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Is the Bank of England still
committed to price stability?
Dr Andrew Sentance
Former Member
Monetary Policy Committee
Presentation at Cardiff Business School
2nd November 2011
What the Bank tells the public
“The Bank sets interest rates to keep
inflation low to preserve the value of
your money.”
Summary statement on Bank of England website
The Bank’s remit
Excerpts from the latest mandate letter (March 2011)
“to maintain price stability; and, subject to that, to support
the economic policy of Her Majesty’s Government”
“The inflation target is 2 percent at all times: that is the rate
which the MPC is required to achieve and for which it is
accountable.”
“The framework is based on the recognition that the actual
inflation rate will on occasions depart from its target as a
result of shocks and disturbances. Attempts to keep
inflation on target in these circumstances may cause
undesirable volatility in output.”
What the MPC has delivered
Period
Target
High
Low
Ave
May 1997 - Dec 2003
RPIX = 2.5%
3.2%
1.5%
2.4%
Jan 2004 - Dec 2007
CPI = 2.0%
3.1%
1.1%
2.0%
Jan 2008 – Sep 2011
CPI = 2.0%
5.2%
1.1%
3.4%
Source: Office of National Statistics
Outline

Recent UK inflation performance

Why has UK inflation been so high?

Problems with the MPC

Reforming the UK monetary framework
UK inflation persistently above target
% per annum increase in consumer prices index
Value
6.0%
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
Source: Office for National Statistics
Target
Ave 2008-11
Inflation far above the old RPIX target
Annual % increase in retail prices index excluding mortgage interest
Value
6
5
4
3
2
1
0
Source: Office for National Statistics
Target
Ave 2008-11
Broad-based rise in consumer prices
% annual rise in CPI categories, September 2011
Miscellaneous goods and services
Restaurants and hotels
Education
Recreation and culture
Communication
Transport
Health
Furniture & household eqpt/maint'ce
Housing, water and energy
Clothing and footwear
Alcoholic beverages and tobacco
Food and non-alcoholic beverages
-2
Source: Office for National Statistics
0
2
4
6
8
10
12
What has gone wrong?
•
Global inflationary pressures
•
Large sterling depreciation
•
Persistent services inflation
•
Limited impact of spare capacity
Global inflation on the rise
% per annum change in consumer prices
12
10
8
6
4
2
0
-2
Source: The Economist
Year ago
Latest
Global primary energy consumption
Million tonnes oil equivalent
6500
OECD
6000
Non-OECD
5500
5000
4500
4000
3500
3000
2500
2000
1980
1983
1986
Source: BP Statistical Review 2010
1989
1992
1995
1998
2001
2004
2007
UK goods price inflation
% per annum change in goods prices
CPI goods
Factory gate prices
10.0%
8.0%
6.0%
4.0%
2.0%
0.0%
-2.0%
-4.0%
Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan97 98 99 00 01 02 03 04 05 06 07 08 09 10 11
Source: Office for National Statistics
UK inflation in international context
Index of consumer prices, January 2008 = 100
UK
115
110
105
100
95
Source: Office for National Statistics
Euro
US
The global economy and UK inflation
Impact of monetary
policy
Cost of
imports
Global
economy
Demand
Pricing
climate
Exchange rate
Domestic
demand
Expectations
and credibility
UK inflation
Sterling depreciation since 2007
Rebased to 100 in January 2005
110
105
100
95
90
Euro-Sterling exchange rate
85
Sterling EER *
80
Average EER *, 97-07
75
70
2005
2006
2007
2008
*: Effective exchange rate
Source: Thompson Datastream and Bank for International Settlements
2009
2010
2011
Episodes of Sterling depreciation
Index, base year = 100
110
100
90
80
70
1967-1971
1972-1977
1991-1996
2007-2010
1981-1986
60
50
0
1
2
3
Number of years from start of period
Source: Bank for International Settlements
4
5
Euro/UK inflation differential & exchange rate
Euro/ sterling
%
0.3
2.0
1.5
0.2
1.0
0.1
0.5
0.0
0
-0.5
-0.1
-1.0
-0.2
-1.5
Euro-area/UK CPI differential (RHS) *
-2.0
Euro-Sterling exchange rate (LHS) **
-0.3
-0.4
1997
-2.5
-3.0
1999
2001
2003
2005
2007
*: Euro-Sterling exchange rate is expressed as the deviation from its average over the same period.
Source: Thompson Datastream
2009
2011
Persistently high services inflation
% per annum change in consumer prices
Goods
Services
7.0%
6.0%
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
-1.0%
-2.0%
-3.0%
Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan97 98 99 00 01 02 03 04 05 06 07 08 09 10 11
Source: Office for National Statistics
Capacity utilisation in UK economy
Bank of England Agents’ scores relative to normal
Manufacturing
Services
4.0
3.0
2.0
1.0
0.0
-1.0
-2.0
-3.0
-4.0
Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan98
99
00
01
02
03
04
05
06
07
08
09
