Paul Hajduk
PAYdata Blog, January 19 2011


The Monetary Policy Committee (MPC) of the Bank of England faces a challenging period as it wrestles to manage inflation while protecting the fragile economic recovery. The MPC is charged with managing interest rates so that the Consumer Price Index (CPI) is maintained around its target value of 2%. The theory is simple:

• If interest rates rise, most of us have less to spend
• If we have less to spend demand for goods and services will fall
• If demand falls then prices fall.

In practice this a good deal more complex. It’s made harder still when the Government's own policies (e.g. the recent VAT increase) artificially push up prices. A further complication is that the theory relies on falling demand to hold down inflation. This is all very well when the economy is strong. But if the economy is weak there is a serious risk of creating a downward spiral that results in recession. This is defined as two consecutive quarters of negative growth.

What would you do? Take the long-term view that inflation is likely to fall or take the rap if increasing interest rates contributes to a downturn in the economy? History tells us that the MPC is better placed to make this judgement than the politicians and others who are now clamouring for an increase in rates!

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