Bank of England November 2009 Inflation Report - Treasury Contents

Report to Treasury Select Committee from Dr Andrew Sentance, External Member, Monetary Policy Committee


  Last November, the Monetary Policy Committee had already embarked on a significant easing of policy aimed at combating the recession and heading off deflationary pressures. It was clear that the UK economy had suffered a massive confidence shock, reflecting the financial turmoil in September and October 2008. The global impact of this shock, coupled with the pressures created by the "credit crunch" and the surge in oil and commodity prices in summer 2008, set in train a contraction in consumer and investment spending worldwide. It also triggered a global stock cycle which led to sharp falls in world trade.

  Monetary easing continued through the past year. Bank Rate was reduced from 5% at the beginning of last October to 0.5% in March. But it was not clear that this use of conventional monetary policy would be sufficient to head off the risk of deflation and put the UK economy back on a recovery track. So I strongly supported the decision to embark on direct injections of money through asset purchases—mainly government bonds—which has come to be known as "Quantitative Easing" (QE).

  One reason why I supported this policy of QE asset purchases was that I felt it was very important for the credibility of the MPC and our monetary framework to show that we were prepared to use all levers available to stabilise the real economy and keep inflation close to target. However, the impacts of QE are highly uncertain, particularly with the operation of the banking system impaired by the financial crisis.

  A very important issue in the spring was to calibrate the scale of the QE operations we might undertake. I believed that we needed to make a bold start. This view was based partly on the analysis of the relationship between monetary aggregates and money GDP conducted by Michael Hume, my Monetary Policy Adviser. It also reflected my expectation that a bold QE announcement would have a significant positive impact on confidence in the business community and financial markets.

  I therefore supported the decision to announce an initial tranche of £75bn easing in March—carried out over three months—and to extend the total to £125 billion in May. I believe that it is the stock of additional money which is crucial to the impact of QE, and so the policy needed to raise the stock of money as quickly as possible. There were concerns at that time about the destabilising financial market impacts of large asset purchases, though these were not realised.

  As the QE programme has proceeded, the economic news has improved. The deflationary risk has receded and evidence of stabilisation and recovery has begun to emerge. In response, I believe it has been appropriate to slow the rate of asset purchases. I supported the majority view in August that our increased rate of purchases should be £50 billion over the next three months, slowing further to £25 billion over three months as a result of the November decision.


  The UK economy has suffered a severe recession in late 2008 and early 2009. But the last six months have seen a wide range of signs that the levels of output and demand may be stabilising and recovery is now underway. In a recent speech,[1] I set out four key reasons why I believe the UK economy has started to grow again: global economic recovery; improving business survey evidence; indicators of rising consumer spending; and positive evidence from the labour market.

  In my view, this improving picture reflects the combined impact of stimulus provided by monetary and fiscal policy and measures to stabilise the banking sector in the UK and overseas. The key issue looking forward is whether monetary policy should continue to be relaxed when the economy is on a recovery track, and at what point it might need to be tightened. In the shortterm, the recession will continue to bear down on inflation but if recovery gathers momentum, there will be upward pressures on inflation both at home and abroad.

  My recent speech highlighted two key uncertainties surrounding the economic outlook: the pace of recovery in the global economy; and the required domestic rebalancing as the public sector deficit is reduced. In the mid-1990s, a competitive exchange rate and reasonably healthy growth of domestic spending—household consumption and investment—enabled the UK economy to rebalance in a similar way to the adjustment now required. Our current challenge, however, is complicated by potential drags on private sector spending from the financial crisis and balance sheet adjustment in the household sector, which monetary policy will need to take into account.

  My objective will be to set monetary policy to keep inflation as close to the target as we can. But our recent experience has been global demand and price volatility has greatly complicated that task—which is likely to be a continuing challenge for UK monetary policy in the years ahead.


  Recent monetary policy challenges have made it particularly important that MPC members explain their views in the public domain and engage actively with the business community. My activities over the past year include:

    — six public speeches, addressing a wide range of global and national economic issues;[2]

    — seven "regional visits" (including the MPC Week in Scotland), normally lasting two days, organised by the Bank's Agency network—to Wales, South-East England, Northern Ireland, Scotland (twice), Liverpool and the North-East. A visit to the South-West of England is also scheduled for this month;

    — 24 talks to business groups and 22 company visits, as part of regional visits and from direct invitations;

    — a wide range of interactions with the news media, particularly the newswire services, including coverage on Channel 4 News of my visit to Liverpool in May; and

    — 12 talks at universities, colleges and schools.

17 November 2009

1   Prospects for the British Economy after the Financial Storm, delivered at Royal Holloway, University of London, 16 November 2009. Back

2   Copies are available on the Bank of England website. Back

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