David Blanchflower: Have the policymakers at the Bank of England gone completely nuts?

Economic Outlook:

The Bank of England's Monetary Policy Committee (MPC) last week published its latest forecasts for the British economy in its May Inflation Report. This followed its meeting a week earlier when it decided, presumably much to Chancellor Osborne's chagrin, that it would make no change either to interest rates or to the scale of its asset purchase programme. One of the major lessons from the 1930s is that central bankers are not powerless to act even if they think they are, and more action is better than less. So once again, in my view, the collective sitting on hands looks a major policy error.

We will not know until later this week whether there were any dissenters. My guess is that it may well have been a split of 6-3 with Martin Weale, David Miles and Adam Posen in the minority. In an interview with Market News International Adam Posen (who we also learnt on Friday is leaving the MPC in August to become the next president of the Peterson Institute) says he became too optimistic about the UK's economic outlook in the last few months and he may have been premature to believe the MPC had done enough quantitative easing. That suggests he voted for more QE this month.

The background to this is an economy that has the slowest recovery from recession in over a century, having contracted by 0.2 per cent over the last six quarters. To put this in context, out of the 34 OECD countries, over the last six quarters GDP growth in the UK ranked 29th, ahead of only Japan, Estonia, Italy, Portugal and Greece. On the day the Inflation Report was released there was a welcome reduction in the unemployment rate, but that news was tempered by an increase in the number of long-term unemployed by 27,000. Employment also grew, but that was restricted to older workers; there was no increase in the employment of those under 25.

Of additional concern was that wage growth was reported as 0.6 per cent, driven largely by a drop in bonuses. But this continues a steady trend downwards in both nominal and real wage growth. In March, nominal wages grew by 0.6 per cent, and with a 3.5 per cent CPI that gives a real wage fall of 2.9 per cent. So real wages are falling fast, which goes a long way to explain why consumer confidence and spending are both weak.

The MPC's main forecasts in the form of fan charts for growth and inflation are shown above. Let's start with the growth forecast, which the MPC, as in almost every quarter since the recession started, had to downgrade. It still assumes all is going to be back to normal soon, with growth possibly as high as 6 per cent in 2014, but no chance of zero or negative growth. When I explain this to business audiences, it always draws a big laugh. The MPC failed to incorporate any of the potential risks from the euro area to the forecast, as they said that they are hard to quantify. Of particular concern is that the MPC appears to believe that the majority of the growth they are predicting will come from consumption, as inflation falls. But falling real wage growth suggests that is unlikely.

The inflation fan chart suggests that inflation will come down and will hit the target in mid-2013 and then go below it and stay below it through 2014. The MPC's job is actually to get inflation to hit the 2 per cent target, and so it is hard to understand, on the basis of this chart, why they didn't loosen further and do additional QE. The fan chart says they should have done more and surely would have done more if inflation was above target. The falling oil price suggests that inflation may start to surprise on the downside. Brent crude oil futures are down 10 per cent since the beginning of May. The committee judged that the risks to inflation were balanced on the upside and the downside. Are they nuts? Even though they couldn't quantify the risks from Europe we clearly know the direction: they are on the downside.

Targeting inflation hasn't delivered the promised economic stability, far from it. It is now time for a change. In a new book*, Olivier Blanchard, chief economist at the IMF, puts it well: "Before the economic crisis began in 2008, policymakers had converged on a beautiful construction for monetary policy. We convinced ourselves that there was one target, inflation, and one instrument, the policy [interest] rate. And that was basically enough to get things done. One lesson to be drawn from this crisis is that this construction was not right: beauty is not always synonymous with truth. There are many targets and many instruments ... Future monetary policy is likely to be much messier".

Messy indeed. There have been calls for the MPC to target nominal demand, but I just don't think that is practical given the frequent data revisions that occur. A simple change, which amounts to much the same thing, would be to first raise the inflation target to 4 per cent. This could be done next year when the CPI changes to include house prices based on rental equivalence. Second, the mandate should be extended to become dual and explicitly include "maximum employment" as of the Fed, which is tasked with maintaining "maximum employment, stable prices, and moderate long-term interest rates".

Raising the inflation target to 4 per cent would mean that rates could remain lower for longer, which would boost growth. It also helps to deal with the problem of the zero nominal bound; rates have to rise again eventually so that when the next shock comes along they can be cut. We also have a growing body of evidence from behavioural economics that changes in unemployment have a much bigger effect on wellbeing than do changes in inflation.

In a speech this week the Prime Minister made it clear that there is to be no change fiscally. Policy errors have lowered the UK's growth prospects but have raised the likelihood that the UK will lose its AAA credit rating.

