Dr Andrew SentanceFormer MemberMonetary Policy Committee

Is the Bank of England still committed to price stability?

Presentation at Cardiff Business School2nd November 2011

What the Bank tells the public

“The Bank sets interest rates to keep inflation low to preserve the value of your money.”

Summary statement on Bank of England website

The Bank’s remit

Excerpts from the latest mandate letter (March 2011)

“to maintain price stability; and, subject to that, to support the economic policy of Her Majesty’s Government”

“The inflation target is 2 percent at all times: that is the rate which the MPC is required to achieve and for which it is accountable.”

“The framework is based on the recognition that the actual inflation rate will on occasions depart from its target as a result of shocks and disturbances. Attempts to keep inflation on target in these circumstances may cause undesirable volatility in output.”

What the MPC has delivered

Source: Office of National Statistics

Period Target High Low Ave

May 1997 - Dec 2003

RPIX = 2.5% 3.2% 1.5% 2.4%

Jan 2004 - Dec 2007

CPI = 2.0% 3.1% 1.1% 2.0%

Jan 2008 – Sep 2011

CPI = 2.0% 5.2% 1.1% 3.4%

Outline

Recent UK inflation performance

Why has UK inflation been so high?

Problems with the MPC

Reforming the UK monetary framework

UK inflation persistently above target

Source: Office for National Statistics

1995 Jan 1997 Apr 1999 Jul 2001 Oct 2004 Jan 2006 Apr 2008 Jul 2010 Oct0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

Value Target Ave 2008-11

% per annum increase in consumer prices index

Inflation far above the old RPIX target

Source: Office for National Statistics

1995 Jan 1997 Apr 1999 Jul 2001 Oct 2004 Jan 2006 Apr 2008 Jul 2010 Oct0

1

2

3

4

5

6

Value Target Ave 2008-11

Annual % increase in retail prices index excluding mortgage interest

Broad-based rise in consumer prices

Source: Office for National Statistics

Food and non-alcoholic beverages

Alcoholic beverages and tobacco

Clothing and footwear

Housing, water and energy

Furniture & household eqpt/maint'ce

Health

Transport

Communication

Recreation and culture

Education

Restaurants and hotels

Miscellaneous goods and services

-2 0 2 4 6 8 10 12

% annual rise in CPI categories, September 2011

What has gone wrong?

• Global inflationary pressures

• Large sterling depreciation

• Persistent services inflation

• Limited impact of spare capacity

Global inflation on the rise

% per annum change in consumer prices

Source: The Economist

USEu

ro

China

Japa

n UK

Braz

il CaIn

dia

Russia

Aust

r...

-2

0

2

4

6

8

10

12

Year agoLatest

Global primary energy consumption

Source: BP Statistical Review 2010

Million tonnes oil equivalent

2000

2500

3000

3500

4000

4500

5000

5500

6000

6500

1980 1983 1986 1989 1992 1995 1998 2001 2004 2007

OECD

Non-OECD

UK goods price inflation

Source: Office for National Statistics

Jan-97 Jan-02 Jan-07-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

CPI goods Factory gate prices

% per annum change in goods prices

UK inflation in international context

Source: Office for National Statistics

2008

Jan

2008

Apr

2008

Jul

2008

Oct

2009

Jan

2009

Apr

2009

Jul

2009

Oct

2010

Jan

2010

Apr

2010

Jul

2010

Oct

2011

Jan

2011

Apr

2011

Jul

95

100

105

110

115

UK Euro US

Index of consumer prices, January 2008 = 100

The global economy and UK inflation

Global economy

Cost of imports

Demand

Pricing climate

Exchange rate

Domestic demand

Expectations and credibility

UK inflation

Impact of monetary policy

Sterling depreciation since 2007

Rebased to 100 in January 2005

Source: Thompson Datastream and Bank for International Settlements

*: Effective exchange rate

70

75

80

85

90

95

100

105

110

2005 2006 2007 2008 2009 2010 2011

Euro-Sterling exchange rate

Sterling EER *

Average EER *, 97-07

Episodes of Sterling depreciation

Index, base year = 100

Number of years from start of period

Source: Bank for International Settlements

50

60

70

80

90

100

110

0 1 2 3 4 5

1967-1971 1972-1977 1981-1986

1991-1996 2007-2010

Euro/UK inflation differential & exchange rate

Source: Thompson Datastream

*: Euro-Sterling exchange rate is expressed as the deviation from its average over the same period.

