Free Economics Dissertations - 5% ‘at All Times’, We Are Not Expected To Achieve It Continuously. Inevitably
5% ‘at all times’, we are not expected to achieve it continuously. Inevitably from time to time, there will be demand and supply shocks that drive inflation away from the intended target. Given the lags inherent in the transmission mechanism of monetary policy, it may be difficult to offset such shocks if they are temporary and will have faded by the time the effect of any change in interest rates is starting to be felt. And even some shocks could be offset in principle; there may nevertheless be a good case for allowing temporary slippage relative to target in order to avoid undue volatility in activity; that is particularly the case with some sorts of supply shock. The Governor of the Bank of England stated that ‘in essence, we have a degree of ‘constrained discretion’ in deciding exactly how to deal with shocks and how quickly to plan to bring inflation back to target when it has moved away (King, 1997).
Of course, the remit does not specify the relative weight we are supposed to place on deviations of inflation from target and output potential. So the ‘contract’ between the government and the Bank is incomplete. Svensson (2003) argues that in the interests of transparency the members of the MPC ought to reveal their individual or collective objective function, and in particular the relative weight placed on deviations of inflation from target and output from potential. Empirical evidence suggests that the ‘Taylor Frontier’ that traces out the minimum feasible inflation variance for a given output variance may be quite sharply curved. In that case a wide range of plausible loss of functions lead to a rather similar policy choice (Bean, 1998). More importantly, any deviation of inflation of more than 1% either side of the target triggers an open letter from the Governor to the Chancellor, which amongst other things is supposed to say how quickly the MPC expect to bring inflation back to target. The Chancellors (Open) response to that letter would allow him to indicate whether that was too rapid, or not rapid enough, if he so wished.
Another valuable of feature of the UK model that is worth highlighting here is the emphasis placed on accountability that is accompanied by the decision to delegate operational responsibility for monetary policy to the MPC. The primary channels are threefold. Firstly, the MPC is accountable to the ‘Court of the Bank’ whose job is to oversee the committee’s processes though not its interest rate decisions. Second, members of the MPC appear before the appropriate Committee of parliament, usually shortly after the publication of the Inflation Report, to be questioned about the reasoning behind interest rate decisions. Importantly, members are held individually accountable for their votes.
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