The bottom line is no longer low inflation
Britain's central bank is set to ditch the 2 per cent target
Is one of the cornerstones of British economic and monetary policy about to be scrapped? It certainly seems as if policymakers are moving in the direction of abandoning the inflation target, the first version of which was brought in by Norman Lamont after Britain's ignominious ejection from the European Exchange Rate mechanism in 1992.
Shortly after his appointment as the new Governor of the Bank of England, Mark Carney, in a speech in Toronto, said central banks needed to be willing to keep borrowing costs low for an extended period. And he added: "If yet further stimulus were required, the policy framework itself would likely have to be changed."
That could include adopting a target for unemployment – as with the US Federal Reserve – or nominal gross domestic product growth (NGPD).
Mr Carney is no fool. He knows this will have been heard loud and clear on this side of the pond. And it was. Just a day later, Chancellor George Osborne told a parliamentary committee he was "glad" Mr Carney had raised the issue.
Yes, the party that brought you monetarism and was happy to let unemployment soar above 3 million during the Thatcher years in pursuit of stable prices, is apparently ready to perform a volte-face.
Such talk is anathema to the Bank of England, and on Tuesday in a speech in Belfast, its outgoing Governor, Sir Mervyn King, made his position quite clear. While he said more stimulus might be required to secure Britain's "gentle recovery", he warned of grave consequences of moving too far in the direction Messrs Carney and Osborne appear to be travelling.
"To drop the objective of low inflation would be to forget a lesson from our post-war history," Sir Mervyn said. "In the 1960s, Britain stood out from much of the rest of the industrialised world in trying to target an unrealistic growth rate for the economy as a whole, while pretending that its pursuit was consistent with stable inflation. The painful experience of the 1970s showed that this illusion on the part of policy-makers came at a terrible price for working men and women in this country."
Some might argue that the target – set at 2 per cent based on the consumer prices index measure of inflation –was effectively abandoned by the Bank some time ago. Inflation has been running at above that level since the end of 2009. But, Sir Mervyn made clear these are still exceptional economic circumstances. When – or if – the economy starts to chug along more normally, he believes the inflation target should be moved back into prime position. And his stance enjoys considerable support among business groups.
Katja Hall, chief policy director at the CBI, said: "Sir Mervyn is right to reiterate the importance of well-anchored inflation expectations in delivering economic stability. Clearly, this is an important issue for the incoming Bank of England Governor and the Chancellor to discuss."
Graeme Leach, chief economist at the Institute of Directors, said: "The key problem is that gross domestic product numbers operate on a big lag, so the potential for policy error is far greater. Inflation targeting isn't a perfect science. It is a very difficult thing to do. My view is you should retain inflation targeting, and pay closer attention to broad money growth in combination. It would be a switch in emphasis. But that is what the Bank of England is doing anyway."
The TUC is more sympathetic to Mr Carney, if not the Chancellor. Nicola Smith, TUC head of economics, said: "There's certainly scope to consider widening the Bank's remit to include a focus on growth or employment, as the Fed is now doing. But there is no monetary magic bullet to fix the economy. The Chancellor's supposed monetary radicalism is matched by his refusal to even consider changing his failing fiscal strategy."
In the City, however, they're more sanguine. Philip Shaw, chief economist at Investec, said: "There is a general question as to whether an inflation target is sufficient in this world or whether it is necessary.
"My own view is that it should be followed in a flexible way, supported by measures to ensure financial and economic stability. UK rates were left too low for too long over much of the Noughties, which allowed the economy to become imbalanced. One has to remember that whilst stable prices are an important prerequisite for a prosperous economy they are not on their own sufficient. There are other things that are just as important to consider, such as the financial sector and the rest of the economy."
Andrew Goodwin, senior economist at Oxford Economics, the consultancy, is more radical still.
He said: "Inflation targets worked well while in place in the early Nineties, but in the run-up to the financial crisis it didn't serve us at all well in terms of the asset-price bubble. In the last five to six years we've had inflation well above target and we'd suggest that, certainly, the Bank's Monetary policy committee [MPC] has been been working with a more flexible interpretation of its remit. It would be useful to formalise that in future."
The Chancellor appears willing to contemplate such a move. And if Mr Carney runs into resistance at the Bank, does it matter? Adam Posen this week became the second former member of the MPC to criticise the regime of Sir Mervyn, complaining that he was able to exercise "unfettered power".
Mr Carney, speaking in Ottawa, was at pains to praise the Bank's "analysis and leadership" as "a very important element in addressing the worst of the (financial) crisis". But if he wants to see radical changes to the way the Bank conducts monetary policy, the chances are he's going to get his way.
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