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Budd spells out MPC's methods

THE DECISION-MAKING process of the Bank of England's Monetary Policy Committee (MPC) is today spelt out by one of its members, amid concerns that a lack of information about the way its decisions are made could undermine the Bank's independence.

Writing in November's Economic Journal, Sir Alan Budd stresses that economic judgement plays a key role in Bank decisions, and explains that the MPC does not react to temporary changes in inflation, even if this means inflation misses its target.

Instead, Sir Alan writes, the MPC concentrates on the inflation outlook two years ahead.

He says: "Focusing on a period one to two years ahead provides a practical and approximate way of meeting the Chancellor's instruction that the target is 2.5 per cent at all times while avoiding undesirable fluctuations in output."

In his article, Sir Alan sets out one of the most detailed accounts to date of the MPC's decision-making process.

He emphasises the importance of the Bank's 12 regional agents, three of whom brief the MPC on anecdotal and survey evidence on the Friday preceding the monthly interest-rate meeting. In this regular pre-MPC meeting, which usually lasts a full day, the committee also hears detailed evidence from Bank economists on a wide range of issues.

The interest rate meeting itself is spread over two days, occupying an afternoon and the following morning. On the first day, the MPC revisits the issues raised in the Friday briefing, reserving discussion of the appropriate policy reaction until the next morning.

At the time of the quarterly inflation forecast the MPC has a series of lengthy meetings with Bank staff.

The MPC always holds a monthly interest rate meeting the week before the forecast is published, when it chooses the level of rates most likely to return inflation to target by the end of the two-year forecasting period.

Although the MPC has now been setting interest rates for more than a year, there is still uncertainty in the City about how the committee works. The perception that it is too insulated from the real world has attracted heavy criticism from industry.

Confusion about the precise interpretation of the inflation remit has also prompted concern in academic circles.

Writing in the same edition of the Economic Journal, Professor Charles Bean says that the Chancellor's phrasing of the inflation remit - in particular, the fact that the MPC is not told how quickly inflation should be brought back to target - runs the risk of jeopardising the Bank's independence.

However, Professor Bean concludes that, in practice, the scope for political interference in setting rates is limited.