Assessing the official Brexit simulations

The release of three sets of Brexit impact studies this week showed quite clearly that there is no such thing as a Brexit dividend. To use Boris Johnson's famous metaphor, the choice is between having a cake and eating it - we can't do both. Like the slow motion car crash that I have long used to describe the whole Brexit process, the car is about to hit the tree.

There can be no doubt that the quality of the analysis underpinning each of  the studies is first rate and although the teams involved were able to devote considerably more resources to their analysis than I was, their numbers are not too dissimilar to my own.

Starting first with the analysis produced by the National Institute, their simulations suggest that the Withdrawal Agreement which is to be put before parliament in two weeks' time will cost 4% of GDP compared to the case where the UK remains in the EU, largely due to a reduction in trade with the EU, with services particularly affected. As they put it, "this is roughly equivalent to losing the annual output of Wales or the output of the financial services industry in London." To put it in terms of the cost to individuals, this reduces income per head by around 3% which is the equivalent of £1000 per person. 

The government's own simulations also represented a considerable intellectual tour de force. They were based in four scenarios: (i) The Chequers Plan set out in the summer (and rejected by the EU); (ii) a Free Trade Agreement; (iii) EEA membership and (iv) no-deal. Unlike NIESR it did not consider the agreement reached last week – the FTA is probably the closest we are likely to get. It was also useful that the modelling strategy separated trade costs from the impact of changing migration assumptions. In terms of results, the discredited Chequers Plan implies the lowest output losses relative to the baseline of remaining in the EU, with output losses between 0.6% and 2.1% of the baseline (depending on assumptions used for the extent to which non-tariff barriers are raised – see below). EEA membership implies a loss around 1.4% of baseline GDP whilst an FTA or no-deal could lead to losses of 6.7% and 9.3% respectively on the assumption of no new net migration (in line with the government's plan).

These numbers focus only on the longer-term costs (15 years). But the worst case outcomes imply huge short-term disruptions and it may be the case that there are even bigger losses in the near-term which are partially offset in the longer term. In other words, if there are big short-term output losses this will matter more to people's perception of the Brexit costs than the long-term outcomes. 

The BoE’s analysis focuses on the near-term losses up to five years ahead and models a number of possible outcomes ranging from a disorderly Brexit, a disruptive Brexit; a less close relationship with the EU and a close relationship. In the latter two cases, the impact relative to baseline is minimal. But in the disorderly Brexit scenario, the term premium on UK government bond yields rises by 100bps and sterling collapses by another 25%, in addition to the 9% since June 2016. In this case the inflation rate spikes up to 7.5% whilst output falls by between 7¾% and 10½% which drives the unemployment rate up to 6.5% (see table below).

Indeed, the BoE's simulations dominated the headlines this morning. What was less remarked upon was why the BoE predicted such a large short-term decline in output. It transpires that the worst case scenarios point to a big rise in interest rates to combat a surge in exchange rate-induced inflation (Bank Rate rises to 5.5%). This apparently counter-intuitive result is all to do with the structure of the models used by the BoE. The main simulation tool is a so-called Dynamic Stochastic General Equilibrium (DSGE) model. One of these days I will look at them in more detail but suffice to say they assume that Brexit represents a supply shock that results in a slowdown in potential GDP growth and thus to a narrowing of the output gap. This in turn leads to a rise in inflation expectations at the same time as measured price inflation is picking up, and the model assumes that the BoE will respond by tightening policy, which of course exacerbates the effect of the initial Brexit shock on output.

It is a moot point as to whether the BoE will really respond in such a way. My guess is that it will not and will act in a similar fashion to summer 2016 by assuming that inflation is a one-off exogenous shock that will eventually fade. After all, households will not react kindly to a big income squeeze if interest rates are being raised and I maintain that the BoE will be forced to ease monetary policy rather than tighten it.

Perhaps what all this analysis suggests is that we have to be aware of the different types of models and in-built reaction functions when interpreting the simulation results. Although all the modellers have been explicit about the assumptions and models used, it is difficult enough for specialists to figure out exactly what is going on. Thus the average person on the street has no chance. It is therefore easy for charlatans like Jacob Rees-Mogg to dismiss the carefully constructed analysis as part of Project Fear.

