The Bank of England is right to focus on the future not the present, focusing on growth and employment, argues ippr's Tony Dolphin.
Jeremy Warner, writing in today’s Daily Telegraph, takes the Bank of England to task for ‘putting jobs before inflation’. He believes the Bank should raise interest rates now to tackle the current high level of inflation, but that it is not doing so because of high unemployment. He compares the current situation with the 1970s, when, he says:
“Governments attempted to counter rising joblessness by keeping monetary and fiscal policy as loose as possible, even as they were hit by a series of crippling external price ‘shocks’.”
Of course, there are many differences between the 1970s and now. The degree of inflation pressure was much higher in the 1970s (it peaked at 27 per cent in 1975); fiscal policy was loose then, but is now being tightened more aggressively than at any time in the last 70 years; the money supply was out of control in the 1970s, but is now barely increasing; and wage inflation pressures were rampant then but are extremely low now.
This last point is important. The Bank cannot, on its own, prevent oil and food prices soaring. Such external inflation pressures are out of its control. The Bank can only prevent a build up of domestic inflation pressures and there is little sign that such pressures are building. Average earnings over the last year were up by little more than 2 per cent. High unemployment is holding down wage inflation in the private sector and the government is imposing wage freezes across large parts of the public sector.
The Bank has not stopped targeting inflation and started targeting unemployment instead. The Bank is simply doing what it has done ever since it took responsibility for setting interest rates, accepting that it cannot change the path of inflation in coming months and focusing instead on inflation in the future – in roughly 18 to 24 months’ time.
Future inflation will depend largely on developments in commodity prices and on domestic inflation pressures. The former are unpredictable and almost totally out of the control of the Bank. The latter are currently very low and consistent with the Bank’s inflation target.
If domestic inflation pressures were starting to creep up – if there was evidence, for example, that higher inflation expectations were leading to a pick up in wage settlements – then it might be right for the Bank to act. But they are not. If financial markets were taking fright at the prospect of inflation, then it would be right for the Bank to act. But they are not. The yield on a 10-year UK government bond is just 3.75 per cent and, although it has risen in the last few months, this hardly suggests investors are worried about the medium-term inflation outlook.
Higher interest rates would do nothing to bring inflation down in the next few months, but they would risk damaging the economic recovery, which already looks to have lost some momentum in the last few months. The Bank is right not to act.
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