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Director of Finance Online - Blogs - The Edge » Blog Archive » Inflation’s forgotten target

The Edge

Richard Northedge takes on corporate finance

Inflation’s forgotten target

If you think the UK economy is drifting aimlessly, you’re right. The Bank of England has given up on one target and declined to adopt any other.

The only objective of the Bank is to produce inflation of 2 per cent. That rate hasn’t been seen since 2009 however and the central bank now admits it will be several more years before the rate falls that low. Indeed, it is moving further away from the target.

The 2 per cent target hasn’t technically been abandoned but it is being officially ignored.

However, after floating the idea of substituting an objective of producing growth, incoming governor Mark Carney has now sunk that alternative too. He told the MPs who interviewed him for the job that nominal-GDP targeting, as economists call it, is not his objective.

So there you are. A ship with no compass, no map and no port to aim for.

And no comment or criticism from the government either. When the governor writes his regular letters to the chancellor, as he is required, explaining why he has missed the inflation target he never gets a reply telling him to try harder or roasting him for his failure. The truth is that the Treasury is quite happy for inflation to stay high.

Limiting the increase in social benefits to just 1 per cent a year doesn’t work if inflation is 1 per cent too. To achieve a real cut on welfare spending requires inflation to be much higher than the benefits increase. Freezing the thresholds on income tax and other taxes works fastest too if incomes and wealth are rising quickly.

So inflation is an aid to the government balancing its books and reducing the deficit. But it helps the state’s balance sheet as well as the P&L. All that debt – that massive amount of debt – will cost less to redeem if inflation is high, eroding the maturity value.

Don’t expect the government to set a higher inflation target for the Bank of England. But don’t be surprised if it continues to turn a blind eye for several more years to the fact that the target is persistently being missed.



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