It may indeed be true that the worst case outcomes do not materialise. But for his ilk to dismiss the costs associated with a no-deal Brexit is irresponsible. It is certainly unworthy of JRM to dismiss Mark Carney as "a second tier Canadian politician", particularly when he himself has never held a frontline political position and struggles to count to 48. The sky may not fall in next March, in which case it will be the result of a degree of preparedness on the part of responsible adults such as Carney. But if it does, we know where to come looking to apportion the blame.

The case for a UK rate hike

The Bank of England is widely expected to raise interest rates by 25 bps this week, taking them above 0.5% for the first time since March 2009. The markets seem convinced, pricing such an action with a probability around 90%. It would be a major surprise if the Bank were not to deliver, with the markets so apparently sure. Indeed, if the BoE had a problem with current market pricing it would almost certainly have said something before now to try and nudge expectations. The fact that it has not done so is a strong indication in favour of a policy tightening. (If a rate move is not forthcoming … well, that is another story and we will deal with it if it happens).

There are those who believe that raising rates is a mistake (or at the very least that there is no need to act now). Their argument is sound enough: Price inflation is slowing; wage inflation is not picking up as anticipated and there are sufficient headwinds from Brexit that caution is warranted. If we were talking about an economy in which rates were a little bit higher than those introduced when the economy was about to fall off a cliff in 2009 I would be a bit more receptive to that view. But we’re not! Whilst Bank Rate of 0.5% may have been appropriate for an economy which was expected to contract by more than 3% in real terms, it is hard to make the case that is still the right interest rate 9 years later for an economy expected to grow by 1.5%.

For quite some time, I have believed that the UK rate setting process has taken an overly short-term approach to monetary policy. By looking only at short-term issues (e.g. the latest inflation or growth data) policymakers have been able to defer the need for a policy tightening. But in so doing, they appear to have suffered from what we might term “horizon myopia” without taking account of the fact that all these short terms eventually add up to an extended time horizon.

My argument for raising rates is the same as it has been for the last 3-4 years: The current interest rate is too low for general economic conditions. Those who believe that nominal GDP growth should act as a benchmark for the policy rate – and I am semi-persuaded of the merits of such a policy – argue that UK interest rates have deviated from GDP to an unprecedented degree in recent years (see chart). By itself, that is not proof of anything but it is an indication of the extent to which financial rates of return are out of line with those in the real economy which is likely to lead to economic distortions.

Arguably, excessively low (or high) interest rates distort capital allocation decisions – for example, by propping up zombie firms (though I am not sure that is a problem in the UK right now). However, they do distort savings choices. If returns to saving are low, this is a strong argument in favour of spending rather than saving. This is, of course, precisely what policy was designed to achieve during the depths of the recession but is it really necessary almost a decade on? And as I have pointed out previously, the longer interest rates are held at emergency levels, the bigger the risks to future generations of pensioners whose pension pots will not grow as rapidly as they ought. Indeed as John Authers noted in the FT last week whilst low interest rates prevented an economic meltdown, “it grows ever clearer that risk has been moved, primarily to the pension system.”

In my view, this is another strong argument in favour of modestly tightening monetary policy. At this stage we are not talking about a dramatic stamp on the brakes, but allowing rates to edge upwards by (say) 50 bps per year for the next couple of years would take some of the heat out of the problem. Whether the BoE will be in a position to do that depends, of course, on the extent of any damage that Brexit inflicts on the UK economy.

Inflation Report post mortem

The Bank of England’s decision to keep interest rates on hold today may have been what the markets were ultimately expecting – after having been conditioned between February and late-April to expect a rise – but I can’t help thinking that the late change of mind has caused more problems than was strictly necessary.

The forecast upon which the decision was based was not hugely different from that presented in February. Growth is a bit weaker this year but that is primarily due to the weakness of Q1 GDP. Inflation is moderately lower, but we are only talking about a few tenths of a percent. However, the BoE did go to great lengths to persuade us that some things have changed – notably the fact that the pass-through from sterling’s depreciation in 2016 has operated more quickly than expected, and as a result CPI inflation does slow more quickly in the early part of the forecast period than in February. As they pointed out, the March inflation figure (2.5%) turned out some 0.4 percentage points lower than expected three months ago (when the last observation was the December inflation rate of 3%).

As noted a couple of weeks ago the weakness of Q1 GDP, which at 0.1% q/q undershot even the most modest of expectations, was the key factor in the decision. In the past, the Bank has tended to raise rates only when quarterly GDP growth is at 0.5% or higher, so the majority of MPC members were clearly uncomfortable with tightening policy when growth is so far below this threshold.

