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Carney strategy must be treated with caution

In the first few days of 2013, The Herald reported on the high level of personal insolvencies and warned that household debt had reached a crisis level in Scotland.

Now, 12 months later, here we are in the last days of the year with no signs of improvement - indeed, there is every indication that the personal debt crisis is deepening.

On the face of it, a growth in employment would ease the crisis, but as the Chartered Institute of Personnel and Development points out today, growth in employment could also trigger a review of the Bank of England's so-called forward guidance policy, which dictates that interest rates will remain at 0.5% until unemployment falls below 7%.

If such a review went ahead, it would have serious consequences for families struggling to pay the bills. The Resolution Foundation, for example, has suggested that two million people would be in danger of being driven to the edge of their means, and beyond, if rates rose.

That prediction was based on figures from the Office of Budget Responsibility showing household debt is rising faster than income and, with any sign of a turnaround in earnings a long way off, forward guidance will be a critical factor influencing how families in debt will cope in the coming months.

The strategy was introduced by Mark Carney, the Governor of the Bank, and there is no question it gave the economy a welcome boost in the summer by reassuring households and businesses that the rate would remain low for the immediate future.

However, even if the freeze can be seen to have worked in the short term, there were always dangers attached to the policy. It also depended on individuals and firms believing the Bank would hold rates down until 2016, a promise that looks increasingly shaky with unemployment falling faster than expected.

Should this drop continue, it raises the possibility of the Bank unfreezing rates as early as next year and the Resolution Foundation has rightly expressed its concerns about that, although it is worth stressing that a rate rise remains a possibility rather than a certainty even if unemployment does dip under 7%.

When the time does come to consider a rise, the Bank will have to exercise caution. A rise risks exacerbating the unsteady position of many businesses and forcing householders to spend even more on their mortgages - and even a modest rise will have serious consequences for families who are scraping by. But the Bank will also have to keep a close eye on the housing market for any sign that low interest rates are contributing to another bubble or that the recovery is overly dependent on household spending.

The limits of monetary policy should also be remembered. Forward guidance may be a powerful economic tool, but it is not the only one. Just as important are government efforts to stimulate growth based on manufacturing and exports and these are still not good enough. There is an economic crisis at the end of the year, just as there was at the start, but the Bank of England alone cannot fix it.

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