One more time – good policy takes account of risks, and what happens if they materialise

From the Guardian's reportof Mervyn King’s press conference today, where the Bank of England lowers forecast UK growth this year to zero.

Paul Mason of Newsnight suggests that the Bank of England should stop trying to use monetary policy to offset the impact of chancellor George Osborne's fiscal tightening, and call for a Plan B instead.

King rejects the idea, saying that Osborne's plan looked "pretty sensible" back in 2010. Overseas factors have undermined it, he argues.

Now Mervyn King had little choice but to say this, but he is wrong (and probably knows he is wrong) for a simple reason. Even if the post-2010 Budget forecastof 2.8% growth in 2012 had been pretty sensible, there were risks either side. There always are, although the nature of the recession probably made these risks greater than normal. It is what you can do if those risks materialise that matters.

Now if growth had appeared to be stronger than 2.8%, and inflation becomes excessive, the solution is obvious, well tested and effective – the Bank of England raises interest rates. But if growth looked like falling well short of 2.8%, the solution – more Quantitative Easing - is untested and very unclear in its effectiveness. (And before anyone comments, the government knows it has no intention of telling the Bank to abandon inflation targets.) With this basic asymmetry, you do not cross your fingers and hope your forecasts are correct. Instead you bias policy towards trying as far as possible to avoid the bad outcome. You go for 3.5% or 4% growth, knowing that if this produced undesirable inflation you could do something about it. That in turn meant notundertaking the Plan A of severe austerity.

So all the talk about how much austerity, or the Eurozone, or anything else, caused the current UK recession is beside the point when it comes to assessing the wisdom of 2010 austerity. Criticising the Bank of England for underestimating inflation in the past is even more pointless – do those making the criticism really think interest rates should have been higher two or three years ago? Even if the Euro crisis has been unforeseeable bad luck for the government (although I think excessive austerity is having its predictable effect there to), the government should not have put us in a position where we seem powerless to do anything about it.

If you are sailing a ship near land, you keep well clear of the coast, even if it means the journey may take longer.  So the fact that the economy has run aground does not mean the government was just unlucky. You do not embark on austerity when interest rates are near zero. Keynes taught us that, it is in all the textbooks, and a government bears responsibility when it ignores this wisdom. To the extent that the government was encouraged to pursue this course by the Governor of the Bank of England, that responsibility is shared.