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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?