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<title>Inflation targeting</title></titleStmt>

<publicationStmt><distributor>BASE and Oxford Text Archive</distributor>


<availability><p>The British Academic Spoken English (BASE) corpus was developed at the

Universities of Warwick and Reading, under the directorship of Hilary Nesi

(Centre for English Language Teacher Education, Warwick) and Paul Thompson

(Department of Applied Linguistics, Reading), with funding from BALEAP,

EURALEX, the British Academy and the Arts and Humanities Research Board. The

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The recordings and transcriptions used in this study come from the British

Academic Spoken English (BASE) corpus, which was developed at the

Universities of Warwick and Reading under the directorship of Hilary Nesi

(Warwick) and Paul Thompson (Reading). Corpus development was assisted by

funding from the Universities of Warwick and Reading, BALEAP, EURALEX, the

British Academy and the Arts and Humanities Research Board. </p></availability>




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<item n="speechevent">Lecture</item>

<item n="acaddept">Economics</item>

<item n="acaddiv">ss</item>

<item n="partlevel">UG</item>

<item n="module">Economic policy in the UK</item>




<u who="nf1139"> # <pause dur="0.4"/> in the course handout the overview for the whole course <pause dur="0.6"/> # i included <pause dur="0.4"/> # an outline of <pause dur="0.2"/> the topics that i'm going to cover <pause dur="1.1"/> and one of the major components is <pause dur="0.3"/> comes under the basic heading inflation targetry <pause dur="0.3"/> and that's what we're going to start <pause dur="0.3"/> almost immediately today <pause dur="1.1"/> now inflation targetry really <pause dur="0.3"/> in my view covers <pause dur="0.8"/> # <pause dur="0.7"/> well basically all of the current macroeconomic monetary policy <pause dur="0.3"/> # framework <pause dur="0.2"/> and policy <pause dur="0.4"/> and <pause dur="0.2"/> # <pause dur="0.3"/> basis in the U-K at the moment <pause dur="0.6"/> and i think that's really important <pause dur="0.2"/> not only because <pause dur="0.3"/> it's important for the U-K but also the U-K's policy <pause dur="0.3"/> has been extremely influential throughout the world <pause dur="0.4"/> i mean a lot of countries <pause dur="0.2"/> refer to the U-K when they look at <pause dur="0.2"/> how they should set out their monetary policy <pause dur="0.4"/> we've just been very very influential <pause dur="0.4"/> that's partly as we'll see because we started quite early <pause dur="0.5"/> not necessarily through design <pause dur="0.4"/> but partly through accident of nature <pause dur="1.2"/> # so that's going to constitute <pause dur="0.3"/> # at least half the

course really discussing inflation targets <pause dur="0.5"/> the the current policy regime <pause dur="0.5"/> arguments for and against the this regime compared to other previous regimes <pause dur="0.6"/> # <pause dur="0.4"/> all of this is really tied in with # <trunc>top</trunc> topics that you may well have covered previously like central bank independence <pause dur="0.5"/> just so i know <pause dur="0.2"/> roughly where to pitch that sort of topic i'd be interested to know who did <pause dur="0.4"/> ECAP-<pause dur="0.5"/>two or the one that's taught by <gap reason="name" extent="2 words"/> last year <pause dur="0.4"/> can you just stick up your hand if you did that <pause dur="1.7"/><kinesic desc="put hands up" n="ss" iterated="n"/> okay how many people didn't then <kinesic desc="put hands up" n="ss" iterated="n"/> it's <trunc>e</trunc> going to be easier <pause dur="0.2"/> just a few <unclear>okay</unclear> <pause dur="0.8"/> okay so <pause dur="0.2"/> you've already covered topics like central bank independence which which is going to be really really useful <pause dur="0.3"/> and also hopefully what i'm going to say today and in <trunc>f</trunc> <pause dur="0.3"/> # future lectures <pause dur="0.3"/> relates to that <pause dur="1.3"/> # <pause dur="1.1"/> okay we're <trunc>al</trunc> also going to talk about <pause dur="0.3"/> other <pause dur="0.2"/> what you <pause dur="0.3"/> might think of in principle as general economic issues like <pause dur="0.4"/> are there costs of inflation <pause dur="0.5"/> but really i'm hoping to help you see that <pause dur="0.3"/> that sort of