-0.4

-0.3

-0.2

-0.1

0

0.1

0.2

0.3

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

1997 1999 2001 2003 2005 2007 2009 2011

Euro-area/UK CPI differential (RHS) *

Euro-Sterling exchange rate (LHS) **

Euro/ sterling %

Persistently high services inflation

Source: Office for National Statistics

Jan-97 Jan-02 Jan-07-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

Goods Services

% per annum change in consumer prices

Capacity utilisation in UK economy

Source: Bank of England

Jan-98 Jan-03 Jan-08-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

Manufacturing Services

Bank of England Agents’ scores relative to normal

Unemployment in UK recessions

Source: Office for National Statistics, Labour Force Survey * Q3 based on Jun-Aug average

-8 -6 -4 -2 0 2 4 6 8 10 12 14 164

5

6

7

8

9

10

11

12

77Q4-83Q4 88Q2-94Q2 06Q2-11Q3*

Unemployment rate, % of labour force

Number of quarters from employment peak

Wage growth picking up

Source: Office for National Statistics

Jul-01 Jul-02 Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11-10.0

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

Monthly 3-month m.aAverage since 2001

% per annum growth in private sector average weekly earnings

UK economic growth

Source: ONS

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011-8

-6

-4

-2

0

2

4

6

Previous data Latest data Trend

% per annum change in non-oil GDP

High inflation squeezing sales volumes

Source: Office for National Statistics

1997MAR 1999FEB 2001JAN 2002DEC2004NOV2006OCT 2008SEP 2010AUG-2

0

2

4

6

8

10

Value Volume Average 97-08

% per annum growth in retail sales (3-month ave)

“Output gap” model weaknesses

• Revisions to GDP

• Uncertainty about capacity limits and trend growth

• Does not capture dynamic effects (eg growth of nominal demand, “speed limits”)

• Globalisation is reinforcing “small open economy” inflation behaviour

• “Hysteresis” may erode spare capacity effects

• Not a robust framework in presence of large supply shocks

Large official inflation forecast errors

Source: Bank of England

Mean of forecast percentage annual increases in consumer prices

0

1

2

3

4

5

6

2007 2008 2009 2010 2011 2012 2013

May-09 Nov-09

May-10 Nov-10

May-11 Actual CPI inflation

October 2011 MPC decision

“…the weaker outlook for, and the increased downside risks to, output growth mean that the margin of slack in the economy is likely to be greater and more persistent than previously expected.

“…measures of domestically generated inflation remain contained and inflation is likely to fall back sharply next year as the influence of the factors temporarily raising inflation diminishes and downward pressure from unemployment and spare capacity persists.

“The deterioration in the outlook has made it more likely that inflation will undershoot the 2% target in the medium term.”

The view from the Governor

“Our objective must be to steer the UK economy slowly back to a position of more normal interest rates and lower budget deficits. With a lower level of sterling and a credible plan to reduce the fiscal deficit over the medium term, we were on track. But the problems in the euro area and the marked slowing in the world economy have lengthened the period over which a return to normality is likely.”

Sir Mervyn King, 18th October 2011

MPC meetings attended

• Internal members (Total = 493)

• Sir Mervyn King (174)• Charles Bean (134)• Paul Tucker (113)• Spencer Dale (40)• Paul Fisher (32)

• External members (Total = 75)

• David Miles (29)• Adam Posen (26)• Martin Weale (15)• Ben Broadbent (5)

Problems with the MPC

• Emphasis on forecast has allowed the Committee to redefine its own target

• Persistent modelling and forecasting errors, with excessive weight on “output gap” model

• Assymmetric policy response

• “Benign neglect” of sterling and policy of talking down the pound

• Lack of effective scrutiny and accountability

• Perception that inflation target has been downgraded and that growth is now the focus of monetary policy

Proposals for MPC reform

• Strengthen and diversify external membership of the Committee: eg 6 (external) to 3 (internal)

• MPC mandate to be tightened to counter reinterpretation and redefinition of inflation target

• MPC should be held more firmly to account for inflation performance by the Government and TSC

• Letter exchange to be more substantial, with statement to Parliament and TSC hearings

• TSC inquiry into conduct of monetary policy and Bank forecasting record since the financial crisis

• Separate forecasting from decision-taking, as in the fiscal framework. An OMR to match the OBR?

Message from the MPC: “Help!”

When we were younger, so much younger than today,

We never needed any help in any way.

But now those days are gone, we’re not so self-assured:

Now we can’t make up our minds and inflation’s over four!

 

Help us please to bring inflation down,

So we can stabilise the value of the pound,

And ensure that our economy is still sound.

Won’t you please, please help the MPC?

Message from the MPC: “Help!” (cont)

And now the world has changed in, oh, so many ways:

Our independence may soon vanish in the haze.

So every now and then we feel quite insecure,

George Osborne could decide to show us all the door!

 

Help us please to bring inflation down,

So we can stabilise the value of the pound,

And ensure that our economy is still sound.

Won’t you please, please help the MPC?