The Bank of England’s inflation target should be scrapped in favour of aiming for nominal GDP (NGDP), according to a report to be published today by a free-market think tank.
The Adam Smith Institute will say an NGDP target – the economy’s output not adjusted for inflation – would allow “more accurate and responsive decisions” by the Bank, and stop the current situation where it must sometimes override its target.
An NGDP target would mean the Bank does not have to differentiate between shocks to the supply side, such as oil price movements, and increases or decreases in demand.
The Treasury currently sets a two per cent target for annual inflation, which the Bank of England aims to control by adjusting interest rates, as well as more recent innovations such as quantitative easing bond buying.
A 2013 review of the monetary policy framework by the Treasury dismissed the idea of NGDP targeting, saying it would be more difficult to communicate to the public than price increases. GDP figures are also subject to major revisions on a regular basis, which could influence policy.
Political concerns would be an important factor if the target were introduced, said Simon French, chief economist at Panmure Gordon.
Anthony Evans, author of the report and Professor of economics at ESCP Europe Business School, said: “Since the financial crisis monetary policy has played a reasonable role in stabilising the economy, but only because it has strayed from its conventional remit.”
He added: “Reforming open market operations and adopting a nominal GDP target is effective in good times and bad, and provides a coherent, rule-based framework for monetary stability.”