question really underlies the design of policy it should really drive <pause dur="0.4"/> # <pause dur="0.7"/> what policy looks like in the U-K and beyond <pause dur="1.3"/> okay <pause dur="0.3"/> also once we've discussed <pause dur="0.2"/> that sort of policy framework issue <pause dur="0.3"/> we also are going to have to look at how monetary policy actually works <pause dur="0.5"/> because we're going to move from assessing <trunc>mo</trunc> we just look at the Bank of England setting interest rates through <pause dur="0.2"/> to affect policy <pause dur="0.3"/> to <pause dur="0.5"/> see how that actually affects the real the real economy <pause dur="0.3"/> to how it how it actually affects inflation <pause dur="0.3"/> and the paths through which it can act <pause dur="0.5"/> because an understanding of that <pause dur="0.6"/> is going to also influence how we think policy should be set up <pause dur="2.2"/> then we've finished basically <pause dur="0.2"/> that side of monetary policy <pause dur="0.4"/> and then we move onto <pause dur="0.2"/> EMU <pause dur="0.4"/> as a topic which it i'm sure you're already familiar with but also <pause dur="0.4"/> it's obviously of <pause dur="0.2"/> great relevance today <pause dur="0.6"/> # we'll look at the transition to EMU the costs and benefits <pause dur="0.2"/> that sort of thing <pause dur="0.3"/> and then we're going to end up talking about <pause dur="0.5"/> an issue which has really i guess come to the fore over the last year <pause dur="0.4"/> with crises in Asia <pause dur="0.3"/> in Russia <pause dur="0.4"/> and <pause dur="0.2"/> you know potential

crises beyond that <pause dur="0.2"/> in <trunc>f</trunc> in the financial world this is to do with <pause dur="0.3"/> stock exchange market volatility <pause dur="0.6"/> and exchange rate volatility <pause dur="0.9"/> both of those <pause dur="0.4"/> # <pause dur="0.3"/> are potentially endemic problems and problems that <pause dur="0.3"/> at the moment don't look like they're going to <trunc>wi</trunc> go away <pause dur="0.7"/> and also presenting real headaches for policy makers in <trunc>t</trunc> in terms of the designer institutions <pause dur="0.6"/> are the I-M-F the World Bank current set-up are they sufficient to deal with these sorts of <pause dur="0.4"/> relatively new problems which seem to have <pause dur="0.4"/> arisen through <pause dur="0.2"/> # the increased capital flows <pause dur="1.6"/> now in terms of what we expect from you from this course <pause dur="0.4"/> i guess Steve probably may have already given you <pause dur="0.2"/> some idea <pause dur="0.9"/> the course tries to tie in economic theory quite heavily with # <pause dur="0.6"/> policy <pause dur="0.6"/> and policy aspects <pause dur="0.3"/> so we will be using theoretical models quite <pause dur="0.2"/> well quite a lot as i'm sure Steve's already done <pause dur="0.6"/> but <pause dur="0.6"/> in for example the assessments that you've got to do by the end of this term it <pause dur="0.2"/> we don't necessarily

require you to <pause dur="0.3"/> # <pause dur="0.6"/><kinesic desc="makes quotation mark gesture" iterated="n"/> be theoretical to use those sort of models <pause dur="0.6"/> it is possible in this course <pause dur="0.3"/> because it's a policy course <pause dur="0.4"/> to <pause dur="0.2"/> provide arguments in a non-mathematical manner <pause dur="0.8"/> and for example <pause dur="0.6"/> well the analysis one sometimes sees in the Economist <pause dur="0.5"/> is <pause dur="0.2"/> actually a <trunc>go</trunc> <trunc>e</trunc> <trunc>e</trunc> good example of economic analysis and that type of <pause dur="0.4"/> argument although not necessarily potentially using economist language which some people <pause dur="0.5"/> # don't don't like very much has its <gap reason="inaudible" extent="1 sec"/> problem <pause dur="0.6"/> that sort of analysis I-E verbal analysis of economic policy and economic theory is perfectly adequate <pause dur="0.8"/> so i mean don't <pause dur="0.5"/> if for those of you who don't like theory if i <pause dur="0.4"/> put up a model i'm going to try and explain it intuitively <pause dur="0.8"/> # to try and # to try and ensure that you know maths isn't <pause dur="0.5"/> the overriding <pause dur="0.2"/> # <pause dur="0.7"/> thing that's important <pause dur="2.0"/> # <pause dur="0.3"/> what else to say <pause dur="0.8"/> at the end of this lecture i'm going to try and finish a bit early so we can discuss <pause dur="0.4"/> and get volunteers for seminars <pause dur="0.6"/> and get times for seminars in particular Steve <pause dur="0.3"/> Broadberry's

