Monetary failures

Despite the obvious monetary-induced stresses that have emerged since mid-2007, few economics commentators have questioned the role that monetary policy has played in causing this situation. In fact, monetary policy has everything to do with where we are today. The low levels of interest rates that were maintained on both sides of the Atlantic between 2002 and 2004 are the main reason why there was a surge in debt-financed activity, undertaken by financial businesses, households and government.

In the UK, inflation targeting has failed to create the conditions necessary for sustainable growth. Indeed, it has more than failed; it has actually been a significant cause of the credit boom. The problem with all static policy targets, whether they are for monetary variables, the currency or inflation, is that they work only so long as they remain consistent with longer-term equilibrium between supply and demand. Inevitably, however, they are framed by politicians and civil servants looking into the rear-view mirror.

Had it been in place earlier, inflation targeting inflation might have prevented some previous acts of economic vandalism. But it is hard to establish a rigid policy framework capable of accommodating future changes in the economic environment. Worse than that: the goal of monetary policy becomes solely to achieve the target; policy makers become blind to other evidence that suggests a change of course might be appropriate. The problem in the UK has been that the inflation target was not designed to accommodate a situation in which there was excess domestic demand at the same time as significant downwards pressure on inflation.

Because the policy framework established by Gordon Brown in 1997 was so narrow, the MPC was encouraged, if not mandated, to ignore obvious signs of overheating in the economy. The result was that the policy signal became stuck on Go.

The MPC should be given a broader remit. This may still have inflation at its heart, but it should also be made clear that policy must be formulated to ensure that the UK is on a sustainable growth path. Sometimes this may mean that inflation deviates from an explicit target – but on the basis that this is consistent with a wider balance being maintained in the economy.

Richard Jeffrey is Head of Securities at Ingenious and is a member of the ASI's regulatory action group.

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written by David Brand, April 18, 2008

I'm no economist, but I've never understood why it's considered desirable to control interest rates directly.

Governments attempt to control the 'price' of borrowing by adjusting interest rates, but that 'price' depends ultimately on the supply of money - and that, surely, is what should be controlled.

If a government attempts separately to control interest rates and money supply, it's likely to be attempting the impossible, and will cause other, undesirable effects as a result. So why not let interest rates be determined by the market alone? Let them float, and control the money supply instead?

Perhaps the ASI could address and explain this issue sometime?

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written by Steve Giess, April 19, 2008

Quote: The MPC should be given a broader remit

Jenny's new job?

Written by Richard Jeffrey
Friday, 18 April 2008
Despite the obvious monetary-induced stresses that have emerged since mid-2007, few economics commentators have questioned the role that monetary policy has played in causing this situation. In fact, monetary policy has everything to do with where we are today. The low levels of interest rates that were maintained on both sides of the Atlantic between 2002 and 2004 are the main reason why there was a surge in debt-financed activity, undertaken by financial businesses, households and government. In the UK, inflation targeting has failed to create the conditions necessary for sustainable growth. Indeed, it has more than failed; it has actually been a significant cause of the credit boom. The problem with all static policy targets, whether they are for monetary variables, the currency or inflation, is that they work only so long as they remain consistent with longer-term equilibrium between supply and demand. Inevitably, however, they are framed by politicians and civil servants looking into the rear-view mirror. Had it been in place earlier, inflation targeting inflation might have prevented some previous acts of economic vandalism. But it is hard to establish a rigid policy framework capable of accommodating future changes in the economic environment. Worse than that: the goal of monetary policy becomes solely to achieve the target; policy makers become blind to other evidence that suggests a change of course might be appropriate. The problem in the UK has been that the inflation target was not designed to accommodate a situation in which there was excess domestic demand at the same time as significant downwards pressure on inflation. Because the policy framework established by Gordon Brown in 1997 was so narrow, the MPC was encouraged, if not mandated, to ignore obvious signs of overheating in the economy. The result was that the policy signal became stuck on Go. The MPC should be given a broader remit. This may still have inflation at its heart, but it should also be made clear that policy must be formulated to ensure that the UK is on a sustainable growth path. Sometimes this may mean that inflation deviates from an explicit target – but on the basis that this is consistent with a wider balance being maintained in the economy. Richard Jeffrey is Head of Securities at Ingenious and is a member of the ASI's regulatory action group. Bookmark Comments (2) Subscribe to this comment's feed ... written by David Brand, April 18, 2008 I'm no economist, but I've never understood why it's considered desirable to control interest rates directly. Governments attempt to control the 'price' of borrowing by adjusting interest rates, but that 'price' depends ultimately on the supply of money - and that, surely, is what should be controlled. If a government attempts separately to control interest rates and money supply, it's likely to be attempting the impossible, and will cause other, undesirable effects as a result. So why not let interest rates be determined by the market alone? Let them float, and control the money supply instead? Perhaps the ASI could address and explain this issue sometime? ... written by Steve Giess, April 19, 2008 Quote: The MPC should be given a broader remit Jenny's new job? Write comment This content has been locked. You can no longer post any comment. Powered by Azrul's Jom Comment for Joomla!