In the News
27 January 2011
Monetary Policy
The news about weaker gross domestic product (GDP) in the UK released earlier this week was followed by a speech made by the Governor of the Bank of England, Mervyn King, in Newcastle and the release of the minutes of the January meeting of the Monetary Policy Committee (MPC). Mr King's speech was keenly followed by analysts looking to read between the lines to get any messages that might give a hint to future direction in monetary policy at the Bank.
In his speech, Mr King acknowledged that inflation would continue to speed up into 2011 before contracting sharply into 2012. He further noted that this would put pressure on the standard of living (defined as the amount of goods that incomes can purchase) given that wages have been lagging behind the rise in prices. He hinted that the economy was in a transition phase and that households would feel pain before the economy settled back into more sustained growth in the coming years. Mr King explained why inflation was above the target level of two per cent citing higher import prices the rise in price of fuel and energy, the rise in global commodity prices and the increase in value added tax (VAT). However, Mr King also pointed out that a weaker pound which brought higher import prices also meant that the UK economy was more competitive and as a result higher exports could be expected to offset some of the negatives.
The Governor insisted that the factors driving inflation were 'temporary' and that when stripped out of the calculations left underlying inflation close to zero. One of the major concerns for the Bank has been the possibility that inflationary expectations could be adjusted upwards as a result of the persistence of prices to be above target. If this happens then workers might begin demanding higher pay and if higher pay claims were awarded by businesses, a wage-price spiral could begin. As a result, Mr King has urged pay restraint whilst acknowledging that in doing so living standards would be squeezed.
The release of the minutes of the MPC showed that there are differences of opinion on the Committee about the direction of monetary policy. The Governor proposed that the Bank maintained interest rates at 0.5 per cent and also not to extend the asset purchasing facility beyond its existing £200 billion. Of the nine member committee, six voted for the proposal, two - Andrew Sentance and Martin Weale - voted for a quarter point rise in interest rates and one, Adam Posen, voted to increase the asset purchasing facility by £5 billion. The split in voting highlights just how difficult a job the Bank currently has. When the economy is performing in line with expectations setting interest rates can seem relatively easy but since the financial crisis (and some would argue, just before it) the economic rules seem to have changed and economists are having to come to grips with the longer term effects of the crisis.