Thursday, 15 December 2011
The BoE misses their inflation target (again)
The latest UK inflation number came out a few days ago. Unfortunately, I was too carried away with Cameron's historic stand against EU encroachment to pay any attention. The number fell slightly but a single snow drop doesn't mean that we will shortly be able to ski down Oxford Street.
UK inflation is the highest amongst the advanced economies. Since early 2005, inflation has been above target for all but three short periods amounting to 12 months out of a possible 77 months. More bluntly, over the last six years, the Bank of England monetary policy committee has met its mandated target in just 15 percent of the time.
In normal circumstances, inflation occurs when an economy is operating above capacity. However, the UK has been operating massively below trend since 2008. Why have prices increased while output has stagnated and unemployment increased?
The thing that resolves this conundrum is quantitative easing. The Bank of England has been printing money, which has driven up prices. QE has also generated negative interest rates, which creates enormous uncertainty that in turn discourages investment. Why would a firm build capacity today when there prospects of more inflation induced macroeconomic instability is on the horizon?
QE isn't working. We know this because the data tells us so. It is time to try something different.