The inflation "doves" in the Bank of England may be winningby Liam Halligan / May 20, 2002 / Leave a comment
The defining act of New Labour’s economic policy- absent from its manifesto-was granting “operational independence” to the Bank of England in 1997.
Responsibility for the setting of short-term interest rates was handed to a nine-member Monetary Policy Committee (MPC) comprising four in-house officials and four outside experts, with Governor Eddie George in the chair. These arrangements would, the chancellor proclaimed, ensure monetary policy was guided by “the long-term needs of the economy, and not short-term political considerations.” The left groaned at this act of neo-liberal orthodoxy while the financial markets cheered. Long-term interest rates fell in anticipation of low inflation.
So, five years on, how has the reformed Bank of England performed? Politically, the new arrangements have worked well. The Tories now accept the MPC. Concerns about democratic accountability, most audible among Labour backbenchers, have also died away, as rates have dropped to 4 per cent-their lowest for 38 years.
Any judgement on the new Bank depends, of course, on the interest rates it has set. Here the evidence is mixed. There are concerns that over the last five years rates have been systematically too high-with adverse effects on thousands of redundant employees and millions of mortgage-holders. Inflation has been below the 2.5 per cent target for most of the last three years-which suggests rates could have gone lower, faster. Research by Ken Wallis, a Warwick University economist, says the MPC has consistently overestimated the threat of higher inflation.
Wallis calculates that since 1997, the MPC’s one-year forecasts of underlying inflation have been, on average, 0.2 percentage points too high. “The numbers are small and the MPC is still learning,” he says. “But these mistakes have costs, and more accurate probabilities would have made earlier reductions in interest rates more likely.”
Many businesses and trade unions, and even some MPC members, agree with Wallis that rates should be below 4 per cent. British rates, while historically low, are still the highest in the western world. Rates are 1.75 per cent in the US and 3.25 per cent in Euroland.
Underlying this inflation debate is an unresolved dispute about the “new economy” effect. This describes the idea that heightened competition-in markets for everything from food to microchips-has coincided with technology-induced productivity gains and a more flexible labour market to create a new lower-inflation world.
Several proponents of this theory sit, or have sat, on the MPC. The so-called “doves” think…