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Monetary Policy - Monetary Policy CommitteeTheory 2 - Inflation targeting - where are we aiming?Since leaving the Exchange Rate Mechanism (ERM) in 1992, the UK has had inflation targets. At first the government set a target of 1-4% for inflation, with the intention that it would be gradually reduced over successive years. That target was then changed to a target of 2.5% or less. However, in 1997 the Chancellor (Gordon Brown) changed the target to a target of 2.5% with an allowance of 1% above or below that target allowable. Since the adoption of the Consumer Price Index as the official measure of inflation in 2003, the inflation target for the MPC became 2% but is still symmetrical. This target is called a 'symmetrical target' because the MPC are just as concerned about under-shooting it as over-shooting it. A symmetrical target means that if inflation seems to be heading well under target, the MPC can reduce interest rates to encourage growth in demand. They can be just as active in cutting rates when inflation is under-shooting the target, as they would be in increasing rates if it was going over. A target of 2% or less may encourage a greater degree of caution and act as a constraint on growth. With a symmetrical target the MPC can ensure that GDP stays as close as possible to its potential. If inflation misses the target by more than 1% either side, the Governor of the Bank of England (as Chairman of the MPC) is required to write an open letter to the Chancellor. The letter would set out why inflation was adrift from the target, how long the divergence was expected to last and the action the MPC would be taking to bring inflation back on course. |
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