Jeremy Warner's Outlook: Close to the top. Federal Reserve serves up reassuring message on US interest rates

Monetary policy: time for a new approach; No quick fixes for aviation emissions; BP looks increasingly accident prone
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The Independent Online

No prizes for forecasting last night's quarter point rise in US interest rates. Attention instead was focused on the accompanying statement from the US Federal Reserve. To the extent that this wasn't much different from the one before, markets breathed a collective sigh of relief.

Something much more hawkish had been anticipated. In the event, the only significant difference between last night's statement and the one six weeks ago was the observation that "recent indicators suggest that economic growth is moderating from its quite strong pace earlier this year". In terms of its implications for interest rate policy, this would seem an almost dovish remark. Finally, the monetary medicine - almost two years of steadily rising interest rates - seems to be working.

The Open Markets Committee was quick to point out that inflationary risks remain. But it now seems more than conceivable that one more quarter point rise will mark the peak of the present cycle. Many economists have been worrying about the possibility of 6 per cent interest rates. That now seems less likely. If we are within a whisker of the peak, fears of outright recession should begin to ease. For the time being, markets are in bounce back mood.

Monetary policy: time for a new approach

Mervyn King, Governor of the Bank of England, wants a more formal approach to MPC appointments. Who can blame him? The present system allows the Chancellor to appoint all but two of the MPC's members. The suspicion that these appointments are done on a whim according to who's most in favour with the Chancellor at the time does little credit to the idea of a professionally conducted, independent monetary policy. At the very least, the Chancellor's appointments should be subject to parliamentary veto. As things stand they are not.

Yet perhaps the bigger question for the conduct of monetary policy nine years into an independent Bank of England is whether the present system of inflation targeting is still strictly speaking relevant. The Chancellor requires the MPC to meet an inflation target of 2 per cent as defined by the consumer price index, with the flexibility to wander up to 1 per cent either side of this target before being held to account.

This served the Government well during its early years in establishing credibility with financial markets, but the policy objective was set to meet the economic circumstances of a different age and may now have outlived its usefulness.

The deflationary effect on the price of goods of rapid industrialisation in the developing world, in combination with a massive influx of cheap labour from eastern Europe, has enabled the Bank of England to keep policy far looser than it would otherwise have been and still meet the inflation target. Unable to find its way into ordinary inflation, this wall of cheap money has instead fed a series of asset bubbles, the biggest one of the lot being house prices.

While general price inflation has remained largely in abeyance, the cost of buying and owning a home has been inflating away like topsy. Yet the CPI takes little if any account of this vital ingredient in the cost of living. Nor does inflation targeting adequately address the possible economic and social consequences of such asset bubbles.

Circumstances demand a more flexible approach. The time may already be right to consider giving the Bank of England the fully fledged independence enjoyed by the Federal Reserve in the US, whose brief is broadly to do what it thinks right for the US economy. Ironically, the new man at the Fed, Ben Bernanke, is said to favour inflation targeting. Perhaps he should think again. Root and branch changes to the way MPC members are selected and confirmed would need to be made to justify vesting such freedom and authority in the Bank of England. But it is an idea whose time has come.

No quick fixes for aviation emissions

We all love our cheap air travel. Five hundred pounds return to Sydney? Why, we might take the dog along too for that. For how much longer might this happy state of affairs continue? Despite growing concern about the impact of aviation on climate change, quite a bit longer yet if the industry gets its way.

There are still a few unreconstructed aviators out there who would argue that the industry shouldn't be subject to any controls whatsoever.

Yet most are wise enough to see that since some form of emission control is inevitable, the best policy is to lobby for the least worst solution. In this way the politicians might be persuaded against the draconian. It is nearly always better to concede ground than have it forcibly taken from you. That way you might hope to keep more of it.

British Airways yesterday became the latest airline to spell out its commitment to seeing aviation join the European Emissions Trading Scheme. As things stand, travel is excluded, even though aviation is the fastest growing emitter of greenhouse gases. And because the fuel is burnt at altitude, the effect on climate change may be doubly harmful.

But just which trading scheme should aviation be governed by? The industry wants to be included in the general trading scheme; the European Parliament wants a separate trading scheme set up especially for the aviation industry. The difference in approach is easily explained.

Such is the anticipated growth in aviation, that it really doesn't matter how much more fuel efficient the industry becomes. On current projections, growth in air travel is always going to far outstrip any improvement in fuel efficiency. In order to keep growing, the industry therefore needs to be able to purchase emission permits from other industries. And how. The UK Government has committed Britain to a 60 per cent reduction in greenhouse gases by 2050.

In the absence of some extraordinary and as yet unforeseen breakthrough in aviation technology, airline emissions will continue to grow throughout this period, raising aviation's share from the present 4 per cent to something like 17 per by 2050 even on the most optimistic assumptions. The true figure might be closer to 50 per cent. Either the objective of a 60 per cent reduction in total emissions by 2050 is cloud cuckoo land or something much more serious is going to have to be done about aviation.

For the industry, the least worst solution is plainly to be part of the general emissions trading scheme. As things stand, this is far too lax to make any impact on climate change, but even if the permits were to become scarcer, it would at least allow people to exercise a choice as to where they pollute. If they want to spend their entire carbon allocation on flying to Australia and freeze for the rest of the year, then so be it. However, if aviation is confined to its own trading scheme, it ought in theory to be easier to put an absolute cap on the growth of aviation.

Unfortunately, there is in practice very little that policymakers can do. Most of this batting to and fro of the argument is just fiddling while the world burns. Whatever we do here in Europe, it will make no difference at all as long as the US and the developing world refuse to play ball.

This in itself prevents some of the more extreme solutions being imposed in Europe, for nobody likes to put themselves at a competitive disadvantage. Good for cheap travel. Bad for the future of the planet.

BP looks increasingly accident prone

Is BP's halo finally coming loose? For one of the world's oil majors, this is a company which manages to portray an almost incredibly squeaky clean image. Now in swift order it finds itself up before the beak for the Prudhoe Bay oil spill, an explosion at a Texas oil refinery which killed 15, and finally for alleged price fixing in the US propane market. With profits gushing as never before thanks to the high oil price, BP needs to watch its step. American prosecutors need little excuse to crack down on "big bad oil" these days.

j.warner@independent.co.uk

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