Two members of the Bank of England’s
Monetary Policy Committee (MPC), Ian McCafferty and Martin Weale, voted to
raise interest rates this month. This was the first time any member has voted
for a rate rise since July 2011, when Martin Weale also voted for a rate
increase. A key factor for those arguing to raise rates now is
lags: “Since monetary policy …. operate[s] only with a lag, it was desirable to
anticipate labour market pressures by raising bank rate in advance of them.”
The Bank of England’s latest forecast assumes interest rates rising
gradually from 2015. It also shows inflation below target throughout. The
implication would seem to be that the MPC members who voted for the rate
increase do not believe the forecast. But it could also be that they are more
worried about risks that inflation will go above target than risks that it will
stay below, much as the ECB always appears to be.
I like to apply a symmetry test in
these situations. Imagine the economy is just coming out of a sustained boom.
Interest rates, as a result, are high. Growth has slowed down, but the output
gap is still positive. Unemployment is rising, but is still low (say 4%) and
below estimates of the natural rate. Wage inflation is high as a result, and
real wages had been increasing quite rapidly for a number of years. Consumer
price inflation is above target, and the forecast for inflation in two years
time is that it will still be above target.
In these circumstances, would you
expect some MPC members to argue that now is the time to start reducing interest rates? Would you expect them to ignore the
fact that price inflation is above target, wage inflation is high, the output
gap is positive and unemployment is below the natural rate, and discount the
forecast that inflation will still be above target in two years time? There is
always a chance that they might be right to do so, but can you imagine it
happening?
You could? Now can you also imagine
large numbers of financial sector economists and financial journalists cheering
them on?
