Monetary Policy Committee and Recession
Until 1997, Monetary policy was controlled by the Government. However, this was blamed for many boom and busts, e.g. Lawson boom - when government allowed economy to grow too quick causing inflation. Therefore, the government made the MPC independent to set interest rates. The government gave the MPC an objective of:
- 1. Low inflation of CPI 2% +/-1
- 2. Consider wider macro economic objectives such as growth and unemployment.
Therefore, the MPC’s primary target is low inflation, but the second objective enables them to give less importance to inflation if there is an unexpected shock to the economy.
Many argue the MPC have done a good job. Between 1997 and 2007, they kept inflation low whilst maintaining strong but sustainable growth. Unemployment fell and the UK enjoyed the longest period of growth on record (16 years). It appeared the MPC had avoided the old boom and bust cycle.
However, the MPC have been criticised
- For allowing a boom in house prices which was unsustainable. Now house prices are falling the economy has suffered lower growth
- Ignoring the impending recession and giving too much importance to temporary cost push inflation. e.g. David Blanchflower criticised MPC for keeping interest rates too high for too long. The dramatic cuts in rates, show how the MPC perhaps admit they were too high for too long.
However, in defence of the MPC
- The MPC were not asked to target house prices with interest rates. Arguably this was a micro economic problem. If they had increased interest rates in 2004-05 to reduce house prices it would have caused lower growth even when inflation was on target. Rising house prices reflected shortage of supply and excess lending. The boom in house prices was undesirable, but, it needed to be tackled by measures other than interest rates.2. The recession was mainly caused by the global credit crunch outside their control. The UK government could have done more to regulate the financial system.
- Many were surprised at how quickly the UK Economy slid into recession
- Also the cost push inflation presented a difficult dilemma. The MPC feared that if they cut rates as inflation was increasing it could lead to permanently higher inflation expectations. The MPC were not confident oil prices would fall.
In hindsight, interest rates could have been cut earlier in 2008. The concerns over inflation have been outweighed by the much more serious decline in growth and rise in unemployment. This may have caused a sharper downturn. But, it was not the main cause of the recession - far from it. The main cause of this recession was the combination of a global credit crunch, falling house prices and decline in consumer confidence.
Overview of MPC at Bank of England
Original post by Tejvan R Pettinger