Questions are increasingly being asked as to whether this slowdown is a one-off triggered by weather effects, or whether it marks something more serious. The ONS reckoned that the impact of the snowstorms in early March explained only part of the weakness. They may be right, but apparently this deduction was derived from a survey it sent out asking firms whether output had been affected by the snowstorms. When relatively few firms responded this was the case, the statisticians deduced that the weather effect was not so significant. In my view, and one which the BoE shares, the impact of the snowstorm was greater than the weight attributed to it by the ONS. Indeed, survey-based estimates suggest that Q1 GDP growth was higher than the initial estimate of +0.1%. The Bank believes that the figure will be revised up. That being the case, why did it simply not look through the temporary distortion? Presumably, the decision was partly based on how raising rates when the economy is going through a soft patch would play with the wider public. Or it could be that the BoE believes underlying growth is slowing.

Across the channel, we have already seen signs that the euro zone economy has lost momentum. And there is a school of thought which suggests the slowdown in UK monetary aggregates is a sign of weaker growth to come (see this FT article by Chris Giles).  It is always difficult to disentangle the direction of causality between monetary growth and real economic activity. But as Giles notes, “simple correlations show that measures of money have moved closely with the cycle this decade, raising the possibility that monetary indicators are due for a revival in economics.” But the slowdown evident in the money data is not yet evident in survey-based estimates (although last month’s retail sales activity was weak according to the British Retail Consortium). Consequently, the jury is still out on where the economy goes from here, but it seems set to continue growing much more slowly than prior to the EU referendum.

Not surprisingly, the big issue at the Inflation Report press conference was the BoE’s communication strategy. Having built markets up to expect a rate hike in May, only to backtrack in the face of the data, has led to accusations of inconsistency in expectations management. The BoE will point out, of course, that the decision was conditional – in this case on the data – so that a change of heart was the rational response. And there was a sense of testiness on the part of Bank officials when faced with intense grilling on the subject. Governor Carney sought to deflect criticism of misleading markets by referring to the fact he is trying to appeal to firms and households rather than just markets. But since markets set prices which impact on the decisions of firms and households, I am not sure I fully buy it.

However, I can see both sides of the debate. The BoE makes conditional forecasts and when the conditioning assumptions change it is entitled to change its view. The press in particular may not always understand the nature of a conditional forecast. Arguably, however, the BoE has to work harder to make sure that the conditional nature of its forecasts is better understood.If the BoE wants to improve its communication strategy, this might be a good place to start. But there is a wider problem. The MPC is comprised of nine members, each of whom is independent. Given the tendency of economists to disagree on any given issue, one could be forgiven for suspecting that it will prove almost impossible to get the MPC to speak with one voice, thus reducing the effectiveness of the forward guidance strategy.

Silence can be golden

If you had asked me a week ago, I would have said that a rate hike of 25 bps by the Bank of England in May was a high probability event. However, I had reckoned without the intervention of BoE Governor Carney who warned in a BBC TV interview last week that any such move was not a done deal. In his words, “there are other meetings over the course of this year” at which a rate hike can be delivered. As a consequence, the implied market probability attached to a 25 bps hike collapsed from 80% last Thursday to 52% today, thereby turning a near-certain rate hike into a toss-of-a-coin event (chart).

It would appear that Carney was trying to warn the market that a string of weaker data argues against treating a May hike as a given. On the one hand, CPI inflation has slowed more rapidly than the BoE expected in its February forecast, coming in at 2.7% in Q1 versus a predicted 2.9%, with the March rate slowing to 2.5% - the lowest in twelve months. Then there is the likelihood that Q1 GDP growth will come in weaker than expected, posting a rate of 0.2-0.3% q-o-q (an annualised rate of 0.8% to 1.2%).

Whilst these are mere statements of fact when viewed in isolation, in my view neither are good enough arguments to postpone the rate hike. For one thing the weak activity data are largely the result of cold weather at the beginning of March (remember the Beast from the East?). In the sense that this is a temporary factor, we should be looking through it to assess the underlying strength of the economy especially since: (a) there may well be a partial countermovement at the start of Q2 and (b) previous attempts by the ONS to measure the impact of a cold spell on activity growth have tended to be revised away (as occurred in Q1 2012 for example when the initial GDP estimate posted quarterly growth of -0.2% but now shows a rate of +0.6%). As for inflation, it has long been known that it would begin to slow after peaking in the early months of 2018. The BoE has been softening us up for a monetary tightening on the basis that inflation is above target but now that it is less above target than expected, it seems they are backing away from their long-held view.

