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Why Change the Bank of England’s Inflation Target? 

The Bank of England’s role has been in flux ever since it was founded in 1694 to fund a war with France. Its main job these days is to keep prices in check, something it has largely achieved since being handed control over interest rates 25 years ago. But like other central banks, it’s now struggling to calibrate policy in response to the economic shocks unleashed by the pandemic and Russia’s invasion of Ukraine. Inflation in the UK is soaring, leaving an institution long seen as a model for others to follow facing a crisis of credibility. 

1. How does the BOE achieve its goals? 

The BOE is tasked with achieving a rate of inflation set by the government each year. Right now that rate is 2% based on the Consumer Prices Index, a goal it shares with most central banks in advanced economies. If inflation diverges by more than 1 percentage point in either direction, the bank’s governor must write to the chancellor of the exchequer -- Britain’s finance minister -- explaining why, and what the bank will do about it. Its main policy tool is the Bank Rate, the rate of interest it pays to commercial banks that deposit money with the BOE. Those banks need to make higher returns than they can earn from risk-free central bank deposits, so when the Bank Rate rises, so does the cost of borrowing for consumers and businesses, restricting the supply of money in the economy and curbing prices. In times of crisis, the BOE can also buy government bonds, a tool known as quantitative easing, to bring down borrowing costs and stimulate spending. Between 1997 and the eve of the pandemic, inflation averaged 2% a year. 

2. How has the BOE’s role changed? 

Prior to 1997, rates were set by the chancellor, with the BOE governor providing advice. Within days of taking office, Tony Blair’s Labour government gave the bank operational independence and created a nine-member Monetary Policy Committee led by the governor, a move designed to insulate monetary policy from the risk of political opportunism. The BOE initially targeted an inflation rate of 2.5% based on the Retail Prices Index excluding mortgage interest payments. In 2003, the goal was shifted to 2% based on the CPI. In 2013, the BOE saw its remit change again when George Osborne, the Conservative chancellor, said that letting inflation overshoot the target was tolerable if it was required to support growth and employment. At the time, inflation was running close to 3% and the economy was emerging from the euro area’s sovereign debt crisis. 

3. What might happen now?  

Foreign Secretary Liz Truss, the front-runner to succeed Boris Johnson as prime minister, has said the UK is facing an unprecedented economic situation and that the “business as usual economic strategy” isn’t working. The BOE should remain independent but the time has come to revisit its mandate, she said. In a recent newspaper article, Truss said the recent commodity-induced inflation spike has been “exacerbated by monetary policy.” How she would revise the current system is unclear. She hasn’t said she would scrap inflation targeting, but did mention the possibility of widening the target to include a measure of money supply or nominal gross domestic product. Inflation in the UK is not out of line with the pressures being experienced in other advanced economies, where prices are rising at their fastest pace in decades. 

4. Does money supply targeting work?

In the early 1980s, Margaret Thatcher’s government set money supply targets to grapple with double-digit inflation. The idea was to reach a certain level of money supply to keep prices stable in the long term, even if it meant higher inflation in the near term. However, the metrics being measured were volatile and sometimes contradicted other signals on the state of the economy. That led to monetary targets falling out of favor in official circles and an ill-fated shift to manipulating foreign exchange rates as a way to anchor inflation. Proponents of money supply measuring have reclaimed some authority after Tim Congdon, who advised Thatcher, predicted the latest inflation spike early on after seeing broad money growth rocket by 15% at the start of the pandemic.

5. Is the independence of the BOE at risk? 

Some analysts have expressed concern that talk of revising the BOE’s remit again raises questions about the independence of the central bank from political meddling. Any loss of credibility for the BOE could damage the economy by making monetary policy less predictable, leading investors to demand higher returns for owning UK government debt. The chancellor can change the BOE remit overnight if needed by sending a letter to the governor. In practice, the government would probably formally consult on the matter to signal its intentions. 

• A Bank of England guide to interest rates and how they work.

• The chancellor who introduced Britain’s first inflation target in 1992 says it would be a mistake to abandon the regime in favor of a money supply goal.

• QuickTakes on the post-Brexit City of London and changes to the US Federal Reserve’s framework.

• QuickTakes from the archive on central bank independence and the perils of inflation measurement.

• Bloomberg Opinion’s Marcus Ashworth discusses the BOE’s “apocalyptic” economic outlook, while Paul J. Davies examines the motivation behind Brexiteer attacks on the BOE.

• A veteran UK monetarist who was an early prophet of the global inflation shock speaks out against the economics profession.

• Liz Truss’s inflation-fighting options if she becomes prime minister.

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