One possibility is that the inflation target has prevented the Bank from relaxing policy as much as it might have done, in which case changing the remit will give us looser policy and stronger economic growth.
But has the inflation target really been a big constraint upon policy? One simple fact suggests not - that inflation has overshot its target for most of the last five years. This has led some of us to suspect for some time that the Bank has been a closet money GDP targeter. A recent speech by Charlie Bean, a deputy governor at the Bank, has confirmed our suspicions. He said the Bank has always been allowed to tolerate inflation if it is due to cost increases. "Such flexible inflation targeting can thus look quite similar to targeting nominal income growth" he said. "I do not believe that a shift to a nominal income growth target would represent a major change in the regime."
This raises a nasty possibility. Maybe monetary policy hasn't done more to boost the economy not because the Bank is constrained by the inflation target, but simply because monetary policy isn't very powerful in our current predicament.
Let's quantify this. The Bank estimates that its first £200bn of QE raised real GDP by 1.5-2 per cent and inflation by up to 1.5 per cent. This implies that only around £30bn of that £200bn boosted the real economy. Most of the rest stayed in the financial system, as institutional investors simply exchanged cash for gilts, and a little leached into inflation.
However, QE now might have even less effect than this. One reason to fear so is that there is probably now less spare capacity in the economy than there was in 2009 - thanks to falling productivity and increased employment. This raises the possibility that, even if a monetary expansion does stimulate nominal demand, more of it will raise inflation and less will raise real growth.
And there's a reason to fear monetary expansion won't do so much to raise nominal demand. Back in 2009, the problem was tail risk; investors and companies feared the small risk of an economic catastrophe, and this fear stopped them borrowing and lending. QE helped reduce this risk by showing that the Bank was willing to take radical measures, and so it helped boost activity. However, the problem now is not so much the left side of the probability distribution for our economic future as its central clump; firms just don’t expect much growth, and this is curbing their investment and demand for credit. There's not so much that QE can do about this. And this is why the Funding for Lending Scheme has - so far - failed.
If people don't want to borrow - because of a dearth of investment opportunities, pessimism or a desire to reduce debt - then measures to reduce the price and increase the availability of money won't do much good. As Simon Hayes at Barclays Capital says, "QE may be relatively ineffective in the current low-confidence environment." In this, he is echoing Keynes. "It is not so easy to revive the marginal efficiency of capital, determined, as it is, by the uncontrollable and disobedient psychology of the business world" he wrote. "This is the aspect of the slump which bankers and business men have been right in emphasising, and which the economists who have put their faith in a "purely monetary" remedy have underestimated."
I don't say all this to claim that monetary policy is totally ineffective - merely that it's possible that there's not very much it can do, especially when interest rates are almost zero anyway. A more promising way to revive the economy would be through fiscal policy – perhaps financed by printing money. However, for reasons which might not be fully founded in economic thinking, this seems to have been ruled out.