Around the same time as Carney was making his comments, MPC member Michael Saunders argued forcefully that “the economy no longer needs as much stimulus as previously” and that in terms of the pace of hiking “’gradual’ need not mean ‘glacial’”. That was a direct contradiction of Carney’s view – as is the right of external MPC members – but it sends a conflicting message to both markets and individuals and very much calls into question the usefulness of forward guidance as a policy tool. 

Forward guidance is designed to provide greater clarity about the central bank’s view and reduce uncertainty about the future path of monetary policy whilst delivering a robust policy framework. The Governor’s intervention just three weeks before the May rate decision does nothing to enhance clarity; has introduced more, not less, certainty about the path of interest rates and the differing messages from policymakers suggests that the policy framework is anything but robust. It is not as if this is the first time the Governor has blown a hole in the communications strategy. His comments at the Mansion House speech in June 2014 hinted strongly at a rate hike that did not materialise and led MP Pat McFadden to dub Carney “the unreliable boyfriend.”

As I have argued before (here), policymakers are making a mistake by focusing on the change in interest rates conditional on current economic circumstances when what really matters is the level of interest rates conditional on general economic conditions. Even if Brexit is curbing economic activity, as Carney argued, the economy is by no means falling off a cliff and therefore does not need interest rates at levels consistent with the threatened meltdown of 2009.I fully understand policymakers’ caution. After all, it is not just the markets that they have to convince: It is those individuals whose economic prospects are dependent on the path of interest rates. But I cannot help thinking that on credibility grounds, the MPC would be better advised to deliver the May rate hike they had strongly trailed, and allow themselves a more fierce debate about whether there is a need for additional tightening. As it is, they almost now cannot win. If they do raise rates next month it will call into question why Carney needed to wade into the debate. But if they don’t, it will raise questions about the message that the BoE was communicating in the two months prior to last week. Silence can be golden.

The BoE and a bit of cold turkey

It is widely expected that the Bank of England will raise interest rates this week for the first time since 2007. There have been some influential academic voices suggesting that this would be the wrong time to raise rates – the more I think about it, the more I disagree with them. And before we all get carried away, the expected increase from 0.25% to 0.5% would only represent a move from the lowest level in history to the second lowest.

The first reason for disagreeing with some of the wiser heads is purely to do with the signalling effect. Having suggested in September that “some withdrawal of monetary stimulus was likely to be appropriate over the coming months” financial markets have increasingly interpreted this as meaning that a rate move is likely in November and are now pricing such action with a probability of almost 90%. Although the BoE has suggested in the past that a near-term rate hike might be in the offing – which subsequently never materialised – not since Mark Carney assumed his post in 2013 have markets been so convinced about the likelihood of a rate hike at the upcoming meeting as they are now. The only comparable degree of market conviction was in the wake of the EU referendum, when in July 2016 markets fully priced a 25 bps rate cut at the August 2016 MPC meeting (a reduction which was duly delivered).

Of course, it is not the MPC’s job to reinforce the market’s conviction. But to the extent that the strategy of forward guidance relies on the predictability and credibility of central bank communication, any decision to hold interest rates unchanged in view of current market expectations would seriously undermine this plank of monetary policy because it would suggest that communication has not been sufficiently clear.

Another strong argument in favour of raising interest rates is that they are (arguably) too low given where we are in the economic cycle. Much of the academic opposition to a rate hike stems from the fact that wage inflation remains low, and uncertainty surrounding the Brexit decision suggests that this is not a good time to tighten policy. I have sympathy with these views. Indeed, I have argued recently that the inflation excuse used to justify the need for higher interest rates does not wash because it reflects a one-off spike triggered by currency depreciation. But opponents of a rate hike may be guilty of confusing the impact of interest rate levels and a change in rates. Even though the UK economy has lost momentum over the course of this year it is still growing at a rate of around 1.5% in real terms. Inflation, at 3%, is right at the top end of the threshold above which the BoE Governor has to write to the Chancellor explaining what he intends to do in order to bring it back towards target. Moreover, monetary policy is still operating on a setting designed to promote recovery in the wake of the 2008 financial collapse, with an additional bit of Brexit insurance thrown in. The UK simply does not need rates at current levels.

