APPENDIX 2
Memorandum by Mr Roger Bootle Specialist
adviser to the Committee
COMMENT ON THE MPC'S
ROLE AND RECORD
1. The record of the MPC in achieving low
inflation is remarkably good, as Chart 1 indicates. Although there
are a number of comments and quibbles one would want to make about
this, this excellent record is surely the appropriate place to
start.
2. Chart 1 also makes clear, however, that
the sharp change in the inflation regime in this country came,
not with the establishment of the MPC, but rather in the aftermath
of Britain's exit from the ERM in 1992 and the establishment soon
afterwards of a greater role for the Bank of England in the setting
of interest rates and the publication of the Inflation Report.
The "Ken and Eddie show" was also successful in terms
of the remit which was subsequently set for the MPC.
3. It is noteworthy that the MPC's inflation
record has not been achieved at the expense of weak growth, or
even of considerable instability in the real economy. On the contrary,
the economy has grown strongly on average, with unemployment falling
sharply, and by the standards of the past, it has been highly
stable. Indeed, this very stability may have contributed to high
average growth, for in the post war period, UK economic performance
was characterised by strong booms, followed by steep slowdowns,
and occasional contractions. Both the speed of the expansions
and the abruptness of the slowdowns may have misallocated resources
and the instability itself deterred investment and encouraged
short-termism. Accordingly, on the face of it, the MPC has also
achieved a remarkable record with regard to its secondary objectives
of supporting government policy with regard to output and employment.
4. But this should not necessarily be taken
as an endorsement of the MPC, and still less of its detailed arrangements,
for we do not know what would have happened in the absence of
the MPC, nor if one or more interest rate decisions had been taken
differently. Specifically, it is striking how small the variation
has been in inflation. There is a strong possibility that inflation
at these levels exhibits such inertia that it would have been
very close to the target within a pretty wide range of interest
rates.
5. Accordingly, it is appropriate, I would
argue, to say that good though the record of the MPC is, it has
not really been properly tested. A proper test would involve at
least one period when a shock took the inflation rate well away
from the target. Especially if this was accompanied by weak growth
and rising unemployment, the MPC would then face difficult decisions
as to how rapidly to seek to get back to target and what level
of interest rates would deliver this result.
6. The closest the MPC has come to such
a test is the period in late 1998/early 1999 when in the wake
of the Asian financial crisis and the Russian default, the world
seemed to be teetering on the brink of a recession, and for a
while the UK economy was only crawling along. The response of
the MPC in cutting rates was fast and vigorous. Most importantly,
the Committee was able to convey the idea that if world conditions
worsened further they would act still more vigorously to forestall
a recession in the UK. In this way the MPC contributed greatly
to the subsequent recovery of confidence.
7. Moreover, whatever an objective assessment
of the Bank's record might be, the market gives a very encouraging
verdict on its performance looking forward. For, as Chart
2 indicates, 10 year government bond yields have essentially converged
with those of our European neighbours while longer yields (subject
to certain distortions) have undershot them. This is arguably
one of the most important indicators of the MPC's success—dispelling
the long-held market view that the UK is an inflation-prone country.
8. Arguably, the most serious criticism
of the Committee's decisions is that it has been persistently
too pessimistic about the inflation outlook and consequently has
kept interest rates too high, with the result that inflation has
trended down to the point where a letter may soon have to be written
explaining why inflation has fallen below 1.5 per cent. At the
point of writing, inflation has been below target for 22 months
and even the Bank's Inflation Report envisages it remaining below
target for most of the next two years. Accordingly, even on the
Bank's forecast, inflation will have been consistently below target
for almost four years. And even if it continues to cut interest
rates throughout 2001, in my view, it is not difficult to see
the period of below target inflation extending well beyond two
years.
9. In view of the UK's recent economic history,
this record might be judged by some observers to be a triumph.
But the inflation target is supposed to be symmetrical. I am left
with the suspicion that if the target had been overshot this
consistently, then the Committee would have been more vigorous
in seeking to bring it back. A less than even-handed approach
would be understandable, although still not within the MPC's remit,
if the members thought that a reform of the targeting regime which
would have the result of lowering the effective target was likely
at some stage after the election. It could also be explained,
but again would not be consistent with the remit, if members felt
that in view of the UK's record on inflation it was especially
important not to take risks on the upside.
10. The MPC has to take both the target
variable and the level of the target as given by the Chancellor.
Both are open to criticism. Most importantly, although it is far
from clear what the optimal rate of inflation is, it is difficult
to find a good justification for a figure as specific and apparently
arbitrary as 2.5 per cent. This difficulty itself makes it more
difficult to explain the inflation target widely to the public
and to get the public to believe in it. But it would not be right
for the Chancellor to spring a sudden change in the target variable,
or the target number. We are in need of a wide-ranging national
debate about this subject.
11. In relation to the larger issues discussed
above, some of the detailed arrangements concerning the operation
of the MPC regime may sound trivial. Nevertheless, they may come
to have greater importance in future—particularly when the
MPC comes to face extremely difficult decisions. The most important,
perhaps, concerns the status of the "central forecast".
In practice, there is likely to be considerable disagreement between
different members, about the future outlook and it may be misleading
to pretend that there is a Committee central forecast, with the
occasional dissenting view. There are no easy answers to this
issue but I would favour a single forecast produced by Bank staff,
without any presumption that individual MPC members would necessarily
subscribe to it.
27 February 2001
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