King's new inflation target
It’s is well-known what the Bank of England’s inflation target is:
The Bank’s monetary policy objective is to deliver price stability – low inflation – and, subject to that, to support the Government’s economic objectives including those for growth and employment. Price stability is defined by the Government’s inflation target of 2%. […] The inflation target of 2% is expressed in terms of an annual rate of inflation based on the Consumer Prices Index (CPI).
Readers of this blog will know that I’ve often been wondering why the BoE kept overshooting their target, when it’s been clear to many observers that the dramatic devaluation of the pound would have massive inflationary consequences.
However, Mervyn King has now revealed (PDF format) what is going on (reactions here, here and here):
If the MPC had raised Bank Rate significantly, inflation might well have started to fall back this year, but only because the recovery would have been slower, unemployment higher and average earnings rising even more slowly than now. The erosion of living standards would have been even greater. The idea that the MPC could have preserved living standards, by preventing the rise in inflation without also pushing down earnings growth further, is wishful thinking. […] Further rises in world commodity and energy prices cannot be ruled out, and attempts to resist their implications for real take-home pay by pushing up wages would require a response by the MPC. There is some evidence – for example from household surveys – to suggest that inflation expectations have moved higher.
The way I’m reading this, King has quietly redefined the BoE’s price stability target to mean wage stability, at least during a recession and the subsequent recovery. In other words, inflation that is due to external factors is ignored, and only inflation that is caused by earnings growth is taken into account, which means that interest rates will stay low until salaries start rising again.
It actually makes sense, but I’m not sure I like changing the target by stealth. If the Bank of England think that the inflation target is harmful and should be redefined, why can’t they put their case to the government and have them change it?
Which means that various cost-of-living measures no longer get adjusted for the actual cost of living? That’s handy. And you can keep have a nice low “inflation” while everybody gets poorer. Sneaky. And I’l bet you twenties to donuts[1] that they don’t change it back when they get out of “recovery”[2].
[1] Dollars to donuts is no longer a good bet, for the very same reasons.
[2] “We have always been at war with Oceania”.
Well, actually pensions and benefits and the like get adjusted using the CPI measure — the interest rate has mainly got consequences for the price of mortgages. But it definitely means that savings are being eroded because prices are going up all the time.
However, I do agree with the spirit of your comment.