Arguably, the BoE should have raised rates in 2014 or 2015 when growth was back at trend and house price inflation was running at double-digit rates. However, the global interest rate cycle was not then supportive of a unilateral move by the BoE, with the Fed not yet having commenced its rate hiking cycle and the ECB beginning a phase of more aggressive monetary easing. As it turned out, with UK inflation running close to zero during 2015 and H1 2016, the BoE would have run the risk of repeating the mistake of the Swedish Riksbank which began tightening in 2010 only to have to reverse course in the face of a collapse in inflation.

As for Brexit risks, the BoE has been clear all along that this represents an economic shock against which interest rates can only provide limited insulation. In any case, taking back the precautionary 25 bps rate cut implemented in summer 2016 makes sense in view of the fact that the worst case scenario did not materialise. But a wider point is that ultra-expansionary monetary policy can inflict just as much harm as an overly restrictive stance – perhaps in ways we do not yet fully understand. We do know that low interest rates have helped to propel equity markets to record highs and produced an unjustified tightening of credit spreads. To the extent that investors have become less discriminating about what they buy when they are simply chasing yield, low interest rates distort normal market behaviour. And as the Japanese experience has shown, a lax monetary stance is no guarantee of economic recovery.

Rising interest rates will hurt – mortgage payments, for example, will go up which is no fun at a time when real wages are falling. But as those professionals treating drug addicts will tell you, sometimes it is necessary to take a clear look at where we are, how we have got there and accept that a bit of cold turkey is necessary for the longer term good.

Conditional credibility

With interest rates trapped at the lower bound central banks have in recent years adopted a policy of forward guidance to help markets interpret what they were likely to do in the face of the incoming data flow. Its success has been mixed. Recall the bond market “taper tantrum” in 2013 when the Federal Reserve announced that it was about to slow down the pace of asset purchases - though in fairness, this was more the result of a market which panicked rather than the fault of the central bank. But so far this year the Fed has more or less adhered to the message contained in the dot plot (see p3 here) despite the market’s initial scepticism.

Arguably, the Bank of England’s efforts at forward guidance have not been quite as successful, and in a week of important UK data releases which may determine whether the BoE will soon raise rates, it is important to understand the nature of the forward guidance message. In August 2013 the BoE pledged “not to raise Bank Rate from its current level of 0.5% at least until … the unemployment rate has fallen to a threshold of 7%.” The BoE was clear that this was a conditional target, subject to (i) CPI inflation 18 to 24 months ahead no more than 0.5 percentage points above the 2% target; (ii) medium-term inflation expectations no longer remaining sufficiently well anchored and (iii) the stance of monetary policy posing a significant threat to financial stability. Even though unemployment fell more rapidly than the BoE – and indeed, most other forecasters – anticipated, none of the knockouts were ever triggered. Thus although policy was conditional, it was never fully clear why the BoE did not raise rates once the unemployment rate fell below 7%. Good arguments could be made for leaving rates on hold but it rather defeated the purpose of the forward guidance framework.

By February 2014 the BoE abandoned the simple mechanistic link between monetary policy and unemployment in favour of a less easily defined policy based on the nebulous concept of spare capacity. Since the measure of spare capacity was determined by the BoE, this meant that outside observers became increasingly reliant on the information feed from the MPC to determine the future policy stance. The clarity of rule-based forward guidance policy was lost. Later in 2014, at his Mansion House speech, Governor Carney suggested that the first rise in interest rates “could happen sooner than markets currently expect.” It didn’t. And to this day it is difficult to explain why the rate hike did not happen other than the fact that the BoE simply did not want to act before the Fed.

Last month “a majority of MPC members judged that, if the economy continued to follow a path consistent with the prospect of a continued erosion of slack and a gradual rise in underlying inflationary pressure then, with the further lessening in the trade-off that this would imply, some withdrawal of monetary stimulus was likely to be appropriate over the coming months.” We know from this morning’s parliamentary testimony that two Committee members (Dave Ramsden and Silvana Tenreyro) are not part of that majority. We also know that four other members appear to be edging towards an earlier rate increase whilst the view of the other three is unknown.

Arguably, given the clarity of the message given in recent weeks, the MPC needs to deliver sooner rather than later after having left markets hanging in the past. Of course, “coming months” does not necessarily refer to November (the next month in which an Inflation Report is released) – it could just as easily be February (the following Inflation Report month). But the fact that little has been done to dissuade the market of this view suggests that November would be a good time to act. Leaving the door open until February runs the risk that events could transpire which change the Bank’s priorities, and despite the conditional nature of the policy decision, markets will see this as another occasion on which it has cried wolf.

