The Monetary Policy Committee - Getting it so wrong on interest rates and inflation

The Monetary Policy Committee have a clear brief from the government to keep control of inflation, and arguably this has been achieved in recent years, but in times such as we have now it seems interest rates have a negligible effect on inflation and instead the MPC looks as it if is re-arranging the deck chairs on the Titanic as the economy goes belly up and the housing market collapses.

You could really argue that inflation has not really been controlled by the MPC at all in recent years. There are many who would argue that inflation has only really been kept under control because of the likes of Tesco and China. Governments are not interested in curbing the power of the supermarket giants by stopping them squeezing the profit margins out of suppliers and farmers, after all, this reduces costs and keeps inflation low.

Likewise, China's massive increase in production meaning their cheap labour force produces DVD players and clothes for next to nothing has similarly meant that the MPC has taken the credit for steering a ship that was already heading in the right direction.

But with the current crisis in the markets, the Bank of England and the MPC's remit looks hopelessly out of sync with what is needed right now.

Everyone knows that interests rates have got to fall much further than they have at present but the MPC keeps then at double the US interest rate levels because "inflation is too high", but in doing so they fail to actually examine why inflation is so high.

The fact is that the luxuries that people spend money on because they have free cash are actually still falling in price. Wide screen TV's, Blu-Ray players, Nintendo Wii's and IPods are not rising in price. No, what is pushing prices up are those essentials that people have no choice over paying for. Grain prices are st to double, the price of beef is up 10% this week whilst petrol and other fuels continue their inexorable rise. People have no choice about whether to heat their houses or eat food, so this inflation will continue unabated whether interest rates are high or not yet the MPC seems completely oblivious to this fact.

The problem is that lots of people are now finding their fixed rate mortgage deals are coming to an end and as a result of the market difficulties, are now finding it much more difficult to find deals which match those deals that are coming to an end. This means that people are now much poorer, they have less money and in some cases they may not be able to afford to pay their mortgages. This means more repossessions and falls in house price which in turn means negative equity and a real crisis in the real economy. But none of this will alter inflation what so ever because inflation is high only because essentials are going up.

The fact is the MPC needs to have its government remit widened, its needs to know that it's raison d'etre is not just to ensure low inflation but to ensure that it considers the money markets and growth too, and for that to happen the government needs to understand the true depth of the problems in the economy. That, however, looks unlikely given their consistently bullish statement about the current problems.

In the long term the only way for to ensure that the MPC has it's remit widened will be if there is a change of government which with each new month looks ever more likely.

Gordon Brown's first act on becoming Chancellor was Bank of England independence. Ironically it might be his inability to see the limitations of what he did in 1997 which will be his undoing.


Johnny Norfolk said...

You dont realy beleive that The bank of England is independent do you ?

Nothing happens without Brown giving the nod. The committee are Labour place men. The whole thing is a sham to avoid the government taking respocibility.

jdc said...

Wrong wrong and triple wrong.

Inflation is high because so much money has been sloshing around the economy that people had more money to spend than there were things available to buy.

So that drove up the global price of basics - notably oil, as production couldn't keep pace, but also food, and the same time as the biofuels insanity. Cue rising inflation in the producing world, and rising cost of our imports.

Then, when the party looked like coming to an end, the Bank of England gave out the signal that they would crack open another bottle of vodka, and to hell with the fact inflation is 25% above target and rising.

Result - a collapse in the value of the pound to a record trade-weighted low, and a 20% increase in the cost of everything we buy from the Eurozone. Input prices in industry are, as of today, rising by more than 20% a year.

Next stop, interest rates lower than retail inflation. The US is there, and we're nearly there - a time when it makes more rational sense to buy things on credit today than for cash tomorrow, because the price will have gone up.

Lower interest rates when our biggest economic problem is too much spending and not enough saving and investing - utter madness.

The MPC should be done for Malfeasance in Public Office, and rates should be going up in May, and again in June.

Anonymous said...

Ots interesting that Ken Clarke and some top US expert on Newsnight last week agreed with the Norfolk Blogger that the MPC had got it wrong to be worried about inflation as there was no evidence that the interest rates were affecting it at all. Also some expert on Sky News said the same earlier today.

Norfolk Blogger said...

"Ots" nice that you agree with me. I did see the very end of the NewsNight thing last week about this.