The Bank of England needs to improve its communication on inflation

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The writer is director of the National Institute of Economic and Social Research

Since being granted operational independence, the Bank of England has had an honorable record of controlling inflation. His Monetary Policy Committee met its inflation target in the quarter century from May 1997 to May 2022. But, as has been well documented in the past year, he appears to have wiped out his notebook.

Inflation has peaked at double digits and the recently announced figures for this month of April fell much less than the BoE had anticipated. It looks likely to remain above target for the remainder of this year and next, raising the strong possibility that monetary policy will need to induce a recession to achieve price stability for the first time since the early 1990s. 1990.

Certainly some mistakes have been made, but what is just as important are the lessons we must learn to set the course for an independent central bank in the second quarter of the 21st century.

First, we need to focus BoE resources on understanding inflation, perhaps even changing the name of the valuable quarterly. Monetary Policy Report the Inflation Report once again. And we must reiterate that inflation is neither temporary nor permanent; it is controlled by the central bank, which responds to shocks given the structure of the economy and the instruments at its disposal.

That doesn’t mean we should become fanatics about inflation; The MPC may choose to move gradually in response to an inflationary shock if it believes that output or employment would be too violently affected by an immediate return to price stability.

Second, we desperately need the right narrative to communicate clearly with market participants and households, who have been shocked by the rapidly rising bank rate.

The UK is a small open economy with supply hampered by the effects of Brexit and labor and supply chain shortages which, in turn, have been exacerbated by the food price shocks and energy.

We do not emphasize the size of these shocks or their specificity to the UK. As a result, we were not clear enough about the need to signal an early start to monetary policy normalization, which was too often confused with tightening.

The situation in the US, for example, a major oil and food producer, was quite different and our tariffs need not have followed the same path.

Third, we must move away from a model, a forecast, and an interest rate choice. The models are almost always wrong, but they have their uses. And generally, that’s to help us think about the risks. It is the job of the central bank to explain and manage these risks on behalf of society.

The risks of higher and lower inflation include assessments of policy transmission and the response to a decisive regime change, which would mean permanently higher interest rates. It is reductionist to translate that risk management task into a single interest rate election every few weeks.

Rather, the central bank needs to spell out the path of rates required to manage these different risks. Or at least allow outside members of the MPC to present their thinking at press conferences. That so many of these risks are financial in nature strengthens the case for merging the MPC with the BoE’s Financial Policy Committee.

Fourth, there is a perception that the Treasury has taken over the BoE since the financial crisis. External and internal members of the MPC have been appointed by the Treasury, and the bank increasingly provides a kind of retirement home for former Treasury officials.

At a time when excessive levels of quantitative easing have blurred the line between monetary and fiscal policy, this is unfortunate.

Although it is highly desirable to have a cooperative relationship between the Treasury and the BoE, the political antennae of the former should not be transmitting a signal to the latter.

The BoE should focus on plumbing the money and financial markets without any suggestion of interference from the other side of town.

And so the government and Treasury should have been warned not to be tempted to take credit for any drop in inflation.

Unfortunately, it is also clear that the level of public understanding of inflation, interest rates and debt is not where it should be. About 30 years ago, the BoE did an excellent job of explaining the case for price stability. The MPC and the central bank can now do more by holding their policy meetings as fixed events across the country.

This would not only support regional economies, but would also promote a national focal point for the vital work of the BoE.