Mark Carney is to succeed Sir Mervyn King. Photograph: Mark Blinch/Reuters
Mark Carney is a smart guy. Far too smart not to realise that anything he says carries more import now he has been named as the next governor of the Bank of England.
Speaking in Toronto on Tuesday night, Carney mused on the need for central banks to be creative in the post-crisis world. Growth has been so slow that the Bank of Canada governor said that in certain circumstances policymakers might need to ditch inflation targets and embrace nominal GDP targets instead.
This sounds esoteric but would actually represent a big change in the way monetary policy is conducted. In the UK, it would have forced Threadneedle Street to adopt a much more activist stance over the past couple of years.
Here's why. In most years, the value of all the goods and services produced in an economy goes up. This is the increase in nominal gross domestic product. Part of that increase is due to the fact things cost more than they did last year, and this is stripped out by statisticians to find how much the economy has really grown.
In the UK and in many other countries, the job of the central bank is to prevent prices from rising too quickly. The Bank of England is obliged by law to try to hit a 2% inflation target, although the annual increase in the cost of living has tended to be higher in recent years thanks to rising global commodity prices, higher VAT and the depreciation of the pound. The assumption is that if inflation is under control, the economy will expand at something like its long-term trend rate of growth, which is in the region of 2-2.5%. If you add real growth of 2.5% to 2% inflation then nominal GDP should rise by, say, 4.5% a year.
Since the slump of 2008-09, this relationship has broken down. The Office for Budget Responsibility is forecasting nominal GDP will rise by just 2.2% this year and, with inflation running at 2.3%, that means the economy is predicted to shrink by 0.1%. Inflation is under control but the economy is struggling.
Now assume the government switches to a nominal GDP target of 4.5%. The Bank would have to adopt a more expansionary monetary policy – perhaps by increasing the size or scope of its quantitative easing programme – in order to boost the value of economic output. Crucially, the split between inflation and real output would not matter: in theory the whole of the 4.5% increase in nominal GDP could be the result of higher prices.
Academics have been discussing the merits of nominal GDP targeting for some time. Carney's intervention suggests policymakers are starting to take notice of the debate. To an extent, this reflects the lacklustre recovery, but there is also a sense that inflation targeting only works well when economic conditions are benign.
Does this mean the UK will be moving to nominal GDP targeting any time soon? Probably not. For the government to replace inflation targeting with nominal GDP targeting, three conditions would need to be fulfilled.
Firstly, ministers would have to be sure a much more activist monetary policy would actually do the trick. There are some economists who argue that central banks are running out of road and it might be time to allow fiscal policy to do some of the heavy lifting.
Secondly, they would have to be sure they weren't changing the target at precisely the wrong time. Monetary policy, according to Milton Friedman, works with long and variable lags, and it could be the lags in the aftermath of a downturn that has left the banks in a terrible state are proving longer than usual. Ultra-low interest rates and oodles of quantitative easing might already be storing up inflationary problems for the future.
Finally, there's the issue of public credibility. The inflation-targeting regime has been around, in one form or another, for two decades and it is relatively easy to understand. Nominal GDP targeting is less easy to grasp as a concept and there a risk the public would see a switch not as a fine-tuning of policy but as a desperate measure from policymakers intent on getting the economy moving at any cost.