The Bank of England risks forgetting its history (parallels with RBI?)

In the recent MPC meeting, Bank of England voted 5-3 to maintain status quo policy. The 3 dissenters suggested a rate hike citing inflation concerns:

CPI inflation has been pushed above the 2% target by the impact of last year’s sterling depreciation.  It reached 2.9% in May, above the MPC’s expectation.  Inflation could rise above 3% by the autumn, and is likely to remain above the target for an extended period as sterling’s depreciation continues to feed through into the prices of consumer goods and services.  The 2½% fall in the exchange rate since the May Inflation Report, if sustained, will add to that imported inflationary impetus.

Mark Gilbert and Marcus Ashworth in their piece says BoE is again making the same mistake as it made around 2010:

The prospect of accelerating inflation is persuading some Bank of England policy makers, including Chief Economist Andrew Haldane, to consider raising interest rates. It’s reminiscent of what happened six years ago, when faster inflation prompted some officials to call for tighter policy. The history of what happened then, though, should restrain them from being too quick to act today.

By February of 2011, three members of the bank’s Monetary Policy Committee — Chief Economist Spencer Dale, along with external members Andrew Sentance and Martin Weale — were calling for higher borrowing costs to damp inflation. The benchmark interest rate had been cut to a then record low of 0.5 percent in 2009; Dale and Weale voted to hike it to 0.75 percent, while Sentance by then was calling for it to double to 1 percent.

At the time, the U.K. economy had been on a roll for several quarters, with gross domestic product growing by more than 2 percent for three consecutive quarters. Annual inflation had passed the Bank of England’s 2 percent target in November 2009, and continued to accelerate. By the start of 2011, it was running at double the target rate, a pace it maintained and even exceeded for much of the rest of the year.

It didn’t last. By the middle of 2012, GDP growth had slowed to just 1 percent. Inflation, meantime, peaked at 5.2 percent in September 2011, dropped below target in January 2014, and was down to just 0.5 percent by the end of 2014.

Luckily for the British economy, higher borrowing costs that might have exacerbated the slowdown were avoided; Sentance’s stint as a policy maker ended in May 2011, while both Dale and Weale fell back into line with the rest of the MPC and were voting for unchanged interest rates by August.


Interestingly, my thoughts went back to RBI’s recent MPC minutes. One member asked for a steep rate cut of 50 bps:

All in all, the prevailing inflation and output conditions and prospects are such that there is enough space for a substantial rate cut of 50 basis points if not more. The risk factors appear to be highly mitigated and the probability of circumstances developing to reverse the decision is very low if not non-existent. Under such circumstances, becoming cautious and not acting amounts to ignoring all costs associated with not supporting growth in terms of unemployment and poverty reduction. Becoming too overcautious under such circumstances is against the principle of prudence. In fact, prudence lies in creating space when conditions are favorable and risks are not high than waiting and losing the opportunity. In case, the conditions were really to turn unfavorable in future, the costs to the society would be severe if during the right time expansionary policies are not followed. I, therefore, strongly plead to the MPC to effect a 50 basis points cut in the policy rate without losing any time.

This takes you back to the 2008 crisis when RBI cut rates sharply seeing no case for inflation. And then inflation surged from nowhere as oil and food prices rebounded. Even now, the bulk of decline in inflation is due to collapse of agri prices which have dipped sharply following demonetisation.

Just all so confusing. I keep wondering whether MPCs really help in making decisions. Yes, it removes the burden of policy from one person to a team but that may not lead to desired outcomes.

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