Inflation is a poor test of MPC, says Budd

WHETHER OR not inflation stays on target is not a good test of whether the Monetary Policy Committee is doing its job properly, according to a former member.

Sir Alan Budd argues that the two-year lag between interest rate and inflation changes and the part played by luck, mean the MPC should be judged in the light of forecasts of inflation at the time interest rates are changed rather than its eventual success with the actual inflation rate.

The committee should do whatever is needed to keep consensus forecasts of inflation near the 2.5 per cent target.

By this standard, the MPC has been doing a good job, he concludes. Expected inflation has fallen steadily since May 1997 to around that level. "The MPC collectively can draw some modest satisfaction from developments so far," he writes in the London Business School's latest Economic Outlook. "The actual inflation path has benefited from an element of luck; but the fall in inflation expectations shows that this success is expected to continue."

He notes that it was the controversial decision to raise interest rates by a quarter point in June 1998 that really shifted economists' forecasts of inflation down to 2.5 per cent.

The rationale for Sir Alan's argument that assessing the MPC is not as simple as comparing actual inflation with the target is the fact that interest rates only affect inflation with a delay of up to two years.

Moreover, within that two-year period, all sorts of unexpected events will influence the inflation rate too.

Interest rate decisions could therefore be correct at the time, even if they turn out to be wrong with the benefit of hindsight, or vice versa.

As Sir Alan points out, it is a mistake ex ante to buy a National Lottery ticket because your expected win will be negative, but the jackpot winner obviously made the right decision ex post. However, he notes that the Treasury Committee, responsible for monitoring the MPC's performance, did not appear to be convinced by this argument.

In a recent report it said it would use contemporary forecasts as a benchmark, but added: "A degree of past accountability is also called for."

Sir Alan stepped down from the MPC at the end of May.

Start your day with The Independent, sign up for daily news emails
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

Recruitment Genius: Digital Optimisation Executive - Marketing

£30000 - £35000 per annum: Recruitment Genius: The UK's fastest growing, multi...

Recruitment Genius: Financial Reporting Manager

£70000 - £90000 per annum: Recruitment Genius: A Financial Reporting Manager i...

Recruitment Genius: Payments Operations Assistant

£23000 - £25000 per annum: Recruitment Genius: They win lots of awards for the...

Recruitment Genius: Telephone Debt Negotiator

£13500 - £20000 per annum: Recruitment Genius: This nationwide enforcement com...

Day In a Page

Sepp Blatter resignation: The beginning of Fifa's long road to reform?

Does Blatter's departure mean Fifa will automatically clean up its act?

Don't bet on it, says Tom Peck
Charles Kennedy: The baby of the House who grew into a Lib Dem giant

The baby of the House who grew into a Lib Dem giant

Charles Kennedy was consistently a man of the centre-left, dedicated to social justice, but was also a champion of liberty and an opponent of the nanny-state, says Baroness Williams
Syria civil war: The harrowing testament of a five-year-old victim of this endless conflict

The harrowing testament of a five-year-old victim of Syria's endless civil war

Sahar Qanbar lost her mother and brother as civilians and government soldiers fought side by side after being surrounded by brutal Islamist fighters. Robert Fisk visited her
The future of songwriting: How streaming is changing everything we know about making music

The future of songwriting

How streaming is changing everything we know about making music
William Shemin and Henry Johnson: Jewish and black soldiers receive World War I Medal of Honor amid claims of discrimination

Recognition at long last

Jewish and black soldiers who fought in WWI finally receive medals after claims of discrimination
Beating obesity: The new pacemaker which helps over-eaters

Beating obesity

The new pacemaker which helps over-eaters
9 best women's festival waterproofs

Ready for rain: 9 best women's festival waterproofs

These are the macs to keep your denim dry and your hair frizz-free(ish)
Cycling World Hour Record: Nervous Sir Bradley Wiggins ready for pain as he prepares to go distance

Wiggins worried

Nervous Sir Bradley ready for pain as he prepares to attempt cycling's World Hour Record
Liverpool close in on Milner signing

Liverpool close in on Milner signing

Reds baulk at Christian Benteke £32.5m release clause
On your feet! Spending at least two hours a day standing reduces the risk of heart attacks, cancer and diabetes, according to new research

On your feet!

Spending half the day standing 'reduces risk of heart attacks and cancer'
With scores of surgeries closing, what hope is there for the David Cameron's promise of 5,000 more GPs and a 24/7 NHS?

The big NHS question

Why are there so few new GPs when so many want to study medicine?
Big knickers are back: Thongs ain't what they used to be

Thongs ain't what they used to be

Big knickers are back
Thurston Moore interview

Thurston Moore interview

On living in London, Sonic Youth and musical memoirs
In full bloom

In full bloom

Floral print womenswear
From leading man to Elephant Man, Bradley Cooper is terrific

From leading man to Elephant Man

Bradley Cooper is terrific