Page last updated at 05:27 GMT, Tuesday, 17 June 2008 06:27 UK

'Keep system which has worked well'

By Sir Alan Budd
Provost, Queen's College, Oxford

Sir Alan Budd
Sir Alan: "British economy is slowing down in response to the credit crunch"

There are calls to change the way in which monetary policy - which mainly means the setting of interest rates - is organised in this country.

The suggestions vary from abandoning the inflation target to taking responsibility away from the Bank of England and handing it to the Chancellor of the Exchequer.

These calls are profoundly mistaken.

The system which was introduced in 1997 under which the Monetary Policy Committee (MPC) is given a clear remit for the control of inflation - and the freedom to set interest rates to achieve it has worked brilliantly.

When the inflation numbers are published today the figure for the Consumer Price Index is likely to be higher than 3% and the governor of the Bank of England will have to write a letter to the chancellor explaining why this has happened, what is being done about it and how soon inflation will come back to its target.

If that is headline news, that only shows how far our standards have risen.

When the new system was established it was expected that the governor would have to write a letter every 15 months or so.

After 11 years, only one letter has been written. And low inflation has been accompanied by steady economic growth and a significant fall in the level of unemployment.

Three factors are making life particularly difficult at the moment.

First, the current rise in inflation owes little or nothing to events in this economy. It results from a world-wide rise in commodity prices.

Second, the British economy is slowing down in response to the credit crunch.

Third, and perhaps most serious, people seem to be losing faith in the MPC's ability to bring inflation back to its target.

The MPC may feel that, despite the economic slowdown, it has to take a tough action to re-establish its credibility.

And that is what the markets seem to expect.

I disagree. I believe that the rise in inflation is temporary and that an increase in interest rates is unnecessary.

But disagreements about actions in particular months matter less than the preservation of a system which has worked so well.

Sir Alan was a founding member of the Bank of England's Monetary Policy Committee. His essay was first broadcast on BBC Radio 4's Today programme.


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