What is the Bank of England’s mandate on inflation and why it matters
The Bank of England has been increasingly criticized by Conservative MPs who argue that the central bank has been too slow in tackling rising inflation.
Andrew Bailey, the bank’s governor, warned this week that consumer price inflation, which had already hit a 40-year high of 9.4 percent in June, will exceed 13 percent by the end of the year.
Liz Truss, the foreign secretary and frontrunner in the race to become the UK’s next prime minister, said at one of the leadership meetings this week that she wants to change the central bank’s mandate to ensure they keep inflation below. keeps control. Here, the FT looks at how the BoE is fulfilling its role and where it stands relative to its peers.
What is the BoE’s mandate?
The Bank of England has a primary mandate to maintain price stability. It also supports the government’s economic policies, including its growth and jobs goals.
The then British government sets the inflation target for price stability, which is currently 2 percent based on the consumer price index. This target is the same for most central banks of advanced economies, including the US Federal Reserve, the European Central Bank and the Bank of Japan. Unlike the BoE, all three of its competitors set their own inflation targets.
The Fed has a second maximum employment target, which allows the US central bank to give more weight to labor market developments than the BoE can in determining monetary policy.
The BoE’s inflation target is usually confirmed annually by the government. The last time it was changed was in December 2003, when it replaced a 2.5 percent target based on the retail price index.
If inflation exceeds or falls below the target by more than 1 percentage point, the BoE governor must write a letter to the chancellor explaining why and what action the bank is taking to resolve the situation.
Ruth Gregory, a senior UK economist at Capital Economics, said the BoE’s mandate was “the least tolerant on paper at least” for higher inflation compared to the Fed, ECB and BoJ.
How does the mandate relate to the bank’s ability to set interest rates?
Since it became operationally independent in 1997 by Labor Chancellor Gordon Brown, only the BoE decides which policy measures to take to meet its inflation target.
The bank influences price growth in two ways. First, it sets the “bank rate” — the interest a central bank charges other domestic banks to lend money — and takes steps to ensure it’s passed on to households and businesses.
Second, it can use asset purchases, otherwise known as “quantitative easing.” When the bank buys bonds, interest rates for bondholders fall, leading to lower lending rates for households and businesses. This should help boost spending and keep inflation on track.
James Smith, director of research at the Resolution Foundation, said this approach “has been a mainstay of UK economic policy-making for the past quarter-century,” a period when inflation averaged almost exactly 2 percent.
Would changes to its mandate jeopardize the BoE’s independence?
Some experts argue that there is room for revision. “It makes sense, 25 years later, to rethink the issue [of the mandate] and look for things to do better,” said Costas Milas, professor of finance at the University of Liverpool.
In 2013, Tory Chancellor George Osborne revised the BoE’s mandate to give formal support to the central bank’s practice of leaving inflation above its target if the alternative threatened to trigger an economic downturn.
Changes to the mandate may include a different target tolerance range, the introduction of money supply targeting, or changes to the voting system for the external members of the monetary policy committee.
However, some economists point out that in most other advanced economies, most central banks are reviewing their strategies to make sure they can fully comply, rather than changing the mandate.
And many have expressed concern that any call for a government revision of the mandate raises questions about the BoE’s independence.
To the extent that this has become a central part of the leadership debate, “there is concern about the level of politicization of this issue and the potential risk to the perception of the BoE’s independence,” said Paul Hollingsworth, chief economist for Europe at BNP Paribas. .
Krishna Guha, vice chairman of investment banking consultancy Evercore ISI, said any talk of the mandate review carried the risk of “creating uncertainty in financial markets and business. Good care.”
Has the BoE fulfilled its mandate?
Average annual CPI inflation of almost exactly 2 percent since the bank’s independence in 1997 “suggests that the BoE has done a good job,” said Andrew Goodwin, an economist at Oxford Economics.
Inflation is now well above the inflation target, but that is also the case in most countries, due to the sharp rise in commodity prices after the Russian invasion of Ukraine.
With an inflation rate of 9.1 percent, the US has only marginally lower price pressures than the UK. In many eurozone economies, looser labor markets and government support for households affected by rising energy prices have kept price growth lower.
Aside from differences in rates, inflation has been high in most advanced economies for decades.
Hollingsworth said it would have been nearly “impossible for monetary policy alone” to reach the 2 percent target, given the double shock of the pandemic and the war in Ukraine.