The MPC has lost the plot again . . .

This time on inflation.

The Monetary Policy Committee (MPC) appears to have lost the plot. It seems to have given up on targeting inflation. The likelihood is that, because of the committee's lack of action, the UK economy may well experience a bout of deflation that will be hard for the economy to recover from. This is a very big worry.

Its job is to target the CPI in the medium term. Specifically it is supposed to aim to get the CPI back to target two years ahead. Its normal policy trigger is to adjust interest rates up or down. Interest rates are at 0.5 per cent now and can't really go any lower. Hence, the MPC has been increasing the amount of money in existence by quantitative easing. Up to this point, it has injected just over £200bn of new money into the UK economy.

Today it issued its Inflation Report with its forecast for inflation and growth. The growth forecast is much more optimistic than those of other forecasters such as the National Institute of Economic and Social Research. But the inflation forecast is more interesting.

Below are two fan charts from the report which show the range of the forecast. The fan widens as time moves forward, as it is harder to forecast further into the future. For those who are technically minded, this is the 90 per cent confidence interval rather than the single line that most other forecasters produce, and suggests what the MPC sees as its range of error.

 

CPI inflation

 

The first chart (5.4) is the forecast produced today and the second (5.5) is the one produced in November 2009. It is clear that the central forecast for inflation -- the darkest part of the fans -- is lower two years out than it was in November. The vertical dotted line is the outcome that the MPC, by statute, focuses on, because its job is to target inflation a couple of years in the future. It can't do anything to influence the inflation rate next week or the week after. Changes in interest rates, and changes in quantitative easing, take some time to work through the economy.

Inflation is going to jump over the next few months, primarily because of the rise in petrol prices and the increase in VAT from 15 per cent to 17.5 per cent. Indeed, the likelihood is that the committee will have to write a letter to the Chancellor, Alistair Darling, explaining why inflation is above target. They will just say: "Don't worry, it will fall back down very quickly."

 

CPI inflation 2

 

But the big concern is that inflation is below the target two years out, according to the MPC's forecast. The implication of this is that the Bank of England either should have been cutting interest rates further by a lot, which it can't, or it should have been doing more quantitative easing. Another possibility is that the pound would have to fall further, which may be something the MPC is targeting.

And the committee's forecast for growth is incredibly optimistic. It is much more optimistic than I think is reasonable, and also more optimistic than the recent projections from the NIESR. If output turns out to be lower than the MPC forecast, then inflation will be even lower. The likelihood is that before two years are up, even based on this forecast, the committee will have to write a letter to the Chancellor explaining why inflation is below the target!

The MPC conditions its forecast on market interest rates, which have fallen since November, so that should imply more inflation, not less, as such a change is stimulative. The MPC doesn't forecast these rates in its report but just accepts what the markets predict they will be. Worryingly, even when the assumption is made that interest rates will remain at 0.5 per cent across the forecast horizon, inflation never hits the target. It did hit the target in November using this assumption. So the implication is that the future will be more disinflationary than the MPC thought in the past.

The implication of this latest inflation forecast is that the MPC needs to put more stimulus into the market. In normal times, I would be voting for a big cut in rates, perhaps as big as 150 basis points. These days I would also be voting for lots more QE -- and sensible members of the MPC such as David Miles probably did that. An alternative would be to see the exchange rate fall in the wake of this news -- which it already has this morning -- and for gilts to rise, which they also have done this morning. It is now clear that interest rates are not going to rise any time soon, and so the expectation is that the yield curve will fall further.

As each week goes by, I am becoming more and more convinced that this MPC is not fit for purpose. The Inflation Report published today was another nail in its coffin.

David ("Danny") Blanchflower is Bruce V Rauner Professor of Economics at Dartmouth College, New Hampshire, and professor of economics at the University of Stirling. He is a former member of the Monetary Policy Committee. His economics column appears weekly in the New Statesman.

David Blanchflower is economics editor of the New Statesman and professor of economics at Dartmouth College, New Hampshire

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Hannan Fodder: This week, Daniel Hannan gets his excuses in early

I didn't do it. 

Since Daniel Hannan, a formerly obscure MEP, has emerged as the anointed intellectual of the Brexit elite, The Staggers is charting his ascendancy...

When I started this column, there were some nay-sayers talking Britain down by doubting that I was seriously going to write about Daniel Hannan every week. Surely no one could be that obsessed with the activities of one obscure MEP? And surely no politician could say enough ludicrous things to be worthy of such an obsession?

They were wrong, on both counts. Daniel and I are as one on this: Leave and Remain, working hand in glove to deliver on our shared national mission. There’s a lesson there for my fellow Remoaners, I’m sure.

