Yesterday, the Bank of England passed up another opportunity to tackle inflation. It chose to keep rates fixed rather than hike them and tell the world that it would get serious about rising prices.
There is always next MPC meeting. If the MPC again fails to act, there is always the meeting after that. Difficult decisions can always be pushed into the future. Why risk taking a tough and unpopular decision when it can wait until next month.
Unfortunately, inflation isn't waiting around for the MPC. It is raging and looks ready to cross over the 4 percent mark by the end of the summer. Once it is there, a 5 percent inflation rate doesn't look so far way. Within 12 months, the MPC could find that short term real interest rates have turned negative.
The MPC will, of course, cite the "balancing act" defence. It has to "balance" the inflation risks with the threat of a downturn. This defence is becoming a little worn out. With every passing month, inflation keeps rising and the threat of a recession keeps growing. The MPC might think it is trading off higher growth for a little more inflation. In reality, it may end up with both.
If the economic difficulties of the 1970s prove anything, it is that there is no long run trade off between growth and inflation. Trying to keep growth bubbling along with low real interest rates only serves to push up inflation. Wage setters quickly react when central bank shows any cowardice before the inflationary enemy. Expectations begin to rise, and before you can say stagflation, the economy starts to suffer from a nasty case of a wage-price inflationary spiral.
There is still a short window of opportunity before the inflationary expectations begin to take off. The MPC could delay a rate hike for a few more months. Who knows, maybe the MPC might get lucky. Commodity prices might fall sharply; sterling might mysteriously begin to appreciate, and inflation might begin to fall.
Alternatively, inflation could continue to keep rising, and wage setters begin to demand higher wage settlements. Then, the MPC may look back on those lost opportunities, when in the summer of 2007, it could have acted decisively to bring inflation down, but instead waited in the hope that good fortune would help them out.