Select Committee on Treasury Written Evidence


Memorandum submitted by Roger Bootle

  1.  Although inflation is set to fall, perhaps sharply, in the next few months, there are several factors which suggest that there is a significant risk of inflation rising again: the strength of asset prices of almost all sorts, the rapid growth of the money supply, and the low level of real interest rates and bond yields. Moreover, there is some evidence that firms are starting to regain pricing power.

  2.  In addition, there are three key strategic risks: that the disinflationary forces emanating from China might be on the wane; that the exchange rate may fall; that inflationary expectations may become unhinged.

  3.  Furthermore, there are three wider concerns which argue in favour of higher interest rates, although they do not fit easily within the current remit of the MPC and Treasury Committee members may care to enquire of MPC members what consideration they give to these factors.

  4.  First, the targeted measure of inflation, the CPI, may not be giving a fair reflection of wider inflationary pressures in the economy. Various other measures suggest that inflation is much higher.

  5.  Second, although the inflation target is symmetrical, at the moment the dangers are not. If inflation turned out to be 1% below the target, ie at a rate of 1%, in view of the UK's monetary history that would not be a disaster. By contrast, inflation stuck 1% above the target, ie 3%, is not only a realistic prospect but it would run the risk of becoming a platform for higher rates of inflation.

  6.  Third, after a period in which inflation has overshot the target it would be no bad thing to go through a period in which it undershot the target. This would help to stabilise inflation expectations over the medium term.

  7.  A further issue which Treasury Committee members may want to explore is the delicate position of the Governor. Is he more hawkish than his voting record suggests? Although it is okay for him to be outvoted once in a while, to be regularly outvoted would undermine his authority and weaken the MPC as an institution. Accordingly, although I do not expect him to admit this very readily, if he wanted a decidedly tighter monetary stance would he be well advised to keep his powder dry until he could muster a majority on the Committee?

  8.  I think that the balance of risks now comes down strongly in favour of more vigorous action on interest rates. Interest rates might need to go to 6% or even 6.5% in order to be reasonably sure of containing inflation.

  9.  Moreover, it would be more effective to deliver a shock by increasing rates by ½% rather than the usual ¼%. I believe that in that sense the MPC has been too timid. The MPC prefers not to surprise the markets. But in not surprising the markets the danger is that it won't surprise consumers or consumer lenders either. Yet a surprise is exactly what they need.

June 2007





 
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