10
11
Source: Bank of England
Unemployment in UK recessions
Unemployment rate, % of labour force
77Q4-83Q4
88Q2-94Q2
06Q2-11Q3*
12
11
10
9
8
7
6
5
4
-8
-6
-4
-2
0
2
4
6
8
10
12
Number of quarters from employment peak
Source: Office for National Statistics, Labour Force Survey
* Q3 based on Jun-Aug average
14
16
Wage growth picking up
% per annum growth in private sector average weekly earnings
Monthly
3-month m.a
Average since 2001
10.0
8.0
6.0
4.0
2.0
0.0
-2.0
-4.0
-6.0
-8.0
-10.0
Jul-01 Jul-02 Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11
Source: Office for National Statistics
UK economic growth
% per annum change in non-oil GDP
Previous data
Latest data
Trend
6
4
2
0
-2
-4
-6
-8
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: ONS
High inflation squeezing sales volumes
% per annum growth in retail sales (3-month ave)
Value
10
8
6
4
2
0
-2
Source: Office for National Statistics
Volume
Average 97-08
“Output gap” model weaknesses
•
Revisions to GDP
•
Uncertainty about capacity limits and trend growth
•
Does not capture dynamic effects (eg growth of
nominal demand, “speed limits”)
•
Globalisation is reinforcing “small open economy”
inflation behaviour
•
“Hysteresis” may erode spare capacity effects
•
Not a robust framework in presence of large supply
shocks
Large official inflation forecast errors
Mean of forecast percentage annual increases in consumer prices
6
May-09
Nov-09
May-10
Nov-10
May-11
Actual CPI inflation
5
4
3
2
1
0
2007
2008
Source: Bank of England
2009
2010
2011
2012
2013
October 2011 MPC decision
“…the weaker outlook for, and the increased downside risks
to, output growth mean that the margin of slack in the
economy is likely to be greater and more persistent than
previously expected.
“…measures of domestically generated inflation remain
contained and inflation is likely to fall back sharply next year
as the influence of the factors temporarily raising inflation
diminishes and downward pressure from unemployment and
spare capacity persists.
“The deterioration in the outlook has made it more likely that
inflation will undershoot the 2% target in the medium term.”
The view from the Governor
“Our objective must be to steer the UK
economy slowly back to a position of more
normal interest rates and lower budget deficits.
With a lower level of sterling and a credible plan
to reduce the fiscal deficit over the medium
term, we were on track. But the problems in the
euro area and the marked slowing in the world
economy have lengthened the period over
which a return to normality is likely.”
Sir Mervyn King, 18th October 2011
MPC meetings attended
•
Internal members (Total = 493)
•
•
•
•
•
•
Sir Mervyn King (174)
Charles Bean (134)
Paul Tucker (113)
Spencer Dale (40)
Paul Fisher (32)
External members (Total = 75)
•
•
•
•
David Miles (29)
Adam Posen (26)
Martin Weale (15)
Ben Broadbent (5)
Problems with the MPC
•
Emphasis on forecast has allowed the Committee to
redefine its own target
•
Persistent modelling and forecasting errors, with
excessive weight on “output gap” model
•
Assymmetric policy response
•
“Benign neglect” of sterling and policy of talking down
the pound
•
Lack of effective scrutiny and accountability
•
Perception that inflation target has been downgraded
and that growth is now the focus of monetary policy
Proposals for MPC reform
•
Strengthen and diversify external membership of the
Committee: eg 6 (external) to 3 (internal)
•
MPC mandate to be tightened to counter reinterpretation
and redefinition of inflation target
•
MPC should be held more firmly to account for inflation
performance by the Government and TSC
•
Letter exchange to be more substantial, with statement to
Parliament and TSC hearings
•
TSC inquiry into conduct of monetary policy and Bank
forecasting record since the financial crisis
•
Separate forecasting from decision-taking, as in the fiscal
framework. An OMR to match the OBR?
Message from the MPC: “Help!”
When we were younger, so much younger than today,
We never needed any help in any way.
But now those days are gone, we’re not so self-assured:
Now we can’t make up our minds and inflation’s over four!
Help us please to bring inflation down,
So we can stabilise the value of the pound,
And ensure that our economy is still sound.
Won’t you please, please help the MPC?
Message from the MPC: “Help!” (cont)
And now the world has changed in, oh, so many ways:
Our independence may soon vanish in the haze.
So every now and then we feel quite insecure,
George Osborne could decide to show us all the door!
Help us please to bring inflation down,
So we can stabilise the value of the pound,
And ensure that our economy is still sound.
Won’t you please, please help the MPC?