Policy credibility remains important to policymakers. An absence of such credibility defeats the purpose of forward guidance. Whilst the BoE can justifiably argue that forward guidance is conditional on economic circumstances, it cannot continue to hide behind the Augustinian clause forever (allow us to raise interest rates, but not just yet). Whether or not it is the right time to consider a rate increase is almost irrelevant – my own view is that the recent surge which has taken CPI inflation to 3% is not a good justification for a policy tightening, driven as it is by a one-off sterling depreciation. However, what matters is the consistency of the message. The markets are hearing a very clear message: It would require a lot of explanation on the BoE’s part if it were to pass up on a rate hiking opportunity.

Central banks face an inflation dilemma

Over the course of recent weeks there has been a shift in the message communicated by monetary policy makers. The monetary authorities on the other side of the Atlantic have long been ahead of their European counterparts, with the Fed having raised rates four times since December 2015 and three times in the last six months. But it has now gone further and announced in mid-June that it “expects to begin implementing a balance sheet normalization program this year, provided that the economy evolves broadly as anticipated.” A week prior to that the ECB changed its assessment of the balance of economic risks to “balanced” rather than “tilted to the downside” whilst only last week, Norges Bank removed its previous guidance that interest rates could be cut this year. Also this month, the Bank of England only narrowly voted to hold rates at their all-time low of 0.25% with three members of the Monetary Policy Committee pushing for a 25 bps rate hike.

The narrowness of the BoE vote came as a surprise with the dissenters concerned that inflation had overshot relative to expectations, reaching a four year high last month, at the same time as the margin of spare capacity in the economy has clearly diminished. My initial reaction to this reasoning was that it was flawed: Inflation has surged largely because of the impact of currency depreciation and so long as this does not impact markedly on inflation expectations, which leads to faster wage growth, the BoE may simply have to swallow the problem. Indeed, with wage growth slower today than before the EU referendum, higher interest rates at a time of falling real wages will not do anyone any favours. That said, with the unemployment rate close to the BoE’s estimate of the NAIRU, such concerns are understandable.

My own view is that the uncertainties surrounding Brexit will suffice to keep UK inflation expectations in check for some time to come. Indeed, across much of the industrialised world, it is proving difficult to drive up inflation: In both the US and euro zone inflation is struggling to reach the central bank’s 2% target – a trend which will not be helped by the recent decline in oil prices which has supported headline inflation in the past year. Although central banks have a mandate to control inflation, and in many cases have to meet particular targets, it is difficult to explain to the wider public that there is no automatic link between price growth and interest rates – just as there is not, and never has been, one between inflation and money supply growth, despite the best efforts of many politicians and (some) economists to convince us otherwise. As if we needed proof, consider the case of Japan where despite running a balance sheet equivalent to 90% of GDP – almost four times that of the Fed, ECB or BoE – inflation has only exceeded the BoJ’s 2% target for three months during this century (once we strip out the distortionary effects of consumption taxes, see chart).

There are numerous reasons why inflation today is much lower than during previous periods when prevailing economic circumstances were similar. A much more globalised economy, in which value chains stretch across international borders has been one of the key factors holding down price inflation over the past decade. This has been accompanied by technological change which has depressed wage expectations. In effect, the pricing power of labour has been reduced as wages are increasingly set according to international conditions rather than those in local labour markets. Moreover, as the BIS reminds us in a message that too many economists often overlook, “wage growth is not necessarily inflationary: whenever it is supported by productivity gains, it will not lead to rising production costs.” And as I never tire of pointing out, although the UK’s productivity record has been dismal since the great financial crisis, it has still been stronger than real wage growth.

In an environment where the link between the domestic economy and wages has weakened, this makes it difficult for central banks to justify raising rates based on the threat of more rapid potential wage growth. But low interest rates have contributed to the asset bubble which has forced – or perhaps facilitated – investors to take risks in order to generate faster rates of return. Some form of monetary tightening is thus desirable. It is for this reason that the BoE today announced that it will raise banks’ countercyclical capital buffer – a measure of mandatory additional capital holdings – from zero to 0.5%, with a view to raising it to 1% in November in a bid to curb excess credit growth.

