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Inflation still King’s priority, but with breathing space

Bank of England governor says sometimes it may be necessary to 'aim off' the 2% inflation target to prevent future crises.

Inflation still King’s priority, but with breathing space

It is too soon to ditch the Bank of England’s inflation target, governor Mervyn King said last night, but more leeway is needed to let the inflation rate drift away from 2.0% in order to take action to avert financial crises.

'There may be circumstances in which it is justified to aim off the inflation target for a while’, the governor said in a speech to the London School of Economics where he was reflecting on 20 years of inflation targeting.

Inflation, as measured by the consumer prices index (CPI) targeted by the Bank of England, has averaged 3.2% over the past five years. But during the two decades since inflation targeting began, inflation has averaged 2.1%, King pointed out (see chart below).

Higher inflation rates could have been imposed during the decade up to 2007 – or ‘Great Stability’ – to see off the subsequent financial crisis, King suggested. Such a strategy may have helped achieve financial stability, preventing such steep house price rises and alleviating some of the search for yield.

However, increasing the base rate would have been a ‘big gamble’, possibly at the expense of higher unemployment and with uncertain effects on the exchange rate, King argued. In addition, the crisis was a global one that the United Kingdom alone could not have stopped and higher interest rates may not have necessarily prevented the growth of leverage in the financial system.

'The case for price stability is as strong today as it was twenty years ago', King concluded.

Nevertheless, his comments may fuel the suspicions of King's critics who believe the central bank is going 'soft' on inflation to help the country cut the value of its debts.

King retires from the Bank of England in June, with his deputy and career Bank of England man Paul Tucker the favourite to take on a role which will include much broader regulatory responsibility.

UK CPI inflation, 1972-2012 (source: Bank of England, ONS)

16 comments so far. Why not have your say?


Oct 10, 2012 at 14:35

"Higher inflation rates could have been imposed during the decade up to 2007 – or ‘Great Stability"

Actually it is higher INTEREST rate.

Anyway - BoE is trying to inflate out of this problem while ensuring that things don't go out of control. I wish them luck (while putting my saving into something inflation linked)

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Anonymous 1 needed this 'off the record'

Oct 10, 2012 at 15:02

Let us all hope that whoever replaces Mervyn King considers zero inflation to be a worthwhile and achievable target. It may be a difficult concept when the economy is at a low point, but inflation is particularly bad for a mature economy like ours. The new man must consider the long term consequences of inflating our way out of our current difficulties.

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Geoff Downs

Oct 10, 2012 at 15:05

Anonymous 1,

We all have different views on economic matters. I have to say that we must be worried about deflation from now on.

I just don't get the inflation argument.

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Anonymous 1 needed this 'off the record'

Oct 10, 2012 at 16:03

Geoff Downs

You are not alone, many people have no more than a basic understanding of inflation. Economists understand what they have been taught, which is a considerable amount. Economics however, is not a true science, it would be more accurate to call it Social Economics. To understand how truly destructive inflation can be you have look beyond the received wisdom that misleads so many.

Some do understand the destructive nature of inflation and we must hope that the new governor will be one of them.

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Oct 10, 2012 at 16:12

We are not being told the truth by King.

He has a particular sector in mind when it comes to inflation, but not the general public as a whole. For the so called lower and middle class he is their enemy. Many were (and remain) savers and for them and the others above mentioned he has caused the untold damage..

Why? He was behind the failure to scream long and loud about the bubble back in 2004/5 and then the interest rates of late have favoured the banks and financial institutions (not forgetting the govt) to the detriment of savers and pensioners (even those without savings). For the pensioners who decided to take an annuity they got a bad rate for an annuity, which is directly attributable to the interest rate. When the market picks up and interest rates go up those financial institutions will be guffawing all the way to the bank, and will not re-evaluate the annuity.

For the savers, and pensioners with savings (and reliant on the yield from those savings) the true rate of inflation is far higher. Why? Their savings are being inflated away, and the pensioners, far from getting a return, have to use capital to maintain themselves, so will have less when rates begin to pick up.

For them, those above mentioned, the rate is perhaps 5-10% higher.

Mr King and the BoE has been a complete disaster and the executives should be sacked forthwith, sans pensions.

I am mindful that that King and the Bank are taking orders from the Govt, and the Govt is part of a conspiracy to defraud, for their own reasons.

