The minutes of the July Monetary Policy Committee meeting, just published, show rate setters at the Bank of England have no view about the Budget’s likely effect on the economy and hence inflation. A 7 to 1 vote to do nothing arose from their inability to form a view arises partly because they are unsure about about the private sector’s response to fiscal tightening and partly because they are unsure about the effect of additional spare capacity on inflation.
The MPC needed more time to analyse the additional fiscal tightening, members complained, bizarrely adding that the effect would depend on the October spending review, even though everyone knows that this review will not change the fiscal stance, but just distribute the pain. Even more bizarrely, they then said they would revisit the issue in the August meeting, when they would, by definition, have no new news on the spending review.
“A key determinant of the medium-term outlook for activity would be the response of private sector spending to news in the Budget and the prospective Spending Review. That would depend in large part upon the extent to which the sharp rise already seen in private sector saving had reflected anticipation of the impact of the fiscal consolidation on future post-tax income. Further evaluation of the impact of the Budget on the outlook for private sector saving would be required as the Committee prepared its projections and analysis for the August policy meeting and Inflation Report. “
In conclusion, the MPC said that an analysis of the Budget was really just too difficult:
“The implications of the additional Budget measures for output were hard to gauge and would depend upon the response of the private sector. But it was likely that they had pushed down a little on the most likely path for output, while at the same time reducing the risks to growth from a sharp rise in longer-term interest rates.”
That is what we can expect in the inflation report forecasts, I expect. But when it comes to setting monetary policy, the second problem the MPC complains about is its lost confidence in its ability to judge how inflation will react to changes in demand growth.
“There remained considerable uncertainty over the extent of spare capacity in the economy and the speed with which it would press down on inflation. The recent downward trends in inflation, excluding energy and food, in the United States and euro area suggested that a substantial margin of spare capacity would cause inflation to fall back in the United Kingdom too, as the impact of temporary factors wore off. But the recent resilience of UK inflation had raised the possibility that the impact of spare capacity on inflation might be weaker or operating more slowly than in the past.”
And given MPC members are not confident any more about the determinents of inflation, what did the majority on the MPC decide? That it was best to do nothing since things could go either way and they really did not have a clue.
“On balance, most members thought that it was appropriate to leave the stance of monetary policy unchanged. For them, the weight of evidence from both home and abroad continued to indicate that the margin of spare capacity was likely to bear down on inflation and bring it back to the target in the medium term once the impact of temporary factors had worn off. There remained risks to this outcome to the downside, if the impact of the margin of spare capacity on inflation was greater than anticipated, and to the upside, if the private sector’s expectations of inflation over the medium term rose.”
It is possible to view these minutes in two ways. Either, this is refreshing display of honesty from the authorities that they have an impossible job at the moment. Or, that people paid to take a view on the economy should do better than saying things are just too difficult to decide. I will leave you to make up your minds on that.
But one thing is certain. Doing nothing is not neutral. It places the MPC fully alongside the government in taking the view that the Budget’s fiscal tightening will not cause a big economic slowdown and will not need additional monetary loosening to offset its effects.
The MPC might subsequently change its view, but as a forward looking central bank, it will have missed some valuable time and, as Henry Kelly used to say in Going for Gold, it is now playing catch-up.