Select Committee on Treasury Appendices to the Minutes of Evidence


Memorandum by Mr Roger Bootle Specialist adviser to the Committee


  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

chart 1

chart 2

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Prepared 28 March 2001