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Targeting the Targeters

LONDON – Speaking in the happier economic times of 2005, Mervyn King – then, as now, Governor of the Bank of England – stressed the importance of entrenching public expectations of stable, low inflation. He warned that, “if you let inflation expectations drift too far away from the target, you can end up in quite serious difficulty with a costly process to bring them back again.” King must now be a worried man.

The Bank of England’s own commissioned quarterly surveys of public attitudes reveal that the credibility of its Monetary Policy Committee (MPC) has now been impaired. For the last 15 months, the 2% inflation target, which is set by the government and is supposed to be enforced by the Bank of England, has been exceeded by more than a full percentage point. For most of this period, the British public expected inflation in the coming year to be lower than in the previous year, thanks to the MPC’s strong track record on price stability. That confidence has now dissipated: inflation expectations have caught up with the actual inflation rate of 4%.

There is no mystery about what is going on. The price-stability mandate has been trumped by concerns about growth. The fear is that tightening monetary policy to bear down on inflation could snuff out the faltering economic recovery.

So not only has the MPC kept interest rates at a rock-bottom 0.5% since 2009, but policy has been loosened further by the Bank of England’s so-called “quantitative easing” – that is, expanding the monetary base by the stroke of a pen in the hope of reinvigorating domestic credit markets. But the United Kingdom is now faced with the worst outcome: stagflation. The economy is incurring the inflationary costs of the Bank’s policy while missing out on the intended benefit of growth.