MPC member warns of inflation drop

Adam Posen calls for another round of quantitative easing and insists the Bank should not raise interest rates The Bank of England’s leading dove has predicted that inflation will tumble to 1.5% by the middle of next year as George Osborne’s austerity drive and the underlying weakness of the economy stifle consumer spending. In an interview with the Guardian, Adam Posen admitted he had sleepless nights over his call for more money to be pumped into the economy and said he would not seek re-election to Threadneedle Street’s monetary policy committee if his view turned out to be wrong. Posen said: “If I have made the wrong call, not only will I switch my vote, I would not pursue a second term. They should have somebody who gets it right and not me. I am accountable for my performance. I’m holding my nerve because it is the right thing to do.” The American academic said he would be profoundly affected if it was proved that he had erred in voting repeatedly for bank rate to be pegged at 0.5% and for more money to be pumped into the economy through quantitative easing. “It would not just be terrible that I had messed up for other people but it is also my fundamental world view that I have been testing. “I would take it deeply and personally, which is why I have laid awake at night thinking about it.” But Posen said recent trends in the economy had left him convinced that inflation would fall back below the government’s 2% target in the second half of next year, as the temporary factors pushing up prices washed out of the system and the economy slowed down. This analysis, he said, chimed with the views expressed in recent speeches by the Bank’s governor, Mervyn King, and Charlie Bean, one of the two deputy governors. Three members of the MPC – Andrew Sentance, Martin Weale and Spencer Dale – voted for higher interest rates this month, but Posen challenged their view on four separate counts. He said so-called “core inflation”, which strips out the effects of fuel, food costs and taxes such as VAT, did not suggest that the economy was overheating; the recent strength in manufacturing only affected 13% of the UK’s total output and was not replicated in other parts of the economy; it was too simplistic to say that the economy was overheating if inflation was high; and it would only be costly to take a wait-and-see approach to raising interest rates if there was a risk of an inflationary spiral. “We could get inflation back to target really fast if we put the economy through the wringer,” he said. Posen added that the real debate inside the MPC was whether the increase in inflation to 4.4% would lead to consumers and businesses believing that there had been a permanent upward shift, and thus have knock-on effects on wages and prices. “I don’t see that as a material risk given all else that is going on, which is why I have been leaning the way I have.” He echoed King in calling a small increase in bank rate futile, as any rise would have to be reversed, damaging the Bank’s credibility. Posen said that whatever the merits of the government’s austerity plans, higher taxes and reductions in public spending would have a “meaningful” dampening effect on consumer spending and overall demand in the economy. “Household consumption is going to be pretty darn weak. It may even contract a little”. Consumers, he said, were unlikely to run down their savings in an attempt to maintain spending patterns, while the weakness of trade unions meant it would be hard for wage bargainers to push up pay settlements in response to higher inflation. “Wages will be the dog that doesn’t bark,” he said. Posen said he disliked the idea that interest rates had to be brought back to a more normal level after being cut to 0.5% in early 2009, the lowest level since the Bank was founded in 1694. “If I am a firefighter fighting a fire I don’t say I have pumped more water than I have ever pumped in my life so I must have pumped too much. You stop pumping when the fire is out.” Posen was also sceptical about some economists’ suggestion that the government’s deficit reduction plan could help growth by boosting confidence in financial markets, leading to a fall in long-term interest rates and higher investment. Inflation Bank of England Consumer spending Interest rates Economics Economic policy George Osborne Larry Elliott guardian.co.uk

Posted by on March 27, 2011. Filed under News, Politics, World News. You can follow any responses to this entry through the RSS 2.0. You can skip to the end and leave a response. Pinging is currently not allowed.