15 May 2013

Sir Mervyn’s inflation record: a game of two halves

The problem with the Bank of England’s quarterly inflation report – presented for the last time this week by Sir Mervyn King – is that it feeds the idea that the governor has all the answers.

Today’s inflation report is the last presented by the current governor, Sir Mervyn King, writes Channel 4 News Economics Producer Neil Macdonald. It’s not quite his swansong. He doesn’t step down from his post until the end of June. So he’ll get to cast his vote on interest rates one more time before Mark Carney arrives from Canada. But that doesn’t mean today’s event isn’t significant.

Over two terms as governor – adding up to a decade – Sir Mervyn has hosted, and very much dominated, these press conferences four times a year. There’s a whiff of the gladiatorial contest to them, as the finest of Britain’s economics journalists line up to fire questions at the governor for an hour, hoping against hope that their clever inquiry will be the one to trip him up.

The governor likes his football analogies, and inflation in the UK has been a game of two halves.

Sadly (for the journalists at least), that doesn’t really happen – the governor has spotted most of the economic elephant traps long before they have and has a fascinating table on page 53 of the inflation report up his sleeve that he can divert them to.

What the governor can’t deny – and perhaps wouldn’t seek to – is that the broad story of the British economy as told through the inflation reports has fundamentally changed over his two terms. You can see this by looking at how inflation has performed during that time. The governor likes his football analogies and as you can see from the chart, inflation in the UK has been a game of two halves.

Hardly a great record

The Bank of England’s primary job under new Labour was to hit an inflation target of 2 per cent – but with a little bit of wiggle room either side. So inflation was allowed to move in a range from 1 per cent to 3 per cent.

From the chart, you can see that in the first five-year term of the governor, inflation was inside this range almost all the time. It only exceeded the 3 per cent upper limit on three occasions out of 60, and most of the time it was nowhere near the upper limit, spending a lot of time comfortably below 2 per cent.

But look at the second five years, and the picture is reversed. Inflation has topped 3 per cent in 33 months out of 57 (we haven’t had data for the last three months yet). So inflation has been unambiguously above target for the majority of the governor’s second term. Hardly a great record to retire on.

Beyond the bank’s control

In the past, the governor has correctly pointed out that many factors have pushed up inflation in the second five-year period. Oil and gas and food prices have surged. The government chose to put up VAT. And the weak pound has made all imports more expensive. Much of this is beyond the control of the Bank of England.

And all of it happened when the British economy was in a slump. The traditional response to rising inflation – higher interest rates – would have pushed output even lower. Hardly a sensible policy when the UK was already experiencing its worst recession since the 1930s.

Of course, it’s also true that the low inflation of the first five-year term was not entirely the product of the governor’s decisions either. The strength of sterling and the wave of low-price imports from China made a big contribution too.

Amended target?

And perhaps that illustrates the big problem of the inflation report format. It can’t help but feed the impression that the governor of the Bank of England is the guy with all the answers. He’s expected to have an explanation for everything, even though much of our economic performance is determined by factors over which he has little control – especially in a relatively small open economy like the UK.

But the whole framework of inflation targeting is now creaking a bit. Despite inflation currently standing just below the 3 per cent ceiling, there’s much excitement (not least in government circles) about how the new governor will boost the economy rather than slow it down.

Perhaps the inflation target will be amended or extended. Perhaps the inflation report will become the growth report at some point. Some questions for next inflation report press conference in August, when Mark Carney will have to have all the answers. After handling 40 on the trot, Sir Mervyn will be having a well-deserved rest.