In a speech titled “MPC in the dock” this morning, Spencer Dale, Bank of England’s chief economist, provides both the best defence of the Bank of England’s monetary policy stance I have read in a long time and a much more coherent explanation of recent poor UK economic performance than the Office for Budget Responsibility in yesterday’s Budget.
The title shows the pressure the Bank finds itself in and Dale’s embrace of humility rather than the usual hubris is welcome. When Bank officials – and the governor in particular – take a leaf out of their chief economist’s book and stop saying they have nothing to learn and they have been entirely consistent, people will be much more willing to listen to their argument.
Mr Dale was clear that inflation was set in the UK and not imported, as many MPC members have recently suggested. He was honest that he probably would have voted for different monetary policy had he had better information about the coming price shocks rather than taking the absurd stance the governor took that of course he would not have done anything differently. He pointed out where the MPC was learning from its mistakes, particularly on the issue of import price pass through.
To summarise the speech Mr Dale posed four clear questions. These were his questions and answers
- Why is inflation so high? Price level shocks
- Why have the Bank’s forecasts been so badly wrong? The Bank got its judgment on import price pass-through wrong and did not foresee that a rapid world recovery would boost commodity prices
- Could inflation remain high? It should come down, but it could remain too high for comfort
- How is policy consistent with the inflation target? There is a need for very loose monetary policy to stimulate demand at a difficult time, but a little less stimulus seems right given the risks to inflation.
Most of these are standard Bank arguments apart from Mr Dale’s explanation for his votes to raise rates to 0.75 per cent in February and March. His reasons were:
“Nasty reasons rather than nice ones”
Nasty, because Mr Dale believes there has been a supply shock to the UK economy preventing rapid growth without rising inflation.
“The risks from continuing global price pressures and the effects of the prolonged period of above target inflation meant that the level of demand consistent with achieving the inflation target had probably fallen”
This argument that the supply potential of the economy has been damaged is far more persuasive than the OBR’s view that weak growth is a temporary demand shock which will lead to faster growth at some point after 2015, a stance the OBR struggled to defend at a briefing this morning.