*In the wake of the crisis.  Leading economists reassess Economic Policy, edited by O. Blanchard, P. Romer, M. Spence, and J. Stiglitz, MIT Press, 2012.

News
Russell Brand was in typically combative form during his promotional interview with Newsnight's Evan Davis
peopleReports that Brand could stand for Mayor on an 'anti-politics' ticket
News
The clocks go forward an hour at 1am on Sunday 30 March
news
Arts and Entertainment
The Doctor finds himself in a forest version of London in Doctor Who episode 'In the Forest of the Night'
TVReview: Is the Doctor ever going stop frowning? Apparently not.
News
Voluminous silk drawers were worn by Queen Victoria
newsThe silk underwear is part of a growing trade in celebrity smalls
PROMOTED VIDEO
Sport
footballMatch report: Real fight back to ruin Argentinian's debut
News
Candidates with surnames that start with an A have an electoral advantage
newsVoters are biased towards names with letters near start of alphabet
Arts and Entertainment
Isis with Lord Grantham (Hugh Bonneville)
TV
Arts and Entertainment
Jay James
TVReview: Performances were stale and cheesier than a chunk of Blue Stilton left out for a month
News
ebooksAn unforgettable anthology of contemporary reportage
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Compensation and Benefits Manager - Brentwood - Circa £60,000

£60000 per annum: Ashdown Group: Compensation and Benefits Manager - Compensat...

Data Analyst/Planning and Performance – Surrey – Up to £35k

£30000 - £35000 Per Annum plus excellent benefits: Clearwater People Solutions...

IT Systems Business Analyst - Watford - £28k + bonus + benefits

£24000 - £28000 per annum + bonus & benefits: Ashdown Group: IT Business Syste...

Markit EDM (CADIS) Developer

£50000 - £90000 per annum + benefits: Ampersand Consulting LLP: Markit EDM (CA...

Day In a Page

Wilko Johnson, now the bad news: musician splits with manager after police investigate assault claims

Wilko Johnson, now the bad news

Former Dr Feelgood splits with manager after police investigate assault claims
Mark Udall: The Democrat Senator with a fight on his hands ahead of the US midterm elections

Mark Udall: The Democrat Senator with a fight on his hands

The Senator for Colorado is for gay rights, for abortion rights – and in the Republicans’ sights as they threaten to take control of the Senate next month
New discoveries show more contact between far-flung prehistoric humans than had been thought

New discoveries show more contact between far-flung prehistoric humans than had been thought

Evidence found of contact between Easter Islanders and South America
Cerys Matthews reveals how her uncle taped 150 interviews for a biography of Dylan Thomas

Cerys Matthews on Dylan Thomas

The singer reveals how her uncle taped 150 interviews for a biography of the famous Welsh poet
DIY is not fun and we've finally realised this as a nation

Homebase closures: 'DIY is not fun'

Homebase has announced the closure of one in four of its stores. Nick Harding, who never did know his awl from his elbow, is glad to see the back of DIY
The Battle of the Five Armies: Air New Zealand releases new Hobbit-inspired in-flight video

Air New Zealand's wizard in-flight video

The airline has released a new Hobbit-inspired clip dubbed "The most epic safety video ever made"
Pumpkin spice is the flavour of the month - but can you stomach the sweetness?

Pumpkin spice is the flavour of the month

The combination of cinnamon, clove, nutmeg (and no actual pumpkin), now flavours everything from lattes to cream cheese in the US
11 best sonic skincare brushes

11 best sonic skincare brushes

Forget the flannel - take skincare to the next level by using your favourite cleanser with a sonic facial brush
Paul Scholes column: I'm not worried about Manchester United's defence - Chelsea test can be the making of Phil Jones and Marcos Rojo

Paul Scholes column

I'm not worried about Manchester United's defence - Chelsea test can be the making of Jones and Rojo
Frank Warren: Boxing has its problems but in all my time I've never seen a crooked fight

Frank Warren: Boxing has its problems but in all my time I've never seen a crooked fight

While other sports are stalked by corruption, we are an easy target for the critics
Jamie Roberts exclusive interview: 'I'm a man of my word – I'll stay in Paris'

Jamie Roberts: 'I'm a man of my word – I'll stay in Paris'

Wales centre says he’s not coming home but is looking to establish himself at Racing Métro
How could three tourists have been battered within an inch of their lives by a burglar in a plush London hotel?

A crime that reveals London's dark heart

How could three tourists have been battered within an inch of their lives by a burglar in a plush London hotel?