It is looking pretty dicey for the Bank and it’s inflation-fighting reputation.  Read Jeremy Warner (Does the inflation target actually mean anything any more?) and above all the point made clear in Simon Ward’s post yesterday (UK CPI inflation 3 percentage points above BoE year-ago forecast).  Here is a graph from last year’s May Inflation Report:

One quick observation: the prediction was based on 125bn of QE.  We have had 75bn more than that, which must have had some effect on inflation (though as I droned on in Credit Where It’s Due, the mechanisms are rather wobbly and demand-dependent).

Another is: how on earth did they make such a prediction when they knew VAT would be returning? Did they simply miss it out? the April CPIY index stands at 112.8, which is 2.1 points above the April 09 level of 110.7, or almost exactly 2 per cent higher.   This would put the forecast error down to 1 per cent.  But if it WAS CPI without tax which they were forecasting, they didn’t tell us.  I see a straight mistake.

A third observation is that Britain’s inflation is a bit of an exception within Europe.  See the charts from Wolf’s (rather boilerplate) post today:

A final observation (coz I have to go to lunch) is this: if the Bank has made a mistake, I would rather it made this one than the other one.  Reading Chris Giles today about what this means for you and me, it comes down to this: it makes living standards go down, but it may help make the budget deficit lower.   And so far households are not expecting it to last.  In other words, a one off transfer, lightening the biggest problem (government debt) and making all of us fairly evenly contribute to the problem.

This crisis needs measures OF THAT SORT to get the country back in balance: lower government debt, lower living standards.   (We could also do with being more competitive, which this doesn’t help, but weak sterling manages that).  Though I look like a hubristic fool to some (even though I stand by my points about Base Effects), actual deflation to such an indebted country suffering from insufficient demand may have been worse.



4 thoughts on “Defending the Bank of England

  1. Too damn right! Forecasting is such an inexact scie^-^-^ pursuit, and can so easily be kiboshed by interest/currency/oil/commodity fluctuations, and other imponderables that rock up out of a clear blue sky.

    It’s open season on the Old Lady for the hard of thinking, and it’s utterly undeserved. Had it not been for Boy Peston’s uncannily informed leak, and had regulatory oversight not been handed to the Keystone Gestapo of the FSA, I have no doubt that Northern Rock would never have become a problem. Even assuming that the Bank had allowed NR’s books to go so fiercely out of kilter, it would have been quietly and discreetly bailed out and sold on to Lloyds. No panic, no depositors’ rush, no humiliation for the Government. Yes, I know all about the counter-argument of EU law, but (let’s face it) a way would have been found to avoid embarrassment. That’s where being “terribly British about things” is rather commendable.

    This leads to the inevitable question about the Jock banks. Would the Bank have allowed THEM to go so utterly mad? Would Peter Cummings have been allowed to crank Bank of Scotland’s corporate lending ratios out to such absurd levels, if the BoE had had regulatory responsibility? Would RBS have been allowed to go tonto with a jumped-up, power-crazed accountant pulling the levers.

    If the new government really has bottled the replacement of the FSA, it should at least have the sense to hand regulation of the banking sector back to the Bank of England. The Old Lady is wise and knows what they are doing. She’s been doing it for ever, and she know all the tricks that naughty boys can play.

    [Usual disclaimers!]

  2. I think you might be right as by November’s inflation report they were talking about the imminent VAT rise a lot, but in May the only mention is this “At the start of 2010, there is an upward impetus from the reversal of the VAT cut but much of this is likely to be offset by other factors, including a negative effect from the substantial margin of spare capacity.”

  3. In other words, a one off transfer, lightening the biggest problem (government debt) and making all of us fairly evenly contribute to the problem.

    Er, surely the effect of a one-off inflation is a transfer from people with positive nominal net assets (e.g. savings accounts) to people with negative nominal net assets (e.g. overindebted consumers, and the state)? That’s not a “fairly even” contribution in my book. (Declaration of interest: I have index-linked student debt and mainly non-index-linked savings, so I am being made worse off….)

    It’s a good thing that inflation expectations are still anchored. If they weren’t, the incentive to save would be weakened, which would make it more difficult for the economy to adjust to a less indebted equilibrium. And nominal gilt yields would be shooting up.

    1. I agree, it hurts some and helps others. Yes, I should have acknowledged that.

      But I think economies react in an asymmetric fashion to these shocks – the indebted crunch down their spending in response to a deflationary hit more than the nominal-rich increase theirs. Otherwise, debt crises would not be the murder they are. Debts need to become more servicable – yes, this does punish the thrifty. A very awkward political lesson. But I am sure good for the macroeconomy.

      A v good point Niklas, there are essays waiting here.

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