Bank of England should keep targeting inflation
By Ross Finley | January 31, 2013 3:21 AM EST
Inflation targeting has served the Bank of England well and it should keep that as its main policy tool, despite the strategy's role in fuelling a credit bubble that led to the financial crisis, a Reuters poll found.
The conclusion, based on a survey of economists taken this week, also comes despite inflation being persistently above the central bank's 2.0 percent target for some years.
The Bank Governor-designate Mark Carney, who currently runs the Bank of Canada, is seen as more likely to favour a flexible inflation target rather than abandoning it.
"There's always going to be a great deal of pressure on the incoming governor to try and magic up a recovery," said Philip Shaw, chief economist at Investec. "But changing targets is not the solution. What you need is a different toolkit."
The poll results suggest that Carney, an outspoken and ambitious central banker, will not push to abandon the inflation target when he checks in to work on London's Threadneedle Street in July. Britain's government sets the target.
"Inflation targeting has served the UK well over the past 20 years but failed to address the various imbalances in the economy during the early half of the 2000s," said Shaw.
What was missing was better oversight of the financial system. Like many, he favours better macroprudential policy to prevent another boom and bust.
Carney will have that and an expanded regulatory role in his remit.
"Beyond that, our view is that expectations on what an inflation target, or any other target can achieve, are often overambitious," said Shaw.
Brian Hilliard, chief UK economist at Societe Generale, said that having another macro target would not have helped prevent the financial crisis.
A clear majority of forecasters, 38 of 51, said that the Bank should not drop inflation targeting, a view outgoing Governor Mervyn King fiercely defended in a recent speech calling instead for fine-tuning.
Only 10 economists said the bank should abandon its inflation target. The remaining three said it should change the measure of inflation it aims to keep under control.
But for most of the past decade inflation has been above target, and during every month since December 2009.
Those results suggest that any serious consideration of targeting economic growth, an argument Carney discussed at length in a speech last year but which he kept mum about in recent public appearances, is highly unlikely.
Britain's economy has barely grown at all since 2010 and is one of the few among its industrialised peers that is still smaller than where it was before the crisis began in 2007. It shrank in the last few months of 2012.
A small majority, 19 of 37, said that if the Bank were to drop inflation targeting it should instead adopt a dual mandate like the Federal Reserve, which also targets unemployment.
The bank has been widely criticised for focusing on consumer prices while letting credit expand wildly early in the last decade, triggering an unprecedented boom in house prices.
Britain's economy is still struggling to escape from the mess after that boom went bust. While printing hundreds of billions of pounds trying to reinflate the economy, the Bank has paid little heed to its inflation-fighting mandate.
"Low inflation was more the result of general global conditions than anything the Bank was able to achieve," noted Commerzbank economist Peter Dixon.
"So whilst it served a useful purpose the target may not, in retrospect, been appropriate for the conditions prevailing at the time, in which asset price inflation was a bigger problem."
Stephen Lewis at Monument Securities was more harsh.
"Inflation targeting failed to take account of the distortion of asset values and excessive credit creation in the years up to the crisis. It is a blinkered approach to policymaking."
Meanwhile, the probability of further bond purchases by the bank, or quantitative easing, has fallen to a median 40 percent from 45 percent in a poll taken earlier this month. Bank Rate was seen on hold at a record low of 0.5 percent until at least the middle of next year.
"Additional QE would provide only marginal benefits for the real economy, while increasing longer-term risks of higher inflation, bubbles and financial distortions," said David Kern, chief economist at the British Chambers of Commerce.
(Polling by Snehasish Das and Rahul Karunakar, Editing by Jeremy Gaunt, John Stonestreet)
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