I must confess to some mixed feelings on the situation we now find ourselves in. On the one hand, central banks are concerned about the impacts of low interest rates on credit and asset price growth. Yet on the other, they wish to ensure financial stability which appears to be at odds with the current loose monetary stance. The case for higher rates based on price inflation or wage growth is weak. But there is an argument to suggest that the wider impacts of running a loose monetary policy require some tightening. For the moment, the likes of Norges Bank and the ECB can get away with merely talking about it. The BoE fiddles around the edges by adjusting macroprudential measures. But before long, they may all be forced to follow the Fed – everyone does in the end.

Don't make it personal

Depending on your point of view, the decision by BoE Governor Carney to step down in June 2019 is either a one year extension of his term, having previously said he would leave in 2018, or he is leaving two years earlier than the mandated eight years. Either way, at least we have some clarity on where we stand ahead of the release of tomorrow's Inflation Report.

The whole affair does raise a number of issues regarding the role of central banks. For one thing, does it even matter whether Carney stays a year longer? His decision is based on the notion that the Brexit negotiations will be completed by that point and he will thus have steered the BoE through this critical period. That said, the hard work will only just be beginning. So whilst an extra year is welcome, in reality he probably only has a couple more years of any real authority. Once he enters the last year of his contract the markets will be less willing to hang onto his every word. Just ask Sir Alex Ferguson, who announced he would retire as Man United manager in 2002 but his team stopped listening to him and they underperformed as a result. And as we now know, Ferguson reversed his position and stayed for another 11 years.

Then there is the ongoing saga regarding the personification of central banking. Just over twenty years ago, central banks were secretive places where senior officials went out of their way to be anonymous. Alan Greenspan put a stop to that, of course. But the Fed has done just fine since he left. Indeed, Greenspan's reputation, which was such that Republican senator John McCain once remarked that he would like to  “prop him up and put a pair of dark glasses on him and keep him as long as we could," has since taken something of a beating.

Carney himself was hailed as the "rock star" central banker. But his decisions have been far from flawless and his forward guidance policy got off to a very shaky start, although he redeemed himself in many people's eyes with his conduct during the Brexit campaign. However, personification of policy issues is to miss the point. Central banks are not about one man (or woman). They are organisations with long institutional memories, staffed with competent people, and in theory it should be possible to find a few possible replacements from amongst the senior members of staff.

The media made a big thing of the extent to which Carney's reluctance to commit for the full eight years was the result of increasing conflict with the new administration. There may indeed be something to that. The Times reports today that he was "incensed by the criticism of the global elite ... because he saw it as an attack personally." There is no doubt that the government badly handled many economic issues at the Conservative Party conference last month. Thus Carney's extension, whilst not the full three years which the government undoubtedly wanted, represents a compromise which allows him to say he is not cutting and running during the worst of the Brexit negotiations. It also makes Carney look like a guy who hangs around when the going gets tough - no longer the unreliable boyfriend, as he was once memorably described - which is likely to serve him well in future.

Indeed, the small matter of his own personal ambitions may have played a role in all of this. A Canadian election is scheduled no later than October 2019 and Carney would then be well placed to return home to claim a senior political position, should he wish to pursue such a career as often claimed. He would also be well placed for a slot as head of the IMF once Christine Lagarde's term expires in 2021, with the horse trading likely to start well before that. These factors may have been the personal decisions which Carney was referring to when asked last week about his future as BoE Governor.

The big question is how crucial will Carney be to the UK's immediate economic future. There is no doubt that he is a big beast in the economic and political spheres in which he will have to operate. He is far from indispensable but for a government short of serious economic talent, he gives it some cover as it tries to figure out how to move forward on Brexit. Carney has demonstrated his willingness to stand up to preserve central bank independence. This may not be popular in certain sectors of government but it is what he is paid for. As it happens, I do believe that easy monetary policy is more of a hindrance than a help at this stage of the cycle. The difference between myself saying that, and Theresa May expressing the same sentiment, is that I am arguing for a change of the policy mix between fiscal and monetary. The PM made no such claims.

Whatever else Carney does over the next couple of years, the real fun will be watching him take on his Brexit critics. The likes of Jacob Rees-Mogg will undoubtedly be critical of Carney's decision to give the job another year but sniping is Rees-Mogg's default position. Ultimately Carney's position has become highly politicised thanks to the Brexit shenanigans and over the next couple of years that position is unlikely to change.