Free Economics Dissertations - And By Defining The Framework In Terms Of The Objectives Of Monetary Policy,
And by defining the framework in terms of the objectives of monetary policy, an inflation target allowed the strategy for its actual implementation to evolve without requiring continual re-specification of the framework. The target measure was the Retail Price Index excluding mortgage interest payments (RPIX), with a target range of 1% - 4% and the intention that it should be in the lower half of that range by the end of that parliament (scheduled to be in 1997).
It is worth emphasising that the adoption of an inflation target was also accompanied by important institutional changes. For the achievement of a measure of macro-economic stability in the subsequent decade has probably less to do with the adoption of an inflation target, and probably more to do with associated institutional changes. Prior to the adoption of an inflation target, interest rate decisions were often taken in response to a crisis or else with half an eye on political considerations. By instituting a regular monthly meeting between the Chancellor and the Governor of the Bank of England and their respective advisory teams, there was a greater chance that policy decisions might be made in a forward-looking manner rather than purely reactive way. More importantly, the decision to publish minutes of the meeting (dubbed the Ken and Eddie’ show by the media) exposed the thinking behind decisions and thereby allowed the Governor to register disapproval of the Chancellor’s decisions inappropriate (the actual decision was in the hands of the Chancellor). This provided a highly visible check on the monetary decisions of the executive, and was reinforced by the publication by the Bank of a Quarterly Inflation Report containing analysis of the Inflationary trends in the economy, including forecasts of inflation over a two-year horizon complete with estimates of margins of error.
THE BANK OF ENGLAND INDEPENDENCE
Though the post-1992 institutional changes placed some constraints on the ability of the Chancellor to base interest rate decisions on political rather than economic considerations, the discipline was inevitably only partially given the scope for differences in view about the prospects for inflation. Thus a Chancellor could judge that interest rates should be lower than the Governor either because of genuine differences in view about economic prospects or because of political considerations. As an outside observer could never be sure that it was the former rather than the latter, the new arrangements lacked full credibility. That lack of full credibility is evident in long-term (10 year) inflation expectations implied from a comparison of the yields on nominal and indexed government debt.
A lack of counter-inflationary credibility in monetary policy was potentially even more of an issue for the incoming Labour government that took power on 1st May 1997.
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