Anyway. It’s week three, and just as I was worrying what I might write this week, Dan has ridden to the rescue by writing not one but two columns making the same argument – using, indeed, many of the exact same phrases (“not a club, but a protection racket”). Like all the most effective political campaigns, Dan has a message of the week.

First up, on Monday, there was this headline, in the conservative American journal, the Washington Examiner:

“Why Brexit should work out for everyone”

And yesterday, there was his column on Conservative Home:

“We will get a good deal – because rational self-interest will overcome the Eurocrats’ fury”

The message of the two columns is straightforward: cooler heads will prevail. Britain wants an amicable separation. The EU needs Britain’s military strength and budget contributions, and both sides want to keep the single market intact.

The Con Home piece makes the further argument that it’s only the Eurocrats who want to be hardline about this. National governments – who have to answer to actual electorates – will be more willing to negotiate.

And so, for all the bluster now, Theresa May and Donald Tusk will be skipping through a meadow, arm in arm, before the year is out.

Before we go any further, I have a confession: I found myself nodding along with some of this. Yes, of course it’s in nobody’s interests to create unnecessary enmity between Britain and the continent. Of course no one will want to crash the economy. Of course.

I’ve been told by friends on the centre-right that Hannan has a compelling, faintly hypnotic quality when he speaks and, in retrospect, this brief moment of finding myself half-agreeing with him scares the living shit out of me. So from this point on, I’d like everyone to keep an eye on me in case I start going weird, and to give me a sharp whack round the back of the head if you ever catch me starting a tweet with the word, “Friends-”.

Anyway. Shortly after reading things, reality began to dawn for me in a way it apparently hasn’t for Daniel Hannan, and I began cataloguing the ways in which his argument is stupid.

Problem number one: Remarkably for a man who’s been in the European Parliament for nearly two decades, he’s misunderstood the EU. He notes that “deeper integration can be more like a religious dogma than a political creed”, but entirely misses the reason for this. For many Europeans, especially those from countries which didn’t have as much fun in the Second World War as Britain did, the EU, for all its myriad flaws, is something to which they feel an emotional attachment: not their country, but not something entirely separate from it either.

Consequently, it’s neither a club, nor a “protection racket”: it’s more akin to a family. A rational and sensible Brexit will be difficult for the exact same reasons that so few divorcing couples rationally agree not to bother wasting money on lawyers: because the very act of leaving feels like a betrayal.

Or, to put it more concisely, courtesy of Buzzfeed’s Marie Le Conte:

Problem number two: even if everyone was to negotiate purely in terms of rational interest, our interests are not the same. The over-riding goal of German policy for decades has been to hold the EU together, even if that creates other problems. (Exhibit A: Greece.) So there’s at least a chance that the German leadership will genuinely see deterring more departures as more important than mutual prosperity or a good relationship with Britain.

And France, whose presidential candidates are lining up to give Britain a kicking, is mysteriously not mentioned anywhere in either of Daniel’s columns, presumably because doing so would undermine his argument.

So – the list of priorities Hannan describes may look rational from a British perspective. Unfortunately, though, the people on the other side of the negotiating table won’t have a British perspective.

Problem number three is this line from the Con Home piece:

“Might it truly be more interested in deterring states from leaving than in promoting the welfare of its peoples? If so, there surely can be no further doubt that we were right to opt out.”

If there any rhetorical technique more skin-crawlingly horrible, than, “Your response to my behaviour justifies my behaviour”?

I could go on, about how there’s no reason to think that Daniel’s relatively gentle vision of Brexit is shared by Nigel Farage, UKIP, or a significant number of those who voted Leave. Or about the polls which show that, far from the EU’s response to the referendum pushing more European nations towards the door, support for the union has actually spiked since the referendum – that Britain has become not a beacon of hope but a cautionary tale.

But I’m running out of words, and there’ll be other chances to explore such things. So instead I’m going to end on this:

Hannan’s argument – that only an irrational Europe would not deliver a good Brexit – is remarkably, parodically self-serving. It allows him to believe that, if Brexit goes horribly wrong, well, it must all be the fault of those inflexible Eurocrats, mustn’t it? It can’t possibly be because Brexit was a bad idea in the first place, or because liberal Leavers used nasty, populist ones to achieve their goals.

Read today, there are elements of Hannan’s columns that are compelling, even persuasive. From the perspective of 2020, I fear, they might simply read like one long explanation of why nothing that has happened since will have been his fault.

Jonn Elledge is the editor of the New Statesman's sister site CityMetric. He is on Twitter, far too much, as @JonnElledge.