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The Bank of England has come under increasing criticism from Conservative MPs who claim the central bank has been too slow in tackling rising inflation.
Andrew Bailey, the bank’s governor, warned This week, consumer price inflation, which hit a 40-year high of 9.4 percent in June, is set to top 13 percent by the end of the year.
Liz Truss, the foreign secretary and frontrunner in the race for Britain’s next prime minister, said at one of the leadership talks this week that she was want change the central bank’s mandate to ensure it controls inflation. Here the FT examines how the BoE is fulfilling its role and where it stands compared to its peers.
What is the BoE’s mandate?
That Bank of England has a primary mandate to maintain price stability. It also supports the government’s economic policies, including its growth and employment targets.
The British government of the day sets the inflation Target for price stability, which is currently 2 percent based on the consumer price index. This target applies to most central banks in advanced economies, including the US Federal Reserve, the European Central Bank and the Bank of Japan. Unlike the BoE, all three of its peers set their own inflation targets.
The Fed has a second target for maximum employment, which allows the Federal Reserve to give labor market developments more weight in setting monetary policy than the BoE.
The BoE’s inflation target is usually confirmed annually by the government. It was last changed 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 Registrar explaining why and what measures the bank is taking to resolve the situation.
Ruth Gregory, senior UK economist at Capital Economics, said the BoE’s mandate was “on paper, at least, the least tolerant” of higher inflation compared to the Fed, ECB and the BoJ.
How does the mandate relate to the bank’s ability to set interest rates?
Since becoming operationally independent from Labor Chancellor Gordon Brown in 1997, the BoE alone has decided what policy measures to take to meet its inflation target.
The bank affects price growth in two main ways. First, it sets the “bank rate” – the rate a central bank charges other domestic banks for borrowing – and takes steps to ensure it is passed on to households and businesses.
Second, it can leverage asset buying, also known as “quantitative easing.” When the bank buys bonds, the interest rate for bondholders falls, resulting in lower borrowing rates for households and businesses. This should help stimulate spending and keep inflation on track.
James Smith, research director at the Resolution Foundation, said this approach has been “a mainstay of UK economic policy over the past quarter century”, a period when inflation averaged almost exactly 2%.
Would changes to their mandate threaten the independence of the BoE?
Some experts argue there is scope for review. “It makes sense to revisit the subject 25 years later [of the mandate] and look at things that can get better,” said Costas Milas, professor of finance at the University of Liverpool.
In 2013, Tory Chancellor George Osborne revised the BoE’s mandate to formally support the central bank’s practice of allowing inflation to overshoot its target when the alternative threatened to trigger an economic downturn.
Changes to the mandate could contain a different tolerance range for the target, the introduction of monetary targeting or adjustments in the voting system for the external members of the monetary policy committee.
However, some economists point out that in most other advanced economies, rather than changing the mandate, most central banks are reviewing their strategies to ensure they can fully comply.
And many have expressed concern that any call for government mandate reviews will raise questions about the BoE’s independence.
To the extent that this has become a central part of the governance debate, “there are concerns about the level of politicization of this issue and the potential risk to perceptions of BoE 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 a mandate review risks “bringing uncertainty to financial markets and the business community.” This uncertainty has an economic cost and should therefore not be approached lightly or without great care.”
Has the BoE fulfilled its mandate?
Annual CPI inflation averaging almost exactly 2 percent since the bank gained independence in 1997 “suggests that the BoE has done a good job,” said Andrew Goodwin, economist at Oxford Economics.
Inflation is now well above target, but so is most countries, reflecting the rise in commodity prices following the Russian invasion of Ukraine.
With an inflation rate of 9.1 percent, the USA has only marginally less price pressure than Great Britain. In many eurozone economies, looser labor markets and government support for households confronted with rising energy prices have kept price growth lower.
Interest rate differentials aside, inflation is at multi-decade highs in most advanced economies.
Hollingsworth said hitting the 2 percent target would have been nearly “impossible for monetary policy alone” given the twin shocks of the coronavirus pandemic and the war in Ukraine.
https://www.ft.com/content/8bcd5def-7a6f-494e-8ae7-3dea28b4fdec What is the Bank of England’s inflation mandate and why is it important?
What is the Bank of England’s inflation mandate and why is it important? – TheHitc
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