The risk of a “shock” from Brexit justifies a slower return to the targeted rate of inflation, Bank of England governor Mark Carney said today.
Speaking to an audience of the great and the good of British economic policy, as well as Prime Minister Theresa May, Carney said: “In exceptional circumstances like today when the economy is facing profound structural change, the MPC can extend the horizon over which it returns inflation to target from above in order to balance the effects on jobs and activity.”
Carney said: “Monetary policy will be set to achieve the inflation target in a way that helps smooth real adjustment in the economy and supports jobs in the wake of very large external forces.
“Banks will be capitalised so that they can withstand any severe shock that could be associated with Brexit – however unlikely – and still meet demand for credit.”
At a conference to mark 20 years of monetary policy independence, Carney mounted a strong defence of the Bank of England's independent mandate to target inflation.
He said: “Long and varied experience has shown that price stability is the best contribution monetary policy can make to the public good.”
However, Carney did acknowledge that “the financial crisis exposed how a healthy focus on price stability became a dangerous distraction.”
Some influential economists have hinted that a change in approach from inflation targeting may be overdue. Claudio Borio, head of the Bank for International Settlements, said last week that central banks might have to adjust their targets to take into account financial stability concerns.
Yet Carney maintained that the two per cent target was the best way to deliver stability, pointing to the events of Black Wednesday, when the UK crashed out of the European exchange rate mechanism (ERM) 25 years ago.
“The inflation target rose from the ashes of the ERM debacle twenty five years ago this month, marking the point when price stability became the unambiguous objective of UK monetary policy.”
Carney also strongly defended the Bank's independence from political pressure.
Interest rate decisions made by the chancellor are not “fully credible”, Carney said.
The Bank remains accountable to “Parliament and the people”, he added.