Inflation Targeting in the UK

11

I fl ti T ti i th UKInflation Targeting in the UKInflation Targeting in the UK

Gill HammondGill HammondDirector, CCBS Bank of Englandecto , CC S a o g a d

B il 2009Brazil 2009

[email protected] © Bank of England

OutlineOutline

• UK experience of Inflation• UK experience of Inflation Targeting since 1992Targeting since 1992

• Inflation targeting and quantitative• Inflation targeting and quantitative easingeasing

• Challenges for inflation targeters• Challenges for inflation targeters


22

B i f hi t f UK t liBrief history of UK monetary policyBrief history of UK monetary policy

B f 1972 Fi d b t dj t bl h t• Before 1972: Fixed but adjustable exchange rates; j gfiscal policy to manage demandfiscal policy to manage demand

• 1972-79: Active fiscal policy; inflation control1972 79: Active fiscal policy; inflation control through incomes policythrough incomes policy

• 1979 86: Monetary target (MTFS)• 1979-86: Monetary target (MTFS)

• 1986 90: Shadowing the Deutsch Mark• 1986-90: Shadowing the Deutsch Mark

• 1990-92: Exchange Rate Mechanism• 1990-92: Exchange Rate Mechanism

• 1992-97: Inflation target; Chancellor sets rates• 1992-97: Inflation target; Chancellor sets rates

• From 1997: Inflation target; MPC sets ratesFrom 1997: Inflation target; MPC sets [email protected] © Bank of England

UK t li d i fl ti 1970 2009UK monetary policy and inflation 1970-2009

Bretton

30%Money TargetingWoods 30%

Inflation Targeting

25%

g g

DM3 25%DM3

20%ERM

20%ERM

15%

10%

5%RPIX CPIRPIX CPI

0%0%

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 0870 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08


33

C t li f kCurrent policy frameworkCurrent policy framework

Clear responsibilities and objectivesClear responsibilities and objectives

• Price stability is a legal requirement• Price stability is a legal requirement

• Government sets objectives• Government sets objectivesPrecise inflation target is set annually– Precise inflation target is set annually

• MPC sets interest rates• MPC sets interest rates


Remit for the MPCRemit for the MPC

Bank of England Act 1998:Bank of England Act 1998:

to deliver price stability (as defined by the…to deliver price stability (as defined by the Government’s inflation target)Government s inflation target) and subject to this objective…and subject to this objectiveto support the Government’s economic…to support the Government s economic policy, including its objectives for growthpolicy, including its objectives for growth

d l tand employmentp y


44

Inflation TargetInflation Targetg

2% CPI inflation ‘at all times’• 2% CPI inflation ‘at all times’

O l tt if i fl ti b l 1% b• Open letter if inflation below 1% or above p3%3%

• Symmetric target• Symmetric target


The Monetary PolicyThe Monetary Policy CommitteeCommittee

• MPC sets interest ratesMPC sets interest rates

• 9 members; 5 internal 4 external member9 members; 5 internal, 4 external member

• Chaired by the Governor who has castingChaired by the Governor, who has casting tvote

M j i i ki• Majority voting, not consensus-seekingMajority voting, not consensus seeking

• Members are individually accountableMembers are individually accountable


55

MPC’ ti dMPC’s voting recordMPC s voting record

2008 2007 2006 2005

4 2 3 4Unanimous decision

4

(33 3%)

2

(16 6%)

3

(25%)

4

(33 3%)(33.3%) (16.6%) (25%) (33.3%)

2 1Three-way spilt

2

(J l & A )0

1

(M )0y p

(July & Aug) (May)

1 1Governor in minority 0

1

(July)0

1

(Aug)y

(July) (Aug)


Inflation targeting exceededInflation targeting exceeded expectationsexpectationsp

• Adoption of inflation targeting surpassed• Adoption of inflation targeting surpassed t tiexpectations: p

Marked improvement in macro performance:Marked improvement in macro performance:1992-2007 saw unparalleled price stability1992 2007 saw unparalleled price stability

d 65 t f i t t d thand 65 quarters of uninterrupted growthq p g

Inflation expectations well anchored• Inflation expectations well-anchored• Exchange rate volatility not as much a• Exchange rate volatility not as much a

problem as we thought: ER has not beenproblem as we thought: ER has not been independent source of shocksindependent source of shocks


66

Inflation expectationsInflation expectationspPPer cent

8Exit fromExit from ERM 7IndependenceERM

66

5

44

3

2

11

090 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09


Consumer prices have beenConsumer prices have been more volatile recentlymore volatile recentlyy

• Open letters;Open letters; – April 2007 (CPI 3.1%)April 2007 (CPI 3.1%)

J 2008 (3 3%)– June 2008 (3.3%)( )

September 2008 (4 7%)– September 2008 (4.7%)

December 2008 (4 1%)– December 2008 (4.1%)

– March 2009 (3 2%)March 2009 (3.2%)


77

GDP projection May 2009GDP projection May 2009p j y


CPI projection based on marketCPI projection based on market rates May 2009rates May 2009y


Inflation Report, May 2009Inflation Report, May 2009

88

CPI inflation projection based on constant nominal interest ratesCPI inflation projection based on constant nominal interest rates


See footnote to Chart 2.

