News Release
The UK Economy and Monetary Policy - Looking Ahead
27 May 1998
In a speech to the Building Societies Annual Conference in Bournemouth today, Mervyn King, the Bank’s Chief Economist and Executive Director, considers the current UK economic environment and gives his views on its implications for the achievement of the inflation target.
Commenting on the present economic situation Mr King notes,
"Domestically generated inflation is significantly higher than RPIX inflation. As the one-off effects of the rise in sterling wear off over the course of the next year or so - as indeed they will unless sterling appreciates further - inflation will start to rise above the target unless domestically generated inflation declines."
"The earnings figures released earlier this month - which showed that average earnings in the economy grew by 4.9% and in the private sector by no less than 5.6% - were undoubtedly disappointing. It is too soon to judge how far they reflect the impact of higher bonuses this year than last. In any event, to hit the inflation target those rates of earnings growth will have to fall back."
The MPC’s central projection in the May Inflation Report is that the pace of output growth will slow. But Mr King notes that
"a slowdown in economic growth is not, in itself, sufficient to hit the inflation target. The central issue for monetary policy is whether total nominal demand will slow sufficiently quickly to prevent retail price inflation rising when the favourable effects of a high exchange rate and lower commodity prices wear off."
In discussing the role of house prices as an economic indicator Mr King says that the forward-looking information contained in house prices underlined the importance the MPC attaches to measuring them accurately. He then considers the the reasons for the recent divergence between the rates of house price inflation implied by the Halifax and the Nationwide indices:
"The Bank’s preferred explanation is that the divergence reflects the way in which house prices are "mix adjusted" to take account of the different characteristics of the houses bought and sold in any one month."
In response the question of what is really happening to house prices he notes that the Bank has developed an alternative measure of house price inflation using data from the Land Registry. It suggests that house prices increased by 9.0% in the year to 1997 Q4, compared with 6.9% measured by Halifax and 12.9% by Nationwide.
Finally, Mr King discusses the Monetary Policy Committee and emphasises the transparency not only of the policy debate but the voting record of each individual member of the MPC as well.
"Disclosure is an incentive for individuals to cast their vote for the policy most likely to hit the government’s inflation target. I have little doubt that the prospect of having to defend one’s voting record in public makes individual members of the MPC well aware of their responsibilities. There can be no hiding behind the coat-tails of the chairman."
"But there is an additional point which is fundamental to the role of the Monetary Policy Committee. Its purpose is to take technical decisions about the level of short-term interest rates. When the issue is one of technical judgment it is better to rely on the collective wisdom of nine people than the views of only one individual. The Law Lords, for example, reach their decisions by aggregating individual judgments, and the same is true in the United States Supreme Court. The MPC is based on the same principle.
"When policy is clearly off-track, as in the spring of last year, it is not difficult to reach unanimous decisions, as the Committee did through 1997. But when policy is finely balanced, disagreements about the precise level of interest rate are not only likely but an indication that policy is broadly on-track. That is why the motto of the MPC should perhaps be "divided we stand, united we fall".
He concludes his speech with a dismissal of the trend by some commentators to label members of the Committee as either "hawks" or "doves".
"There is a fundamental problem with this labelling. It makes no sense in the new system to describe individuals as hawks or doves. Each member of the Committee has the same inflation target. Unlike some other central banks, MPC members cannot entertain closet views about the attractions or dangers of slightly higher or lower inflation...Actions must be judged in the light of the circumstances. In terms of monetary policy, that means that the positions which members of the MPC take on interest rates will change over time according to the way the economy evolves."
"As the voting record shows, it is seriously misleading to think of the MPC in terms of fixed camps of "hawks" and "doves". As circumstances change, it is easy to imagine that the "hawks" shall be "doves" and the "doves" shall be "hawks". And, over a five year period, since each member of the MPC is trying to hit the same inflation target, I predict that it will be impossible to distinguish between "doves" and "hawks".
