The Bank's St George faces a new kind of dragon

Eddie George has a testing year ahead of him. His career as Governor of the Bank of England - and Saint George to the inflation dragon - has so far been easy. But it may not remain so. The Bank's credibility will really face a challenge in 1995.

Things have been easy until now, not so much because the dragon has been docile, although it has. It is more that fear of inflation has led the country to land a good deal of veneration on the Bank of England and its boss. The Bank - rather than the Department of Trade and Industry, the Wise Men, the International Monetary Fund or the Treasury Select Committee - has been allowed to fill the policy vacuum left in the aftermath of the exchange rate mechanism debacle. The decision to publish (albeit with some delay) the Bank's view of monetary policy was quite the most significant British economic decision of last year.

But this year, the real challenge begins. Now it's not that the Governor should be worried over the possibility that inflation will return and tough decisions will have to be made. Eddie George will have no problem in being tough. After all, his role in the economic constitution of the nation is to have responsibility without power - a position from which it is relatively easy to demonstrate firmness.

And the return of inflation? Well, it could return soon, but on past form it's still likely to be more than a year away. The economy is a beast that is slow to stir; turning points often arrive far later than impatient forecasters predict. More importantly, the economy still has considerable slack. And anyway, as far as the Bank of England is concerned, even if inflation does snort its fiery breath in the distance, that would only enhance the role of the inflation slayer.

No, the threat to Eddie George comes not from the possibility that inflationary signs will return this year, but that they will remain subdued. If the Bank's forecasts remain as consistently wrong - almost always pessimistic - as they have been (see graphic), then instead of looking like a responsible monitor of monetary policy, the Bank will look as though it is out of touch and out of mind. Last year, the Bank gained credibility by overstating the inflationary danger. This year it will not be able to repeat the trick.

Robust credibility So Eddie George's mission for 1995 must be to establish a new credibility for the Bank that is robust enough to withstand the possible non-return of inflation. He needs to give a credibility to the Bank and the new monetary policy framework that is not dependent on immediate fear.

Establishing that credibility was foremost among its goals for 1994. Certainly its economists believe that it is easier to get inflation down when people believe you are going to get inflation down. But while that is true, the Bank has been overwhelmingly concerned with credibility in the financial markets - to the detriment of its credibility everywhere else.

Credibility in the City can be gauged by looking at the short-term fluctuations in long-term interest rates. Every quarter the Bank updates us on its view of its credibility in the bond markets. For example, after the September interest rate rise, long-term bond rates fell - implying that the market thought that higher rates then would mean lower inflation and interest rates later.

But this notion of credibility is only interesting in the way that poll ratings of mid-term governments are interesting. It says how well you are doing, but not in a way that should drive you to respond on a daily basis. Confidence crises apart, credibility in the City is not the foundation of a successful anti-inflationary policy.

Indeed, more credibility in financial markets has a paradoxical negative effect on the impact of monetary policy. Base rate rises are effective at beating inflation substantially by pushing up interest rates across the whole spectrum and suppressing demand. Well, if credibility makes long-term rates fall in response to a short-term rate rise, it has hardly been helpful to the suppression of demand.

Long-term image So in 1995 the Bank of England should be far less concerned about its daily poll rating in the bond markets and far more concerned about its image in two other quite distinct markets instead, markets that will determine the Bank's long-term fate.

First, there are the wage-bargainers and price-setters. We don't need them to have faith in the policy-making framework and inflation 10 years hence. Indeed, the credibility effects of the medium-term financial strategy and the ERM turned out to be unimportant. But we do want them to believe that inflation will be low in the next 12 months. To help them to believe that, however, the Bank should be doing more to sing about how much lower inflation is than most people realise, rather than warning them that it is about to attack again. It is news about low inflation that this audience needs.

The second audience to please is that of policy-makers and politicians. The type of credibility that matters here is the one that encourages decision-makers to put their trust in an independent Bank and overcome their desire to interfere politically in the monetary process.

For the Bank to establish authority, however, it primarily needs to be seen as wise. If the Bank's forecasts consistently make mistakes - all in the same direction - no Chancellor will face the criticism of the intelligent public for overriding the Bank's advice. The politicians will in effect take power back. It is credibility in these respects that will benefit UK monetary policy as much as a short-term quarter of a percentage point off gilt yields.

The Bank may defend itself by arguing that it has been no worse than anyone else in the City at forecasting inflation. But while that is true, most business decision-makers would not use other City forecasts as a benchmark of good performance. That boastwill carry little weight once you get more than three miles away from Bank Underground station.

So that means for 1995, the Bank must make one change. It must stop believing that there is something to be gained by adopting too careful a stance in its forecasts and advice. It has a bigger and more important audience to impress than just the bond markets. For the Bank, 1995 will show that it is better not to err than to err on the side of caution.

Evan Davis is the BBC's economics correspondent.

