The Bank of England has agood case for restarting monetary stimulus, and may need to buyup to 175 billion pounds more of government bonds ($267 billion)if growth is far below potential, a senior policymaker said.
David Miles, in a speech on Thursday, gave a detailed modelof how policy should respond to the amount of slack in theeconomy - something the central bank has generally avoidedbefore, and which moves in the direction of policy guidancefavored by incoming central bank governor Mark Carney.
Miles is an external member of the bank's Monetary PolicyCommittee, and until this month he was alone in voting for anextra 25 billion pounds of asset purchases, also known asquantitative easing.
But his views appear to be gaining momentum. This month hewas joined by Governor Mervyn King and markets expert PaulFisher, prompting economists to pencil in a possible restart tothe bond purchase scheme and pushing sterling to an 8-month low.
The central bank bought 375 billion pounds of governmentbonds between March 2009 and October 2012 to boost Britain'sbattered economy. But in recent months persistent inflation anddoubts about bond buying's effectiveness at boosting growth hadput further purchases in question.
However, in a speech at the University of Bath, Miles setout an economic model which, he said, better captured uncertainestimates of the state of the economy as well as the scope ofstronger growth to boost its ability to overcome supplybottlenecks and avoid accelerating inflation.
"Based on my views about plausible ranges of outcomes, agood case can be made for more expansion," he said.
Miles said he was open to alternatives to buying governmentbonds, but added that he could not see any. If bond purchaseswere less effective than in the past, that generally meant moreshould be bought than before, he said.
The amount of slack in the economy appeared to be the mostinfluential variable in Miles's model. In the central case thatthe amount of slack was estimated to be equivalent to 0-3percent of annual output, this would point to 60 billion poundsmore of asset purchases being needed, Miles said.
If slack were somewhere in a range of 0-6 percent, thispointed to 175 billion pounds' more purchases. Current estimatesfor the amount of slack in Britain's economy range from 0.8percent to 5.2 percent, Miles added.
Some 25 billion pounds of bond purchases would be warrantedif the amount of slack was low, even if the central bank wassolely focused on cutting inflation, if the economy's supplycapacity did not improve at all when growth recovered, he said.
Time to Sell?
Nonetheless, in a question and answer session after hisspeech, Miles stressed the central bank did not intend to buybonds indefinitely, and still intended to sell them back.
"When there is a recovery that has some legs, I think it isthen time to think about normalising monetary policy," he said."At some point down the road, maybe not too far down the road,we can get back to a more normal monetary policy."
Miles said his model suggested the central bank should onlystart to reverse asset purchases when it forecast 3 percentannual growth over the next three years. Currently the centralbank sees growth of around 1 percent this year, picking up to 2percent in 2015.
However, the assumptions in Miles's model may be disputed byother members of the Monetary Policy Committee who do not sharehis enthusiasm for bond purchases.
It assumes that very loose monetary policy does not createany hidden risks - for example, financial market bubbles - andthat medium-term inflation is driven by the size of theeconomy's output gap, not expectations of higher inflation.
Miles said not everyone would accept his conclusions, butthat his approach offered a better way of thinking about theuncertainty affecting monetary policy in Britain now.
Strong employment combined with very weak growth currentlymake it particularly hard for economists to reach reliableestimates of how much spare capacity is in the economy.
"Optimal policy depends on making judgements on the relativelikelihood of different outcomes. It makes no more sense to justfocus on the ... most likely outcomes than it would in makingdecisions on buying insurance or crossing a road," he said.