August 17, 2011, 10:40 AM GMT
The Bank of
England‘s new mandate is to prevent output volatility. It is no longer
There’s no other way to interpret Governor Mervyn King’s open letter on why
inflation remains above the bank’s 2% target. By his own admission, inflation is
likely to breach 5% this year.
OK, so it is well nigh impossible for the bank to control inflation over the
very short term, and double digit utility price rises bake in a further jump in
consumer prices over the coming months.
Mr. King, instead, argues that over the coming year inflation will come down
because it is unlikely commodity prices will continue going up at the pace
they’ve been rising so far, because the effects of this year’s value added tax
rise will fall out of the equation, because sterling’s 25% devaluation in 2007
and 2008 will at long last stop exerting upward pressure on import prices and
because the government’s austerity program will keep the economy fragile.
What’s more, he argued, a slowdown in global growth and renewed financial
uncertainty tilt the inflation risks to the downside.
But there are several important facts that must be considered:
- By his own admission, Mr. King has said a country’s inflation rate is
entirely down to the central bank’s choice. The Bank of England could have met
its inflation remit, but only at the expense of driving down the growth
- The bank’s policy committee has consistently shrugged off inflation rates
well above its target but the moment it looked to dip below 2% it started
warning of deflation and talking about the need for extraordinary measures. It
should be remembered the U.K.’s inflation rate has never even dipped below 1%
since the financial crisis.
- Members of the rate setting Monetary Policy Committee have been clear that
they prefer to err on the side of too much inflation than on the side of too
- The bank has consistently misinterpreted the economy. Before the financial
crisis it allowed the U.K. to overheat because it underweighted the impact of
global factors in keeping inflation down. Since the crisis it has understated
the impact of sterling’s decline on inflation and overestimated how much of an
impact the downturn would have on unemployment. The bank has consistently also
overestimated the degree to which there is an output gap in the U.K. economy and
how much productive potential it has. In all, the biases and errors all point in
one direction: that is towards allowing inflation to be too high.
- As academic economists with a Keynesian background, much of the MPC is
contemptuous of savers. Savers, or rentiers as Mr. Keynes called them, were a
drag on an economy’s potential and deserved to have their money confiscated–his
euthanasia of the rentier.
The upshot is that 2% now represents the U.K.’s inflation floor. The bank has
shown itself comfortable with inflation at 5% and above, which suggests the
ceiling before it starts to react could well be in the order of 6% or 7%. Oddly
enough, economists like Kenneth
Rogoff have long argued that economies with large debt burdens need a few
years of 6% or 7% inflation in order to get back onto an even keel.
Mervyn King was born on March 30th, 1948 according to http://en.wikipedia.org/wiki/Mervyn_King_(economist)
March 30th, 1948
3 + 30 +2+0+1+1 = 37 = his personal year (from March 30th, 2011 to March 29th, 2012) = Looking out for the best interests of his fellow countrymen.
37 month + 8 (August) = 45 = his personal month (from August 30th, 2011 to September 29th, 2011) = Things go horribly wrong.
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