Transcript Inflation Targets

Inflation Targets and
Measurement
A2 Economics
Central Banks and Targets
• Price stability is the primary objective for monetary policy
and subordinates other potential objectives
– European Central Bank (HICP of 2% or below)
– Bank of England (consumer price inflation of 2.0%)
• UK introduced inflation targets in 1992
• A dual mandate recognizes two objectives-price stability
and full employment-and puts them on an equal footing
– Federal Reserve of the United States
• No explicit numerical target for inflation
• Seeks to achieve sustained growth and price stability
Points and Ranges
• The inflation target is sometimes set as a point
and sometimes as a range
• In most cases, the inflation objective is set for a
measure of overall consumer price inflation
• The time period prescribed for return to the
inflation target following departures is sometimes
explicit and sometimes not, generally in the range
of eighteen months to two years.
The UK Inflation Target
• Article 11 of the Bank of England Act
– Sets the objectives for monetary policy as "to maintain price
stability" and
– "subject to that, to support the economic policy of Her Majesty's
Government, including its objectives for growth and
employment."
• The target, set by the Chancellor of the Exchequer is
currently 2.0% for the consumer price index
• The Governor of the Bank of England must write a letter to
the Chancellor if inflation deviates by more than 1
percentage point from the target
• This last happened in April 2007 when CPI inflation
reached 3.1%
Why Have an Inflation Target?
•
Widely agreed that low and stable inflation is desirable
•
Macro-economic stability should lead to higher levels of
capital investment and economic growth in the future
•
Gains from an explicit inflation target:
1. Improved accountability of monetary policy – the general public
can see for themselves whether the target is being achieved
2. Credible target lowers expectations of inflation – helps to
control the growth of wages (the inflation target is an “anchor”)
3. This can help to improve the trade-off between inflation and
unemployment
4. Lower expectations of inflation help to lower long term interest
rates – makes it easier for companies and governments to
borrow
Inflation Targeting and the UK Economy
• 1990s
– October 1990-September 1992: Membership of the EU
Exchange Rate Mechanism (explicit exchange rate target)
– October 1992: Sterling outside of the ERM, Government
introduced an inflation target as a new “anchor” for domestic
monetary policy
– May 1997: New Labour Government gives operational
independence to the Bank of England – but still sets the inflation
target
• 2004 onwards
– Change to the inflation target away from RPIX and to consumer
price index inflation of 2.0%
Meryvn King on the NICE decade
• The new monetary framework—based on an
explicit target for inflation, a high degree of
transparency, and, since 1997, independence of
the Bank of England—made it clear to everyone
that monetary policy was, and would continue to
be, targeted on maintaining low and stable
inflation.
Consumer Price Inflation for the UK Economy
Annual percentage change in the Consumer Price Index
Consumer
Price Inflation in the UK
Percent
9
9
8
8
7
7
6
6
5
5
4
4
3
3
2
2
1
1
0
0
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07 08
Source: Reuters EcoWin
Inflation targets and macro policy
•
There are dangers in having a narrow inflation target:
•
Economy might be hit by an external shock e.g. rising food prices
which could take inflation above target
•
If policy response is too deflationary this might make a possible
slowdown / recession worse
•
The Monetary Policy Committee seems to have taken a flexible /
pragmatic approach to the recent rise in commodity prices – waiting
to see how strong were the inflationary effects
•
They have reduced interest rates slowly – but the fall in the
exchange rate has boosted the effects of monetary policy on
demand, output and jobs
•
But they are determined to avoid a wage price spiral which might hit
the credibility of UK monetary policy
RPI and CPI
• CPI measure of inflation has come in for criticism
• RPI measure is consistently higher partly because
it includes mortgage interest payments
• Loss of confidence among people that the ‘official
measure of inflation’ accurately reflects their own
experiences of inflation
• Government has introduced a ‘personal inflation
calculator’ for people who want to find out more
• http://www.statistics.gov.uk/pic/
Retail Price and Consumer Price Inflation in the UK
RPI and CPI Inflation
Annual percentage change in the retail price index and CPI
5.0
4.5
4.5
4.0
4.0
3.5
Percent
5.0
All items retail price index (RPI)
3.5
3.0
3.0
2.5
2.5
2.0
2.0
1.5
1.5
1.0
1.0
Consumer price index
0.5
0.5
0.0
0.0
00
01
02
03
04
05
06
07
08
Source: Reuters EcoWin
Richer or poorer? The inflation measurement
debate
•
It is impossible to find an exact measure of inflation – which is the %
change in the cost of living using a particular basket of goods
•
Official measure of inflation is a weighted price index – weights
based on spending patterns
•
But no one is the ‘average consumer’! – there are many different
demographic groups
–
Housing costs are left out of the CPI – and for millions of
homeowners this can take up a huge % of their monthly budget
–
Pensioners spend a higher proportion of their bills on energy, food
and fuel
–
Other groups living at home with their parents, spending their money
on DVDs, iPods and imported clothing might actually have a
negative inflation rate!
Selected Weights in the UK Consumer Price Index
Weights used in the CPI
Total weights for the CPI = 1000. Source: Office of National Statistics
140
140
130
130
120
110
110
100
100
90
1996=100
120
Housing, water and fuels
90
Foods
80
80
70
70
60
60
Clothing and footwear
50
50
40
40
Alcohol, tobacco and narcotics
30
30
20
20
Education
10
99
00
01
02
03
04
10
05
06
07
08
Source: Reuters EcoWin
Limitations of the consumer price index
• The CPI is not fully representative
– Since the CPI represents the expenditure of the
‘average’ household, it may be inaccurate for the
‘non-typical’ household
• The Changing Quality of Goods and Services
– Although the price of a good or service may rise, this
may be accompanied by an improvement in quality as
the good is updated reflecting improvements in
dynamic efficiency in the market-place