Stop fixating on the 2 per cent inflation target and focus on growth insteadby John Mills / May 10, 2019 / Leave a comment
Last month the government published its job description for a new Bank of England governor. While this has triggered an important discussion about the type of skills a successful governor needs, much less debate has focused on whether maintaining inflation as close as possible to 2 per cent should still be the centrepiece of the Bank’s and the government’s economic policy.
The Bank’s current mandate owes itself largely to the economic challenges of the 1970s and 1980s. In 1975, year-on-year inflation peaked at 24.3 per cent. The Keynesian consensus on economic policy, which had underpinned the largely successful economic outcome of the previous three decades, had no convincing response to prices rising at this rate. It was, therefore, understandable that new economic doctrines emerged—monetarism morphing into neoliberalism—which did appear to have an answer to the inflationary problem.
In consequence, the fiscal balance and money supply were both tightened, whilst interest rates were raised to staggeringly high levels. The base rate in the UK peaked at 17 per cent and 21 per cent in the US. Inflation did come down and targeting inflation at around 2 per cent became the central economic policy objective, as it still is.
The position now, however, is that keeping inflation down has largely been achieved while pressing new priorities have come to the fore. In particular, over the last four decades, economic growth in the UK—and the western world—has slowed at an alarming rate. Whereas between 1950 and 1975, the average annual growth rate in the UK was 2.6 per cent, between 1975 and 2000 it fell to 2.4 per cent. Since 2000, it has been 1.8 per cent.
Our economy is suffering from an acute investment and productivity crisis. Investment in the UK currently accounts for just 16 per cent of GDP according to the ONS, compared with a world average of 26 per cent and about 45 per cent in China. Productivity in the UK is hardly higher now than it was in 2007. We also have a chronic balance of payments problem, excessive borrowing and rising inequality, all of which are pressing economic imbalances which urgently need remedies.
It is within this context that updating the Bank of England’s mandate to focus directly on economic growth makes sense. Whereas inflation was the big challenge in the…