The new Governor of the Bank of England, Mark Carney, said last week that interest rates will not be raised until unemployment falls below 7 per cent, a process he thinks will take three years. The battle of Austerlitz in 1805 was one of Napoleon’s greatest victories, leading to his complete domination of Continental Europe. In the aftermath, the Prime Minister, Pitt, famously pronounced ‘Roll up that map of Europe, it will not be wanted these next ten years’.
Should we simply adapt Pitt’s phrase? Roll up that Monetary Policy Committee. It will not be wanted these next three years. In reality of course, the MPC will continue to meet, its members will continue to receive their salaries and draw on the resources of the Bank of England.
It will continue to function, despite the fact that the main purpose of the MPC is to set short-term interest rates. The aim has purportedly been to try to control inflation and hit the government’s target, a task which the MPC has been singularly unable to do. The previous Governor, Mervyn King, had to write the obligatory letter almost every year to the Chancellor explaining why the MPC had failed to meet the inflation target.
This is not on account of any deficiencies of the members of the MPC, even though a number of them appointed under Gordon Brown left much to be desired. The ability of any central bank to control inflation through setting short-term interest rates is inherently very restricted. Monetary conditions overall may very well matter for inflation, but the sort of short-term, precision control of inflation required by statute of the MPC is virtually impossible.
A necessary requirement for a policy of detailed control to work is that systematically accurate forecasts have to be made. To try and set interest rates to lead to inflation at 2 per cent in a year’s time, you have to know what inflation is likely to be in the absence of any policy change. The plain fact is that, not just in the UK but throughout the West, the data over time on the annual changes in inflation is effectively indistinguishable from a purely random series. So it is literally a 50/50 guess as to whether inflation will be higher or lower in a year’s time than it is now. It is simply not possible, regardless of the techniques which are used, to make consistently accurate predictions of a random variable.
The MPC does of course have other functions as well as its main one of interest-rate setting. It should not be rolled up. Perhaps instead, the innovation of zero hour contracts should be brought in for its members. Following the Governor’s pronouncement, they will not be setting interest rates for some time to come. So much of their regular, monthly work is no longer required. Their emoluments could be adjusted to take this into account, and the MPC members paid only when there is some work for them to do.
As published in City AM on Wednesday 14th August 2013