Start your day with The Independent, sign up for daily news emails
Arts and Entertainment
EurovisionGoogle marks the 2015 show
News
The coffin containing the remains of King Richard III is carried on a procession for interrment at Leicester Cathedral on 22 March 2015 in Leicester, England.
news
Sport
The Queen and the letter sent to Charlie
football
Arts and Entertainment
Eurovision Song Contest 2015
EurovisionGoogle marks the 2015 show
News
Two lesbians hold hands at a gay pride parade.
peopleIrish journalist shares moving story on day of referendum
Arts and Entertainment
<p>
<b>Kathryn Williams</b>
</p>
<p>
When I was supporting Ray La Montagne I was six months pregnant. He had been touring for a year and he was exhausted and full of the cold. I was feeling motherly, so I would leave presents for him and his band: Tunnock's Tea Cakes, cold remedies and proper tea. Ray seemed painfully shy. He hardly spoke, hardly looked at you in the face. I felt like a dick speaking to him, but said "hi" every day. </p>
<p>
He was being courted by the same record company who had signed me and subsequently let me go, and I wanted him to know that there were people around who didn't want anything from him. At the Shepherds Bush Empire in London, on the last night of the tour, Ray stopped in his set to thank me for doing the support. He said I was a really good songwriter and people should buy my stuff. I was taken aback and felt emotionally overwhelmed. Later that year, just before I had my boy Louis, I was l asleep in bed with Radio 4 on when Louis moved around in my belly and woke me up. Ray was doing a session on the World Service. </p>
<p>
I really believe that Louis recognised the music from the tour, and when I gave birth to him at home I played Ray's record as something that he would recognise to come into the world with. </p>
booksKathryn Williams explores the works and influences of Sylvia Plath
News
Liz Kendall played a key role in the introduction of the smoking ban
newsLiz Kendall: profile
Life and Style
techPatent specifies 'anthropomorphic device' to control media devices
Voices
The PM proposed 'commonsense restrictions' on migrant benefits
voicesAndrew Grice: Prime Minister can talk 'one nation Conservatism' but putting it into action will be tougher
News
ebookA unique anthology of reporting and analysis of a crucial period of history
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

Guru Careers: Software Developer / C# Developer

£40-50K: Guru Careers: We are seeking an experienced Software / C# Developer w...

Neil Pavier: Management Accountant

£45,000 - £55,000: Neil Pavier: Are you looking for your next opportunity for ...

Sheridan Maine: Commercial Accountant

£45,000 - £55,000: Sheridan Maine: Are you a newly qualified ACA/ACCA/ACMA qua...

Laura Norton: Project Accountant

£50,000 - £60,000: Laura Norton: Are you looking for an opportunity within a w...

Day In a Page

Sun, sex and an anthropological study: One British academic's summer of hell in Magaluf

Sun, sex and an anthropological study

One academic’s summer of hell in Magaluf
From Shakespeare to Rising Damp... to Vicious

Frances de la Tour's 50-year triumph

'Rising Damp' brought De la Tour such recognition that she could be forgiven if she'd never been able to move on. But at 70, she continues to flourish - and to beguile
'That Whitsun, I was late getting away...'

Ian McMillan on the Whitsun Weddings

This weekend is Whitsun, and while the festival may no longer resonate, Larkin's best-loved poem, lives on - along with the train journey at the heart of it
Kathryn Williams explores the works and influences of Sylvia Plath in a new light

Songs from the bell jar

Kathryn Williams explores the works and influences of Sylvia Plath
How one man's day in high heels showed him that Cannes must change its 'no flats' policy

One man's day in high heels

...showed him that Cannes must change its 'flats' policy
Is a quiet crusade to reform executive pay bearing fruit?

Is a quiet crusade to reform executive pay bearing fruit?

Dominic Rossi of Fidelity says his pressure on business to control rewards is working. But why aren’t other fund managers helping?
The King David Hotel gives precious work to Palestinians - unless peace talks are on

King David Hotel: Palestinians not included

The King David is special to Jerusalem. Nick Kochan checked in and discovered it has some special arrangements, too
More people moving from Australia to New Zealand than in the other direction for first time in 24 years

End of the Aussie brain drain

More people moving from Australia to New Zealand than in the other direction for first time in 24 years
Meditation is touted as a cure for mental instability but can it actually be bad for you?

Can meditation be bad for you?

Researching a mass murder, Dr Miguel Farias discovered that, far from bringing inner peace, meditation can leave devotees in pieces
Eurovision 2015: Australians will be cheering on their first-ever entrant this Saturday

Australia's first-ever Eurovision entrant

Australia, a nation of kitsch-worshippers, has always loved the Eurovision Song Contest. Maggie Alderson says it'll fit in fine
Letterman's final Late Show: Laughter, but no tears, as David takes his bow after 33 years

Laughter, but no tears, as Letterman takes his bow after 33 years

Veteran talkshow host steps down to plaudits from four presidents
Ivor Novello Awards 2015: Hozier wins with anti-Catholic song 'Take Me To Church' as John Whittingdale leads praise for Black Sabbath

Hozier's 'blasphemous' song takes Novello award

Singer joins Ed Sheeran and Clean Bandit in celebration of the best in British and Irish music
Tequila gold rush: The spirit has gone from a cheap shot to a multi-billion pound product

Join the tequila gold rush

The spirit has gone from a cheap shot to a multi-billion pound product
12 best statement wallpapers

12 best statement wallpapers

Make an impact and transform a room with a conversation-starting pattern
Paul Scholes column: Does David De Gea really want to leave Manchester United to fight it out for the No 1 spot at Real Madrid?

Paul Scholes column

Does David De Gea really want to leave Manchester United to fight it out for the No 1 spot at Real Madrid?