Matthew Robertson 1.36pm
- May 2004: Arsène Wenger hailed as Arsenal go entire season undefeated to win the Premier League
- December 2012: Arsène Wenger under increasing pressure as Arsenal lose to League Two side Bradford City in the Capital One Cup
- October 1992: for the first time monetary policy in Britain would be based on an explicit target for inflation
- December 2012: Mark Carney, the incoming Governor of the Bank of England, has suggested abandoning inflation targeting
"When the facts change, I change my mind". A quote that has long been attributed to the father of modern economics, John Maynard Keynes. It is a belief that policy should be implemented to tackle the world as it is today, not as it was yesterday.
The position of an English football team and the comments of the Governor of the Bank of Canada may not seem interlinked but they do shed light on whether it is beneficial to adapt to changing circumstances or to maintain the current strategy in total belief that it is the correct way.
One of the great success stories of modern economics is the taming of inflation. As Mervyn King, the departing Governor of the Bank of England, stated in a speech in October:
"Over the previous twenty years (1972-1992) inflation had been the single biggest problem facing the UK economy, peaking at 27 per cent a year in 1975. Over the subsequent twenty years (1992-2012), inflation, as I mentioned earlier, would average only 2.1 per cent."
The key to this success was controlling inflationary expectations and the key to that was inflation targeting underpinned by an independent central bank. Exiting the European Exchange Rate Mechanism freed Britain to set their own monetary policy, which culminated in Bank of England independence in 1997.
A target would be set and it would be free of political interference. As long as the target over the long term was met, the expectation was anchored as any deviation would be expected to return to the anchor. This was the case for most of the past twenty years.
This policy was a reaction to the economic difficulties of the time and has been reproduced in many countries over the world. Inflation is well above expectation at the moment but inflation between 2.5 per cent and 5 per cent is low by historical standards and the reason is that the inflationary expectation is still around the 2 per cent mark.
The footballing philosophy of Arsène Wenger when he first arrived in England was equally as successful. His devotion to ‘pass and move’ football led to five trophies in six seasons as well as the first team in 116 years to go a league season unbeaten.
However, times have changed both for the economy and for English professional football. The financial crisis of 2007-2008 precipitated a new thinking in central banking theory. The Bank of England ignored concerns about inflation and reduced interest rates to almost zero per cent in an effort to enhance liquidity and reduce borrowing costs. The greater concern for the Bank at the time was economic output and preventing the economy stagnating into a long term liquidity trap. There were numerous inflationary concerns regarding world food prices at the time but the Bank, quite rightly, decided that the crisis needed urgent, unorthodox central banking. This was further reinforced by a period of quantitative easing where the Bank of England purchased financial assets from commercial banks to inject money into the economy.
In a speech on 23rd January, Mervyn King argued that pursuing a two per cent inflation rate target throughout the financial crisis, would have worsened the recession:
"To bring inflation down ‘would have meant driving down wages by creating a deeper recession, even higher unemployment and lasting damage to the job prospects of many young people."
The question now is whether inflation targeting should be abandoned for nominal GDP targets, something the new incoming Governor, Mark Carney, has suggested. A deeper question is whether the economic circumstances of the economy have altered significantly to warrant a change in approach. Are the economic conditions so benign that there will be insufficient demand to produce growth without active interference from a central bank?
Central bankers will need to factor in these conditions along with inflationary expectations to assess which approach to take. The history of the 1970s suggests that active GDP targets don’t work but that might have been for a different time with contrasting conditions.
Whatever route is taken it raises the question of whether to change one’s mid when the facts change. The arrival of Roman Abramovich and latterly Sheikh Mansour altered the nature of English football completely. Chelsea and Manchester City have the ability to outbid and outspend any club to attract the best talent from around the globe. There is growing doubt as to whether Mr Wenger’s prudent approach of developing youngsters and buying affordable players can be successful in today’s Premier League. Despite constant criticism, Arsenal’s manager has remained dogmatic about what he considers the correct method.
Is this appropriate when the facts change? We shall see when Mark Carney takes over the helm in the summer.
By that time there may even be a trophy in that Arsenal cabinet.
Follow Matthew on Twitter @FlatFootTory