Is the Bank of England still committed to price stability?

1. Is the Bank of England still committed to price stability? Presentation at Cardiff Business School 2nd November 2011

2. What the Bank tells the public “The Bank sets interest rates to keep inflation low to preserve the value of your money.” Summary statement on Bank of England website

3. The Bank’s remit Excerpts from the latest mandate letter (March 2011) “to maintain price stability; and, subject to that, to support the economic policy of Her Majesty’s Government” “The inflation target is 2 percentat all times: that is the rate which the MPC is required to achieve and for which it is accountable.” “The framework is based on the recognition that the actual inflation rate will on occasionsdepart from its target as a result of shocks and disturbances. Attempts to keep inflation on target in these circumstances may cause undesirable volatility in output.”

4. What the MPC has delivered Source: Office of National Statistics

5. Recent UK inflation performance • Why has UK inflation been so high? • Problems with the MPC • Reforming the UK monetary framework

6. UK inflation persistently above target Source: Office for National Statistics % per annum increase in consumer prices index

7. Inflation far above the old RPIX target Source: Office for National Statistics Annual % increase in retail prices index excluding mortgage interest

8. Broad-based rise in consumer prices Source: Office for National Statistics % annual rise in CPI categories, September 2011

9. What has gone wrong? Global inflationary pressures Large sterling depreciation Persistent services inflation Limited impact of spare capacity

10. Global inflation on the rise % per annum change in consumer prices Source: The Economist

11. Global primary energy consumption Source: BP Statistical Review 2010 Million tonnes oil equivalent

12. UK goods price inflation Source: Office for National Statistics % per annum change in goods prices

13. UK inflation in international context Source: Office for National Statistics Index of consumer prices, January 2008 = 100

14. The global economy and UK inflation Impact of monetary policy Cost of imports Exchange rate Domestic demand Expectations and credibility Global economy Demand UK inflation Pricing climate

15. Sterling depreciation since 2007 Rebased to 100 in January 2005 Source: Thompson Datastream and Bank for International Settlements *: Effective exchange rate

16. Episodes of Sterling depreciation Index, base year = 100 Number of years from start of period Source: Bank for International Settlements

17. Euro/UK inflation differential & exchange rate Source: Thompson Datastream *: Euro-Sterling exchange rate is expressed as the deviation from its average over the same period.

18. Persistently high services inflation Source: Office for National Statistics % per annum change in consumer prices

19. Capacity utilisation in UK economy Source: Bank of England Bank of England Agents’ scores relative to normal

20. Unemployment in UK recessions Source: Office for National Statistics, Labour Force Survey * Q3 based on Jun-Aug average Unemployment rate, % of labour force Number of quarters from employment peak

21. Wage growth picking up Source: Office for National Statistics % per annum growth in private sector average weekly earnings

22. UK economic growth Source: ONS % per annum change in non-oil GDP

23. High inflation squeezing sales volumes Source: Office for National Statistics % per annum growth in retail sales (3-month ave)

24. “Output gap” model weaknesses Revisions to GDP Uncertainty about capacity limits and trend growth Does not capture dynamic effects (eg growth of nominal demand, “speed limits”) Globalisation is reinforcing “small open economy” inflation behaviour “Hysteresis” may erode spare capacity effects Not a robust framework in presence of large supply shocks

25. Large official inflation forecast errors Source: Bank of England Mean of forecast percentage annual increases in consumer prices

26. October 2011 MPC decision “…the weaker outlook for, and the increased downside risks to, output growth mean that the margin of slack in the economy is likely to be greater and more persistent than previously expected. “…measures of domestically generated inflation remain contained and inflation is likely to fall back sharply next year as the influence of the factors temporarily raising inflation diminishes and downward pressure from unemployment and spare capacity persists. “The deterioration in the outlook has made it more likely that inflation will undershoot the 2% target in the medium term.”

27. The view from the Governor “Our objective must be to steer the UK economy slowly back to a position of more normal interest rates and lower budget deficits. With a lower level of sterling and a credible plan to reduce the fiscal deficit over the medium term, we were on track. But the problems in the euro area and the marked slowing in the world economy have lengthened the period over which a return to normality is likely.” Sir Mervyn King, 18th October 2011

28. MPC meetings attended Internal members (Total = 493) • Sir Mervyn King (174) • Charles Bean (134) • Paul Tucker (113) • Spencer Dale (40) • Paul Fisher (32) External members (Total = 75) • David Miles (29) • Adam Posen (26) • Martin Weale (15) • Ben Broadbent (5)

29. Problems with the MPC Emphasis on forecast has allowed the Committee to redefine its own target Persistent modelling and forecasting errors, with excessive weight on “output gap” model Assymmetric policy response “Benign neglect” of sterling and policy of talking down the pound Lack of effective scrutiny and accountability Perception that inflation target has been downgraded and that growth is now the focus of monetary policy

30. Proposals for MPC reform Strengthen and diversify external membership of the Committee: eg 6 (external) to 3 (internal) MPC mandate to be tightened to counter reinterpretation and redefinition of inflation target MPC should be held more firmly to account for inflation performance by the Government and TSC Letter exchange to be more substantial, with statement to Parliament and TSC hearings TSC inquiry into conduct of monetary policy and Bank forecasting record since the financial crisis Separate forecasting from decision-taking, as in the fiscal framework. An OMR to match the OBR?

31. Message from the MPC: “Help!” When we were younger, so much younger than today, We never needed any help in any way. But now those days are gone, we’re not so self-assured: Now we can’t make up our minds and inflation’s over four! Help us please to bring inflation down, So we can stabilise the value of the pound, And ensure that our economy is still sound. Won’t you please, please help the MPC?

32. Message from the MPC: “Help!” (cont) And now the world has changed in, oh, so many ways: Our independence may soon vanish in the haze. So every now and then we feel quite insecure, George Osborne could decide to show us all the door! Help us please to bring inflation down, So we can stabilise the value of the pound, And ensure that our economy is still sound. Won’t you please, please help the MPC?