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UK inflation - Under control?

UK inflation - Under control?. Presentation to Policy Exchange London, 20 October 2011. Recent UK inflation performance Why has UK inflation been so high? Problems with the MPC Reforming the UK monetary framework. UK inflation persistently above target.

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UK inflation - Under control?

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  1. UK inflation - Under control? Presentation to Policy Exchange London, 20 October 2011

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

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

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

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

  6. MPC – The inflation record Source: Office of National Statistics

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

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

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

  10. 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

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

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

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

  14. 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.

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

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

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

  18. 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

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

  20. Problems with the MPC Emphasis on forecast has allowed the Committee to redefine its own target Persistent modelling and forecasting errors, reflecting analysis based on “groupthink” Assymmetric policy response “Benign neglect” of sterling Lack of effective scrutiny and accountability Perception that inflation target has been changed or downgraded

  21. 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.”

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

  23. 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

  24. Proposals for MPC reform Strengthen and diversify external membership of the Committee: eg 6 (external) to 3 (internal) 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. End policy of talking down the pound

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