The British Economy
Inflation targeting is something that could be understood on a very basic level, but there are some deeper factors at work, as well. A 2005 article by Business Week did a nice job of succinctly describing inflation targeting as it concerns the English economy. In that article, Newsweek wrote, Its a policy of announcing what youre going to do, and then doing it. Either the central bank or the elected government chooses and publicizes a target goal for the inflation rate -- say, 2 a year. The bank then publicly estimates how high it expects inflation to be in the coming year. It steers monetary policy to try to hit the target inflation rate (Newsweek, 2005). Since 1997, the English economy has been controlled by the Bank of England, which has been one of the worlds strongest central banks during that time. In addition to setting the inflation target, the central bank has been given the controlling duty of going forward with the inflation rate steering. Setting the rate is just the first part of the equation the more important part happens when the bank begins to adjust interest rates later in the year to bring the inflation rate closer to its pre-determined target. As Ben Bernanke describes inflation target in England, it is a process that is not highly regimented, and instead acts as a policy framework for a central bank with a host of other economic abilities. In a 2003 speech, Bernanke said, Inflation targeting is a policy framework, not a rule. If it is to be coherent and purposeful, all policy is made within some sort of conceptual framework the question is the degree to which the framework is explicit. Inflation targeting provides one particular coherent framework for thinking about monetary policy choices which, importantly, lets the public in on the conversation. If this framework succeeds in its goals of anchoring inflation expectations, it may also make the policymakers ultimate task easier (Bernanke, 2003). In England, it all begins with the Bank of England and more importantly, its monetary policy committee, which makes a number of the most important decisions on price in the country.
One of the primary reasons why inflation targeting has been so widely accepted by both established economies and some of the worlds emerging economies is that it offers countries the chance to react to certain market forces. Lots of different things impact a countrys financial viability and if a country is to move forward with a strong economy, it must prepare for these things. Any economic framework policy that a limits a countrys ability to read and react is a poor one. This is one of the strengths of inflation targeting, as countries are not bound by the various inter-dependent economic relationships that are so prevalent. An article by Frederic Mishkin speaks to this fact. He writes, Inflation targeting has several advantages as a medium-term strategy for monetary policy. In contrast to an exchange rate peg, inflation targeting enables monetary policy to focus on domestic considerations and to respond to shocks to the domestic economy. In contrast to monetary targeting, another possible monetary policy strategy, inflation targeting has the advantage that a stable relationship between money and inflation is not critical to its success the strategy does not depend on such a relationship, but instead uses all available information to determine the best settings for the instruments of monetary policy (Mishkin, 2001). It is clear that inflation targeting is a way for countries to limit risk and gain further control over their own growing economies, and it is becoming even more necessary in the increasingly complex global economy of today.
The monetary policy committee, in conjunction with the Bank of England, makes the majority of economic decisions for the country at large. This has been the case for a number of years, as the establishment of the MPC dates back to the installment of the Bank of Englands power base. John Vickers of the Bank of England wrote, Almost immediately after coming into office, the new
Government announced on 6 May 1997 that the Bank of England would henceforth have operational independence for the conduct of monetary policy. While the objectives of policy remain a matter for the Government to determine,responsibility for interest rate decisions moved to the Banks new MPC. The MPC operated for a year on a de facto basis, and now has a statutory basis under the Bank of England Act (Vickers). This committee is made up of nine people and together they act as the keepers of English economic vitality. These individuals measure the countrys gross domestic product, measure its expected output, and make predictions on the direction of the economy. Their chief job is to come up with an inflation target that will be healthy for the countrys economy in its current context. The group generally sets the inflation target at just more than 2, and the goal from there is to steer the economy toward that projection. The reason why this works is quite simple in reality. The basis for the policy framework is that if the economy has an inflation rate in that range, then things must be going well. In this way, it can be said that the inflation rate is a true indicator of economic vitality, which is why countries seek to do the things necessary to guide the economy to their targeted rate.
The MPC of England sets its target inflation rate based upon the retail inflation rate, excluding the prices of mortgages in the country. This is done in order to keep things more centered, given the framework nature of the policy itself. The Bank of England acts as the total authority on the matter, but inflation targeting is a practice that seeks to include many people. The general public is given the price projection by the Bank of England, and any adjustments are made public as soon as possible. This is an important part of the process, as many believe that this helps to revive consumer confidence when things get bad. If the economy is failing to meet its inflation target, the Bank of England is forthcoming in providing updates on its committee meetings and on the interest rate changes enacted to either slow down the economy or to help boost the economy when things might be lagging behind to an extent.
Since inflation targeting is primarily intended to promote solid economic health overall, determining whether or not the policy has been effective can be somewhat complicated at times. With that being said, many believe that inflation targeting has been helpful in England over the last fifteen years. According to Policy Review, which took a hard, analytical look at the success of inflation targeting for a number of countries with the practice, the United Kingdom has seen some success over the last decade or more. The review said, Similarly, in the United Kingdom, the disinflation begun two years prior to target adoption (duringmembership in the Exchange Rate Mechanism) continued against a background of improving growth, falling unemployment, and much lower nominal interest rates in the wake of the United Kingdoms exit from the European Monetary System (FRBNY). Though that report is critical of some of the worlds nations that make use of inflation targeting, it had high praise for England, mostly due to the organization of Englands system. With the Bank of England receiving almost unlimited power and the set of minds being put to work with the MPC, England has been successful in controlling its inflation rate and vaulting the economy forward. The report goes on to say, Our assessment of the effectiveness of inflation targeting in New Zealand, Canada, and the United Kingdom is on the whole positive. In all three countries, the adoption of targets was followed by the movement of inflation into, and the maintenance of inflation within, the announced target range. In the time since the adoption of inflation targets, our unconditional forecasts indicate that inflation and nominal interest rates have remained low in all three countries relative to the amount of output growth seen (which itself approximates the level forecast) (FRBNY).
Inflation targeting in England is not an old practice, but it is one that is key to the economys growth over the last fifteen years. Controlled by the Bank of England and its monetary policy committee, targeting is simply a way of controlling expectations, giving information to the public, and tailoring a system of adjusting the economys structure to meet those expectations. Given that a nation has thinkers capable of setting the parameters for what inflation rate is positive, there is no reason why inflation targeting cannot be a successful practice. Over the last fifteen years in England, it has proven to be just that, having pulled the English economy out of a difficult place nearly twenty years ago and guiding it into the new century as of late.