In a speech to the National Institute of Economic and Social Research in
London yesterday, Kate Barker draws lessons from her nine years as an external
member of the Bank’s Monetary Policy Committee (MPC). She suggests these
might inform the Committee over the “difficult” years immediately ahead. Ms
Barker steps down from the Committee on 31 May this year.
Her central theme is “... whether the approach to policy should be somewhat
different in the more uncertain economic environment we face today, compared
with the relatively tranquil period of the MPC’s first ten years.” In this
context, she considers issues around the role of the output gap and around the
appropriate policy horizon.
Ms Barker suggests that modifications to the way it assessed the output gap
ie “... the implications for inflation of the pressure of demand on the
economy’s supply capacity ... ” in the past “... were pragmatic responses by the
MPC to changes taking place in the economy.” She describes uncertainties
about the size, interpretation, and even the definition, of the output gap, and
the additional factors contributing to difficulties in its measurement at the
current conjuncture. She notes “... that although from time to time it is
criticised for too much reliance on one model, the MPC ... is fully aware that
different circumstances point to different challenges. At present, neither
the extent of excess capacity nor the impact of capacity pressures on inflation
are easy to assess ... It therefore makes sense to look at a range of
estimates both of the gap and of its effect in order to give some guidance to
the range of likely economic outcomes. Implicitly, such a range is
contained within the fan charts of GDP and of CPI inflation published quarterly
in the Inflation Report.” She concludes that, “... the MPC could
consider using a range of different plausible estimates of the output gap and
its effect on inflation as a part of the methodology of constructing the growth
and inflation fan charts.”
On the length of the policy horizon, Ms Barker first expresses reservations
about the proposition that the MPC should have had higher interest rates during
the mid-2000s to control credit growth but concedes “... it is possible that it
would have been preferable to have taken a more long-term view of the risks to
inflation from economic instability.” In the present context, Ms Barker
finds “... a strong argument for continuing to focus on the two-year horizon is
that it would encourage policy to aim at a rate of growth in the short term
which would reduce the scale of excess capacity in the economy as fast as
possible.” However, she suggests, “... it might also be useful to
reconsider the merits of looking to inflation prospects beyond the normal
forecast horizon, to ensure any future risks to economic stability are taken
fully into account.”
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