The BoE is not independent, as boasted by Brown et al, it has the appearance of independence, but that is a con, and a massive one at that. Part of the con is for letters of explanations to be written when 'targets' are missed. They weren't 'missed', they were deliberate and probably the letters are for public consumption to perpetuate the myth of independence and agreed to by bank officials and nameless cyphers in Whitehall and then King 'writes' and publishes the letter.

Many times in the past, when dealing with the civil service, I have spoken to them beforehand about a matter and we virtually agree the type (and content) of a letter they want to receive so that I could get something done (or not done) for clients. I have little doubt that that will be the experience of many readers who have to deal with bureaucracy.

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Geoff Downs

Oct 10, 2012 at 16:16

I know what inflation is. My point is we aren't going to get it. Please let us all know the process that will lead to inflation. It would be good not to just quote money printing or the word de valuation, but actually tell us the process.

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Geoff Downs

Oct 10, 2012 at 16:46

Anonymous 1,

For inflation to rear it's ugly head an economy needs an increase in bank lending and consumer borrowing. Neither are increasing, because banks are reluctant to lend and consumers are already in debt.

Take housing. For the first time in decades prices have stopped rising and in some cases are now falling. That is because people are not borrowing.

As for devaluation. The UK devalued it's currency in 1992 when it left the ERM. It did not cause inflation because we were in a recession, and there was a lot of spare capacity.

People are now basing their investments on inflation happening, but in my view it is the wrong call.

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William Bishop

Oct 10, 2012 at 17:07

I am sympathetic with the points made by Geoff Downs, bar one slight caveat. If the monetary stimulus did ever translate into more lending and borrowing, more economic growth and a more fully employed economy, then there would be an increased risk of more generalised inflation. Otherwise, we are only likely to get temporary boosts to inflation deriving from rising commodity prices, that are more prone to depress activity, and push the economy toward more of a deflationary outcome in the medium term.

But I do not see how this caveat could realistically come into play for at least a few years.

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Oct 10, 2012 at 17:12

Geoff, I am investing in companies whose shares will, I hope, rise with inflation/devaluation (QE), and correspondingly pay a higher dividend that will roughly keep pace with inflation.

So, if I am "basing their (my) investments on inflation happening, but in my view it is the wrong call", I am happy to be guilty. I have to look after me, no one else will.

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Oct 10, 2012 at 17:16

@Geoff - yup, people are not borrowing but the government is borrowing in their names, and then dish out the money to various people, such as DFiD 'aid' consultants or cost cutting consultants. So, goods that these group of people interested in will continue to rise in prices - you just need to look at John Lewis, independent schools etc. Some of these might even trickle down.

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Roger Savage

Oct 10, 2012 at 19:42

Inflation has always been King's priority - CREATING IT.

Only a moron would believe King's statement "It is too soon to ditch the Bank of England’s inflation target". Ditch it, they've never done anything to hit it for goodness sake and, surprise, surprise, never have.

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Geoff Downs

Oct 11, 2012 at 00:08

The bottom line is that depite huge amounts of money printing there is no rise in core inflation. QE has been going on since 2008.

Yes of course the world banks are trying to create inflation. You have a country, which I think is on our planet, namely Japan. What do you see, rampant inflation or rapid growth. You have deflation and low growth, with stock markets in a twenty year bear market.

Please some explain why the West will be any different to Japan.

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Rose G

Oct 11, 2012 at 13:52

Despite the huge sums commandeered by those who earn their living by predicting how the economy is going to turn out, it is all a guessing game - but, who is going to pay people to guess?

Just one big smoke screen where they are seen to be doing something, but in actual fact has very little impact on improving our lives.

I wonder how long they believe their conning the population will continue - surely it's time for us to take action against these hugely powerful people who seem to think they can get away with their lies.

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Geoff Downs

Oct 11, 2012 at 14:08

Rose G,

I certainly agree with paragraphs 1 & 2.

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Oct 14, 2012 at 10:20

Let's start such deviation by de linking BoE's pension from inflation. Linked it to a fixed increase of 2% pa.

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Oct 14, 2012 at 10:51

For a government to embrace inflation as a way to solve its economic problems is the ultimate admission of failure.

Any such government should resign and make way for others.

But I expect governments to surreptiously let inflation rise to devalue their debts and stuff their electorates as a side effect, the people whose interest they are supposed to be representing

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