Jeremy Warner: King struggles to make policy work

Outlook Mervyn King came across as defensive and irritable at his quarterly press conference yesterday as he attempted to bat away suggestions that the Monetary Policy Committee (MPC) had somehow failed in its duties, first by allowing the credit bubble to inflate and then by not moving swiftly enough to deal with the consequences once it had burst.

So prickly did the Governor of the Bank of England become that at one stage he showed every sign of losing the plot, which is unusual to put it mildly for such a forceful raconteur. It was not one of his finest performances, but then he was being baited.

First the FT dismissed a key part of the inflation report as "waffle", which didn't get the press conference off to the best of starts; then The Daily Telegraph asked the Governor to apologise for mistakes in policy; and finally The Guardian in what was more of a statement than a question compared him to the French army preparing for German invasion by wrongly concentrating all its defences on the Maginot Line.

Perhaps it is a symptom of our fevered times, with the guillotine all but now erected outside the City to satisfy the baying mob, but is it entirely polite to hold the Governor of the Bank of England to account in this way? Things fall apart; the centre cannot hold; Mere anarchy is loosed upon the world, The blood-dimmed tide is loosed... (WB Yeats). That's how it begins to feel, in any case. There is an out-of-control, lawless feel to the growing tide of anger and economic gloom.

Mr King was having none of it, and certainly he was in no mood to apologise, repeatedly insisted that it wasn't his job to predict the future, and since the future is impossible to predict, nor would anyone reasonable think it was. Is his refusal to accept any degree of culpability justified, and having arguably got it wrong, is the MPC now getting it right?

Mr King's stock answer to the allegation that he failed adequately to address the credit bubble is that interest rates were never the right tool for the purpose, and that, if he had raised rates to choke off the growth in credit, he would only have induced a recession and raised unemployment.

No country in the world was in possession of the right "macro-prudential tools" to address the growth in the financial sector, and in any case countries that hadn't embraced the credit bubble as wholeheartedly as Britain were now suffering equally badly from the synchronised collapse in demand, if not more so.

Fair enough, though the Governor might have voiced his concerns about the growth in credit and consumption more forcibly at the time, if indeed he had any. Had he done so, everyone might have sat up and taken a bit more notice.

In truth, the Governor was part of the comfortable consensus which, though obviously aware of the dangers of ever rising levels of debt, thought the system essentially sound. In that sense, we are all just as guilty as the miscreant bankers. The Bank of England did sound the odd warning, but not loudly enough for it to be heard amid all the partying.

On failure to recognise the severity of the downturn, Mr King is equally unrepentant. The Governor insists he is not paid to forecast the future. The world changed after Lehman Brothers was allowed to collapse, which by implication he characterised as an unpredictable economic shock. Others have likened it to a cardiac arrest.

Economic historians will argue about this for years to come, but personally I don't think Lehman's was either unpredictable or actually had the impact widely attributed to it. The economy was already in deep trouble before the collapse of Lehman's. In Britain at least, it was contracting sharply for months beforehand. The oil price spike seems to have been equally instrumental in undermining consumer and business confidence in the US.

But more importantly, we would in all likelihood have ended up in the same place as we are today even if the US authorities had moved to rescue Lehman's. With deleverage already at full tilt, Wall Street was essentially bust en masse, and if markets had failed to bag the Lehman's scalp, they would only have moved on to someone else. Indeed, the shock of Lehman's acted as a wake-up call to policymakers, without which they might have taken much longer to act.

Whatever. Is the Bank of England now getting things right? Certainly there is no lack of resolve. Interest rates are already at near zero, with the MPC now apparently willing to embark on "quantitative easing", whereby the Bank seeks to expand the money supply so as to ensure the inflation target is met.

The Governor tried to argue yesterday that such policy action is not as "unconventional" as it sounds. All the same, underfunding the budget deficit, which is essentially what it amounts to, hasn't been used in Britain since the 1970s, and we all know where it ended during that troubled decade. It's potentially highly dangerous stuff.

Mr King expressed complete confidence that the combination of policy action together with the reflationary effect of the falling pound would eventually work. Maybe so, but the rapid bounce back in growth implied by the inflation report's central projection to nearly 4 per cent towards the end of next year strikes me as unlikely, given the scale of the debt overhang that still has to be worked off.

As Mr King admits, once all the private debt has been unwound, the process of reducing the public debt that is replacing it must begin. This is bound to crimp growth long into the future. True enough, there could be a quite rapid recovery in industrial production, which for the time being has all but shut down, once the present inventory adjustment is done. But restoring the economy to vibrant growth may be a longer game, and if the step change some predict takes place, where the world returns to much lower levels of overall debt, then the workout will be a mighty long one indeed.