For much of this crisis, I have been a bit critical of the Bank of England. The financial stability risks that triggered the downturn were pretty much buried among a catch-all of about 87* other issues before the crisis, and when the storm broke Governor Mervyn King was worried far too much about moral hazard than the more practical issue of the UK banking sector collapsing. Add to that the fact that the MPC didn't even start to cut interest rates until the UK economy had already been in recession for six months, and it's not hard to see why the BoE hasn't been flavour of the month in many people's eyes.
One of the things I've been particularly critical about is the BoE's communication about policy. In part, this reflected the mad scramble to come up with explanations for how quantitative easing would work – and then various different metrics for knowing whether it had worked or not. In part, it also reflected that fact that, in a Committee with 9 individuals, there are always going to be different views (and they can all get voiced in public). But, nonetheless, I still think the BoE could have given a far clearer steer on inflation and policy over the past three or four years.
Happily, there are signs that this criticism – albeit probably from more distinguished commentators than myself – is starting to have an impact. Mervyn's speech on 25 January was pretty darn good, spelling out the issues facing policymakers very clearly. And his performance at Wednesday's press conference, to mark the publication of the February 2011 Inflation Report, was masterful.
Although he probably leans towards the more dovish side of the Committee at the moment, Mervyn was at pains to emphasise the range of risks to inflation over the medium term, both on the upside and on the downside. He spelt out again that, whatever the MPC did, consumers would have to see the real value of their take-home pay fall. And he also described, plainly and in detail, the 'relative price' effects that are hitting the UK economy at the moment. One chart in the Inflation Report (4.8 on pg 36, in case you're interested) put it very clearly – strip out the impact of VAT, energy prices and imports, and CPI inflation would be somewhere between -0.5% and +1.0%. While some may question the validity of this approach, the fact remains that unless VAT goes up to 22.5% in January 2012, or energy and food prices continue to rise (or sterling falls again), inflation will fall back in 2012. Permanently higher levels of food and energy prices, by themselves, have only a temporary impact on inflation.
To ram the message home, Mervyn then re-iterated what we all know but often forget – changing interest rates today will have very little (if any) impact on inflation this year. Ironically, inflation could even have peaked by the time the MPC really next gets to grips with whether it needs to raise rates (in May). But the short-term profile of inflation will have nothing to do with monetary policy, because it takes at least eighteen months – and some estimates suggest up to three years – for changes in rates to have their maximum impact on inflation. If the MPC jacked up interest rates now, inflation would fall more quickly – but in 2012, not in 2011.
The Committee is also clearly aware how much pressure household finances are under. Rising petrol and food costs, while only a temporary impact on inflation, will mean that households will feel the pinch this year. To reflect this, the MPC has downgraded its growth forecast – although, given that it also slightly upgraded its inflation forecast, and market expectations for interest rates are higher, this means that something else is going on in the background. This encapsulates the difficult judgement call the Committee has to make – while it cannot prevent the coming squeeze in living standards, it can influence how that adjustment happens. It can raise rates, push down on inflationary pressures, and risk a double dip recession. Or it can keep rates low, call for wage restraint, and hope the economy stumbles through to next year in one piece, when inflation should fall back. I for one think Mervyn and co are on the right track – and, on the basis of Wednesday's performance, are serious about communicating to and convincing others as well. It may have been a while in coming, but the Old Lady looks to have finally found her voice.
* Please note this is an illustrative (ie made-up) figure