34. One important risk identified in evidence related
to the possibility of inflation expectations coming loose from
their anchor, especially should economic circumstances be less
benign going forward. Mr Saunders, in his written evidence, explained
that, if inflation expectations rose, then individuals would bargain
for higher wages. Should these increases in wages be granted by
firms, this would lead firms to raise prices to cover the cost,
Explaining the importance of the recent anchoring of inflation
expectations, Professor Wren-Lewis highlighted that "anchoring
expectations does not so much make monetary policy more effective;
I think it makes it easier, in the sense that if the economy is
hit by shocks then the Bank has to do less to counteract those
shocks than if expectations are much more volatile".
But Professor Chadha pointed out that there had been, in recent
times, a slight shift upwards in inflation expectations, both
on the CPI and RPI measures.
He suggested that there was a danger in overusing inflation expectations
as a measure of inflationary pressure, because monetary policy
was expected to move to counteract any movements within them,
thus neutralising their informative power.
35. Lord George pointed out that inflation expectations,
while not anchored precisely to the target, were now no longer
running into "double digits", and that this had been
a success of the regime.
Dr Wadhwani agreed, stating that the lowering of inflation expectations
since the 1997 reforms had been important, and "has made
it much easier for the economy to handle the fluctuations in oil
and commodity prices that we have seen".
Mr Lambert also said that inflation expectations had influenced
the wage bargaining process, and that "people broadly trust
the idea that, over time, the target will be met".
The anchoring of inflation expectations has had an important
role in ensuring that inflation has varied by less than might
have been expected given the external shocks faced by the economy
in recent times. However, we remain concerned that, while inflation
expectations appear anchored in financial markets, the general
public appear to have less understanding of the monetary policy