AT THE Treasury Select Committee last week, the incoming Bank of England governor Mark Carney re-iterated his desire for a more “flexible” inflation targeting regime for the UK. The Bank of England’s current remit is to keep consumer price index inflation at 2 per cent, within a band of 1 percentage point each way. But many have interpreted Carney’s call as a willingness to target forecasts of inflation over a longer period, as a means of keeping interest rates low.
Now, I don’t know whether I’ve woken up in a parallel universe, but isn’t that exactly what the current Monetary Policy Committee has been doing already?
The evidence seems to suggest so. Over the last four years, inflation has been outside of its desired range (above 3 per cent) in 13 of 24 quarters. It’s been above the 2 per cent central target for 22 of those quarters. Economist Andrew Lilico has shown that, since the inflation target breached the 3 per cent barrier in March 2007, the price level has risen 8.4 per cent above the level it would have been if the 2 per cent target had been met. What’s more, in a statement after last week’s meeting, the Monetary Policy Committee admitted that inflation would probably be above target for much of the next two years as well.
The Bank’s get-out-of-jail card has been that it is targeting forecast inflation. And this is the justification it continues to use for ultra-loose monetary policy. “One-time factors” are cited. There are underlying deflationary pressures, so we are told. And it would be silly to adjust monetary policy when the forecasts say we will naturally fall back to target anyway.
This would be a credible get-out if the Bank had a good forecasting record. And it did – up until 2007. But since then its forecasts have been consistently wrong. And not just consistently wrong, but consistently wrong in underestimating inflation.
Since the third quarter of 2007, the Bank has, on average, forecast that inflation one year ahead would be 2.2 per cent. The average outturn has been 3.3 per cent, meaning the Bank has tended to underestimate inflation by 1.1 percentage points. For two years ahead, the average forecast was 1.6 per cent, while the outturn was 3.3 per cent (a huge 1.7 percentage point average error).
These outcomes and their implications are not politically neutral. Inflation favours the indebted sectors of the economy, like the banks and the government, while punishing savers and those whose nominal earnings aren’t increasing. We’ve had four years of the Bank maintaining a policy which has coincided with much more inflation, and much less real growth, than expected.
Carney has said he wants to debate our inflation targeting regime. My questions to him would be: do we have one? And how much more of the same outcomes will it take before the Bank sees the limits and potential damage of “monetary activism”?
Ryan Bourne is head of economic research at the Centre for Policy Studies.