The MPC’s problem: explained, but not solved

Some interesting research* on the UK’s inflation expectations was published this week by the Bank for International Settlement. The research helps explain, but not solve, the credibility problem bedevilling the Bank of England’s Monetary Policy Committee (MPC).

Does it matter if consumers’ views differ from that of the MPC? It matters a lot, because inflation expectations can affect real inflation.

Inflation Cake

The rise of UK CPI to 4%, double the target set by the Bank of England, is a challenge to policy makers: how to bring inflation to target without crushing economic growth in the process.

Mervyn King, 10th letter to the Chancellor.

As Mervy King the governor of the Bank of England explains in his “valentine” to the Chancellor (hat tip John Authors) inflation has risen for three reasons:

“… the rise in VAT relative to a year ago, the continuing consequences of the fall in sterling in late 2007 and 2008, and recent increases in commodity prices, particularly energy prices.” 

Inflation Targeting Questioned

The “inflation nutters”, as Samuel Brittan calls them, are out in force. The Bank of England is being criticised for its recent inability to predict nor manage the UK’s 2% inflation target. According to the Bank website, “Low inflation is not an end in itself. It is however an important factor in helping to encourage long-term stability in the economy”. The two charts shown here raise some questions about that statement, and the entire premise of Inflation Targeting (IT).

The first chart shows the unemployment rate in the five years before and after implementation of IT across a sample of 21 countries. Notably only four showed a decline of more than 1% in unemployment over the period while 10 showed an increase of 1% or more, in some cases significantly so.

Unemployment rate 5 years before and after Inflation Targeting*

Inflation: a good day for Cricket

Yesterday, Mervyn King, the governor of the Bank of England, used a cricketing analogy to describe the response of the Monetary Policy Committee (MPC) to the UK’s future inflation expectation.  He neatly summed up his opening remarks to the MPC’s quarterly inflation report as follows: