View the article online at http://citywire.co.uk/money/article/a625270
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.
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)
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by Gavin Lumsden on Mar 07, 2014 at 18:53