Sunday, 13 February 2011

Looking through inflation

I enjoyed reading these paragraphs in Philip Aldrick, and Emma Rowley piece on inflation, which appeared in the Telegraph:

For the past three years the (Bank of England) has got inflation consistently wrong. Just last year, it predicted the current quarter's inflation figure would be 1pc. When the ONS publishes a figure four times that level on Tuesday, it will only aggravate concerns.

The Governor and his cohorts have a formula for dealing with overshoots now. The Bank needs to "look through" inflation, King says. Shear off the one-off events, oil price spikes, poor harvests that lead to food price rises, the inflationary effect of the pound's devaluation and the VAT rise. Strip all that out and domestically generated inflation in the past four years has been "close to zero and obviously well below the target", King said in Newcastle last month.

"Looking through inflation" - as if we couldn't see it every time we enter a supermarket.

Aldrick and Rowley’s article hints at some deeper problems of monetary policy management. Over the last quarter of the 20th century, a consensus developed that price stability should be the primary focus of monetary policy.

In order to deliver low and stable inflation rates, a parallel consensus emerged. Central banks should be independent of political control and receive a unambiguous mandate for which they are then held accountable.

In order to make this mandate operational, Central banks needed a data-based standard. This meant choosing a single price index, which was compiled independently of the central bank. A third consensus developed. The Consumer Price Index was to be that benchmark, and it was to be produced by an independent national statistical office. (As an aside, I always thought that this was the wrong benchmark, because it excluded house prices. But let’s leave that objection at the cloakroom for fear that it might obscure my central argument. )

In summary, modern monetary policy had arrived that three points of agreement:
  • Monetary policy should be directed towards price stability:
  • Central banks should be independent:
  • The CPI should be the metric for measuring the central bank’s success in meeting its primary objective.

Unfortunately, the Bank of England failed to abide by this social contract. Instead of maintaining price stability, it has chased growth with paltry results and kept the banking sector afloat at the cost of higher inflation.

This race for growth has compromised its independence. Today, the monetary policy committee looks more like a gaggle of incompetent and unelected politicians rather than a group of competent, rational, data-driven bankers.

As for the transparency of the CPI benchmark, the Bank has tried to detract our attention from it by a litany of self serving excuses about global shocks, oil prices, VAT and whatever else seems convenient to put forward as an explanation for unacceptably high inflation.

It is all rather disappointing. There was a time when I though an independent central bank was the answer. Perhaps, this explains my anger what has come to pass as monetary policy. The consensus could have worked, if only the MPC had understood what it had signed up for - keeping inflation under control.


AntiCitizenOne said...

As long as we don't run out of flat Screen TV sandwiches we wont starve.

Anonymous said...

Fortunately, due to suitable educational policy over recent decades, all we have to do is explain that if you strip out all the inflationary elements in CPI and RPI; then ........... inflation is zero.

Problem solved. Simples.

A David

AntiCitizenOne said...

Time is in itself a chain of "one-off" events.

Anonymous said...

Any chain will consist of an infinite number of discrete points. Since one infinity cannot be greater than another infinity, does it matter if we speak of millions, billions or trillions?

Cogito ergo some of us are getting worried.

A David

Trooper Thompson said...

I work to the Austrian definition of inflation as an expansion of the money supply, rather than a rise in prices, and calling you back to the cloakroom, keeping housing prices out of calculating price rises (which is falsely called inflation) makes the whole thing ridiculous, especially as for years we were being led to believe that rising house prices was a good thing.

Alice Cook said...


I agree. Inflation is always a monetary phenomenon, to quote the great man.


TheFatBigot said...

I wouldn't object over-much to the MPC failing to influence CPI sufficiently to get it within the target if they were doing something more substantive. If one accepts that money supply is the key the MPC still fails.