Nothing wrong with the Bank of England's mandate – it just needs to do it better - by Roger Bootle
Updated: May 20, 2022
It is 25 years ago this month that the Bank of England was granted operational independence by Gordon Brown in his first act as Chancellor in the newly elected Labour government of 1997.
Writing for the Telegraph, Roger Bootle assesses the Bank’s record over that period whose fundamental remit was and remains controlling inflation at or around 2%.
Notwithstanding the seismic shocks to the UK and global economy over the period, (the 2008 Banking Crisis, Covid and now the war in Ukraine), the author believes that the Bank’s original remit remains, broadly speaking, the right one.
To those who advocate a change of mandate – that the 2% target should be changed or its remit expanded in response to current events – the author remains unconvinced:
“There is a legitimate debate about whether 2pc inflation is the right target. Some notable economists have argued that it should be increased to 3pc or even 4pc. They allege that this would help to facilitate shifts in relative prices, while also giving more leeway before inflation dips into negative territory, giving rise to the various problems associated with a possible need for negative interest rates.
I don’t find this compelling. Although there is no God-given reason why the inflation target should be 2pc, this figure is low enough for people to almost forget about inflation. Whereas 4pc is a different kettle of fish. At that rate, over 10 years your money loses about a third of its value.
Another suggestion is that, instead of targeting the CPI, the Bank should target nominal GDP, which brings together changes in both the price level and output. Under such a target, if inflation rises at a time of weak output, the Bank would be under less pressure to raise interest rates.
There is something in this argument but again, in the end, I don’t find it convincing. Nominal GDP is not widely understood. It isn’t exactly the subject of frequent discussions down the Dog and Duck.
By contrast, there is a pretty good understanding of what the CPI is trying to measure. Similar objections apply to the idea of the Bank being set an objective for a specified level of prices which rises over time, rather than for a specified rate of change at all times.”
However the author does cite two areas where the Bank’s mandate can be improved: the selection of MPC members and the way they operate.
“In recent years, too many appointees have been consensus thinkers. Unsurprisingly, the Bank has succumbed to groupthink.
Moreover, it has paid too much attention to economic models and has been insufficiently aware of what’s going on outside its hallowed corridors. If the Bank has been complacent about the inflationary danger and operated too lax a monetary policy for too long, these are the major reasons why.”
The full article can be read here with a link to the original at the bottom:
As an addendum to the above, the author looks at the consequential effects of an impending recession on the housing market and its impact on mortgages and valuations.
With rising inflation and weak economic growth, any rise in interest rates may well tip the economy into recession and the effects on borrowers could be severe:
"Because of sharply rising inflation, we seem set to experience a deadly combination of much higher interest rates and a weakening economy.
This combination is relatively unusual because, in normal circumstances, when the economy is weak, inflation tends to be depressed, thereby facilitating low interest rates.
I think that a rise in interest rates to 2.5pc-3pc is likely and an increase to much higher levels is perfectly plausible.
With Bank rate at 3pc, average mortgage rates would probably be about 3.6pc, the highest since 2011. At current house prices, that level of mortgage rates would cause the affordability ratio to worsen from 39pc to 48pc. In the past, a number this high has signalled serious trouble ahead."
And the effect on house prices?
"I remain relatively optimistic about how the labour market is going to fare over the next couple of years. Even so, the coming rises in interest rates, combined with the pressure on people’s real incomes could cause house prices to fall by about 5pc.
And if I am wrong about the state of the labour market, then prices could fall by a good deal more than this. A drop of 10pc-20pc should not be dismissed out of hand."
The full article can be read here with a link to the original beneath it: