degree of prudence in household borrowing has been encouraged. For example, the rate of household credit growth has decelerated and the share of new fixed rate mortgages has almost doubled to 90 per cent this year.

There are limits to this flexibility. The Bank’s scope to exercise it is founded on the credibility built up through its success in achieving the inflation target in the past, and its clarity in communications when it uses it. That links to the second important feature of a flexible inflation target regime – clear and open communication.

On housing bubbles and what the central bank can and cannot do about them:

 ...I view monetary policy as the last line of defence against financial imbalances.

The effectiveness of monetary policy in in this regard depends on the nature of the imbalances, the influence of monetary policy and prudential tools on these imbalances, and the interactions between them. When financial imbalances remain concentrated in a specific sector, well-targeted macroprudential tools should usually be sufficient. Monetary policy is not well suited to address such imbalances, since monetary policy affects the entire economy, meaning that the interest rate increase required to curtail sectoral imbalances would come at the cost of undue restraint on the economy as a whole.

A credit-fuelled housing bubble is a particularly relevant example of a financial imbalance. Bank of Canada research suggests that a significant increase in interest rates could be required to stem the build-up of credit, with material consequences for output and inflation. This illustrates that monetary policy might be too blunt a tool to stem financial imbalances emerging in a specific sector. By contrast, macroprudential policy is as effective in addressing financial imbalances in the housing market without causing any undershoot in output or inflation. Rather, macroprudential in this scenario acts as a complement to monetary policy dampening the increase to output and inflation generated by the shock.

In this way, prudential measures will go a long way to mitigate the risk of financial excesses, but in some cases, monetary policy may still have to take financial stability considerations into account. For instance, where imbalances pose an economy-wide threat and/or where the imbalances themselves are being encouraged by a low interest rate environment, monetary policy might itself be the appropriate tool to support financial stability. Such could be the case when the risk-taking channel of monetary policy is present. The stance of monetary policy may itself lead to excessive risk taking by economic agents, which, in turn can lead to financial instability. Specifically, monetary policy could influence the degree of risk that financial institutions decide to bear by influencing their perception and pricing of risk.