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AllianceBernstein urges reform of UK monetary policy framework

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If the real aim of monetary policy is economic stability, the Bank of England needs a new policy framework that focuses on the root causes of inflation – money and credit – not just one narrow measure of its consequences, according to AllianceBernstein.

A new White Paper, “Money Talks – Broadening the UK’s Monetary Policy Framework”, acknowledges the Bank of England’s inflation targeting policy was widely regarded as a success during its first decade, but argues that the current approach still failed to foresee the biggest economic and financial crisis since the Great Depression.

The paper points out that between 1997 and 2007, broad money increased by 111%, bank lending rose by 155%, house prices by 197% and stock-market prices by 48%. In short, this was one of the most inflationary periods in British economic history. The only indicator that didn’t show this was the consumer-price index.

Darren Williams, European Economist, Global Economic Research at AllianceBernstein says: “Focusing exclusively on consumer prices as a measure of inflation—neglecting money and taking no account of asset-price developments—can lead to serious policy errors.

“We believe the Bank should supplement its approach with a formal role for money and credit, and recognise that monetary inflation can find an outlet through a number of different channels—consumer and/or asset prices—and that it’s not always possible to identify these in advance. Broader inflation measures—such as our own broad-price index, which combines consumer, producer, stock-market and house prices—would be a useful addition to the Bank’s toolbox.

“Consumer-price inflation has been above target for much of the last five years and is currently running at over 4%. For some members of the Bank’s Monetary Policy Committee (MPC), this persistent overshoot of the inflation target, and potential damage to credibility, warrants an urgent tightening of monetary policy. But broader measures of inflation do not support such an early move—bank lending is subdued, the housing market is soft and recent data point to renewed weakness in money-supply growth. Several members of the MPC clearly recognise this, and are more reluctant to increase interest rates.

“For the time being, a period of weak economic data has removed the risk of a premature tightening of monetary policy. But once the economy starts to strengthen, the Bank will come under pressure to raise rates. If it is determined to hit its inflation target against a backdrop of continued upward pressure on commodity prices, it will only be able to do so by imposing interest rates that are too high for the domestic economy. In so doing, it would add to deflationary pressures already present in money, credit and asset prices. In our view, the Bank’s flexibility and ultimate credibility can only benefit from a more holistic approach.”

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