What has been done?What has been done?

• Fiscal expansionFiscal expansion

• 5 point plan to support banks (19 Jan)5 point plan to support banks (19 Jan)– Capital; funding; mortgages; corporateCapital; funding; mortgages; corporate

lending’ APFlending APF

• Bank rate reduced from 5% to 0 5%• Bank rate reduced from 5% to 0.5%

PlusPlus

• Big depreciation of sterling• Big depreciation of sterling

Fall in commodity/oil prices• Fall in commodity/oil [email protected] © Bank of England

99

UK policy interest rate since 1997UK policy interest rate since 1997

8

77.5

6 57

66.5

55.5

4 55

44.5

33.5

2 53

22.5

11.5

0 51

00.5

Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec97 97 98 98 99 99 00 00 01 01 02 02 03 03 04 04 05 05 06 06 07 07 08 08


Lowest rate since 1694Lowest rate since 169418

1617

1516

1415

13

14

1211

910

8

9

7

8

67

5

4

23

1

2

010

1694 1714 1734 1754 1774 1794 1814 1834 1854 1874 1894 1915 1935 1955 1975 1995 [email protected] © Bank of England

1694 1714 1734 1754 1774 1794 1814 1834 1854 1874 1894 1915 1935 1955 1975 1995 2005

1010

Inflation targeting andInflation targeting and quantitative easingquantitative easingq g

• QE has been incorporated into IT• QE has been incorporated into IT f kframework

Exchange of letters between Governor and– Exchange of letters between Governor and C ( )Chancellor on APF (5 March 2009)( )Unchanged objective; inflation target of 2%– Unchanged objective; inflation target of 2%

– MPC makes decisions each monthMPC makes decisions each month

f f• IT framework provides clear guidelines forIT framework provides clear guidelines for unconventional monetary policyunconventional monetary policy

• And will also steer exit strategy• And will also steer exit [email protected] © Bank of England

Quantitative easingQuantitative easinggM h 5 MPC t B k R t t 0 5% d• March 5; MPC cut Bank Rate to 0.5% and announced a programme of asset purchases of p g p£75 billion financed by the issuance of central£75 billion, financed by the issuance of central bank reserves in order to meet the inflationbank reserves, in order to meet the inflation targettarget.

• May 7: asset purchase programme increased toMay 7: asset purchase programme increased to £125bn£125bnB k i b i b th t d t• Bank is buying both corporate and government y g gdebt

• Activity should be boosted by providing liquidity• Activity should be boosted by providing liquidity to private sector and easing credit conditionsto private sector and easing credit conditions.

• Early signs have been positiveEarly signs have been [email protected] © Bank of England

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How does QE work?How does QE work?

ExpectationsExpectationsExpectations

? Total wealth? Total wealth↑ Total wealth

? Asset prices ? Asset prices ↑Asset prices

(?yields)

? Cost of

(?yields)

? Cost of

(↓yields)

Cost of

BoE asset ? Spending Inflation borrowingBoE asset ? Spending Inflation borrowingBoE asset ↑ Spending Inflation borrowing

purchases and income at 2%purchases and income at 2%purchases and income at 2%

? M i hM i h? Money in the

economy

? Bank lending? Money in the

economy

? Bank lending↑ Money in the

economy

↑ Bank lending

economyeconomyeconomy


UK experience; conclusionUK experience; conclusionp

Ad ti f i fl ti t ti f ll d• Adoption of inflation targeting was followed p g gby sustained period of macro economicby sustained period of macro-economic stabilitystabilityI fl ti t ti f l i• Inflation targeting was successful in g ganchoring inflation expectationsanchoring inflation expectations

• Inflation targeting framework provides• Inflation targeting framework provides l id li f ti lclear guidelines for unconventional g

monetary policymonetary policy.• But new challenges aheadBut new challenges ahead


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Challenges for inflation targetersChallenges for inflation targetersg g

• Challenges to the frameworkChallenges to the framework– Target measureg

D d i t t ?– Do we need more instruments?

How we think about markets and models– How we think about markets and models

• IT so far has been flexible enough to• IT so far has been flexible enough to respond to new challengesrespond to new challenges


Documents

Inflation Targeting in the UK