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.