I started this blog in June 2007 asking these questions: Are we in a massive asset bubble that will blow up in our faces ??? - ANSWERED YES ! Is western and particularly British society on the verge of social collapse??? What are the best common sense long term investment strategies to keep you rich? When will consumption/debt bubble economics end and a real savings/production economy begin ???

Thursday, 5 July 2007

Why inflation targeting is a bad idea.

Fifteen years ago, the UK exited from the ERM in humiliation. At the time, the failure struck at the very core of the Bank of England’s counter-inflationary strategy. By targeting the pound to the German DM, the bank hoped that it could hold down inflation. However, the Bank couldn’t maintain the target.

In the days following the ERM exit, the Bank of England faced the difficult question of “what now?” It came up with a barely noticed idea. From now on, the bank announced, we will target inflation directly. No more intermediate targets for us, the Bank declared. The Bank would no longer look at money supply growth, interest rates, or exchange rates; only the end result would matter. Inflation, and only inflation, would be the only target that mattered.

At the time, the implications of this new inflation targeting regime were only dimly understood. Superficially, it seemed like a sound idea. Its simplicity and clarity was appreciated by politicians. In 1997, the inflation targeting regime was further enhanced when the Bank of England gained policy independence from the Treasury.

However, inflation targeting had a deep dark side that only became apparent much later. The chosen target wasn’t price inflation, it was consumer price inflation. The Bank of England chose to target a subset of inflation. Crucially, the Bank chose to ignore asset prices, housing costs and indirect taxes.

Inflation targeting also meant that the Bank no longer paid much attention to other indicators, which could guide monetary policy. The Bank, in effect, threw away, monetary economics as a guide for policy. It ignored the money supply, interest rate policy and exchange rates.

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