RISK CCR Missing the target: t
inflation level too low Identity fraud risk t Less is more t
MPC: MISSING THE TARGET
The Monetary Policy Committee aims at an inflation rate of 2%, so how is it reacting to a level of -0.1%? By Ian McCafferty
inflation for the first time since 1960. Inflation fell to -0.1% in April and is likely to remain around zero through the summer, well below the Monetary Policy Committee’s (MPC) target of 2.0%. As a result, the governor has now
I
had to write two open letters to the chancellor of the Exchequer on behalf of the committee, explaining why inflation has undershot by so much, and setting out how the MPC intends to respond. Also widely reported in the media
was our decision not to change the stance of monetary policy. In fact, the MPC has not voted to change Bank Rate or adjust our quantitative easing programme since 2012. Yet, in the face of low and falling inflation, the MPC might be expected to loosen policy. The objective of the MPC, set by
the Bank of England Act 1998, is to maintain price stability and, subject to that, to support the economic policy of Her Majesty’s government, including its
July 2015
am sure you have all seen the headlines: the UK economy is currently experiencing negative
objectives for growth and employment. The remit for the MPC, given to us by the chancellor and renewed annually, defines price stability as a 2% annual rise in the Consumer Price Index (CPI), a representative basket of goods and services consumed by households. There are three features to which I
would like to draw your attention: t The target is symmetrical. The MPC is to treat positive and negative deviations from the inflation target equally. t The target applies at all times. This means that even in periods when the economy is hit by inflationary or disinflationary shocks, the remit still applies and the objective of the MPC is to bring inflation back to 2%. Under such conditions, the MPC has to decide and communicate the appropriate horizon at which it is optimal to bring inflation back to the target. t The MPC’s primary objective is to hit the inflation target, but it needs to take care that, in doing so, it does not generate undue instability in output and employment. In other words, the remit allows the MPC to use its discretion to
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take account of output and employment conditions when determining how quickly inflation should be returned to the target. Of course, in practice, economic
shocks, emanating from both here in the UK and abroad, regularly push us away from the inflation target. So these three elements are a useful guide to determine how the MPC should respond to such shocks as they occur. Now, not all shocks are equal, nor is
it equally appropriate to use monetary policy to address them. The source and duration of the shocks are important, in particular whether the shock is temporary or more persistent. For monetary policy, temporary
shocks are those that have a one-off impact on the level of the CPI. They arithmetically affect the rate of inflation for the following year, but after that, the impact on the rate of inflation disappears again. An example of this type of shock would be the increase in Value Added Tax in 2011; this pushed up the level of many prices and so contributed to an increase in
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