Friday, March 15, 2013
Bank fights back on inflation
Posted by David Smith at 03:00 PM
Category: Thoughts and responses

Suggestions that the Bank of England has gone soft on inflation, including mine, appear to have hit home. Sir Mervyn King's observation that sterling has fallen far enough - which has lifted the pound - can be seen in that light.

So, more explicitly, can the line taken by Spencer Dale, the Bank's chief economist, in this speech. Talking about the consensus that low inflation is beneficial for growth, he said:

"More recently, though, there have been some worrying signs that cracks may be appearing in that consensus. A sense that inflation is somehow yesterdayís war. That central banks should focus more on growth. That a period of higher inflation may even aid the recovery. This is dangerous talk.

"It sometimes feels like weíve been here before. One of the mistakes made by policymakers in the late 1960s was to allow inflation to get out of control after nearly two decades of price stability. Intellectual ideas pop in and out of fashion. The inflation target and the MPC are the result of a long and painful search for a credible money anchor. They provide the memory to ensure that we donít return to the inefficiency and inequity of the 70s and 80s. They provide the memory that underpins the consensus that low and stable inflation is a perquisite for economic prosperity. And they provide the memory that guards against some of the dangerous talk of late."

He goes on to say:

"The argument that itís possible to grow the economy without much increase in inflation is, of course, seductive and enticing. Itís like being offered a free lunch. And yes, there are some grounds for thinking that the trade-off between growth and inflation may well be unusually favourable. But how strong those mechanisms actually are is far from clear. And it seems particularly optimistic to assume that the financial crisis and the near crippling of our banking system has played little role in the recent limp supply-side performance of our economy.

"Taken to its limit, the argument that monetary policy can be used to expand demand with little or no implications for inflation challenges the consensus that the best contribution that monetary policy can make to the long-term health and prosperity of the economy is to deliver price stability. That consensus is based on painful experience that monetary policy canít affect the level of output in the long run. That we canít generate permanently higher output and permanently higher employment simply by printing more money. We should be nervous about how quickly we overturn that consensus."