already given you <pause dur="0.2"/> the topics for his <pause dur="0.2"/> his first seminar and he needs some volunteers for that but i'm going to deal deal with that at the end <pause dur="2.2"/> right in terms of reading <pause dur="0.4"/> you'll see in the handout that i've given for week one <pause dur="0.2"/> it's relatively unusual in the sense that the reading list is is admittedly <pause dur="0.6"/> # very long <pause dur="0.9"/> but <pause dur="0.3"/> # <pause dur="0.2"/> one <pause dur="0.2"/> you don't have to read <pause dur="0.2"/> everything <pause dur="0.5"/> two <pause dur="0.4"/> a lot of the <pause dur="0.3"/> # items are very very short they're one or two pages <pause dur="0.3"/> particularly those published by the Bank of England which are descriptive of the current policy framework <pause dur="1.5"/> # also it's actually quite interesting they are short and <trunc>y</trunc> really by going through them # <pause dur="0.2"/> <trunc>f</trunc> <pause dur="0.2"/> the first the first sort of sub-heading i put under reading <pause dur="0.4"/> is institutional readings <pause dur="0.4"/> # <pause dur="0.7"/> i should point out that a lot of them do <trunc>cos</trunc> <pause dur="0.2"/> contain a sort of assessment of the current framework <pause dur="0.3"/> but they're in <pause dur="0.3"/> inverse chronological order <pause dur="0.2"/> so you start from the current <pause dur="0.4"/> policy regime and go backwards <pause dur="0.3"/> and they they

finish <pause dur="0.3"/> really <pause dur="0.3"/> i guess at the first change in about <trunc>nineteen-ninety-f</trunc> <pause dur="0.7"/> # five <pause dur="0.2"/> they should do <pause dur="2.0"/> okay so reading those a lot of them are available on the web <pause dur="0.4"/> on the Internet 'cause the bank <pause dur="0.2"/> Bank of England's site's very good <pause dur="0.4"/> at producing documents on the Internet <pause dur="0.6"/> i've starred the ones that are most important i've i've only starred three <pause dur="0.6"/> but those three i really really recommend quite highly <pause dur="0.4"/> not just for this lecture but for all the way through the course there's a Bank of England <pause dur="0.4"/> what they call a fact sheet on monetary <kinesic desc="holds up sheet" iterated="n"/> policy in the U-K <pause dur="0.3"/> it's just a <pause dur="0.2"/> a four three or four page <pause dur="0.7"/> thing which goes through the policy framework <pause dur="0.3"/> it actually goes through topics that we're going to be dealing with next <pause dur="0.3"/> like <pause dur="0.4"/> # <pause dur="0.3"/> alternatives <pause dur="0.5"/> # like the monetary aggregates which are alternative <pause dur="0.2"/> # <pause dur="0.3"/> policy frameworks <pause dur="0.3"/> it goes through techniques like <pause dur="0.3"/> what the Bank actually does in the money markets in order to set interest rates <pause dur="0.5"/> which we also <pause dur="0.2"/> look at and

it basically gives you an overall <pause dur="0.5"/> # picture of <pause dur="0.3"/> monetary policy in the U-K over the last few years <pause dur="1.1"/> the other thing that i really really very highly recommend <pause dur="0.4"/><kinesic desc="holds up paper" iterated="n"/> is this article by Mervyn King which he <pause dur="0.5"/> gave at the L-S-E <pause dur="0.4"/> last <trunc>s</trunc> <pause dur="0.4"/> # September October i think <pause dur="0.9"/> # The Inflation Target Five Years On <pause dur="0.8"/> and Mervyn King is the chief <trunc>economi</trunc> well is the chief <pause dur="0.7"/> used to be the Chief Economist is now Deputy <pause dur="0.3"/> Governor at the Bank of England <pause dur="0.4"/> and <pause dur="0.2"/> he writes very well in that <pause dur="0.4"/> this article it's # twenty-something pages long <pause dur="0.2"/> it really covers <pause dur="0.3"/> mm you could say maybe the first seven <pause dur="0.3"/> or half the course really <pause dur="0.2"/> all in one paper so <pause dur="0.3"/> i really recommend that very highly <pause dur="1.6"/><vocal desc="clears throat" iterated="n"/><kinesic desc="holds up book" iterated="n"/> the other <pause dur="0.6"/> thing i'm <pause dur="0.2"/> going to recommend is <pause dur="0.2"/> there's a one star next to the Bowen article in this book <pause dur="0.3"/> now this is a book i recommended right in the first reading list Targeting Inflation <pause dur="0.4"/> several copies available in the S-R-C <pause dur="0.6"/> # <pause dur="0.3"/> <trunc>i</trunc> <pause dur="0.4"/> the only problem with the book <pause dur="0.2"/> is <pause dur="0.6"/> that it's relatively old it's published ninety-five

or at least it comes from a conference in ninety-five <pause dur="1.6"/> and i mean since then in the U-K there's been quite a lot of developments so the Bowen article in that <pause dur="0.5"/> relates to <pause dur="0.4"/> obviously quite a relatively old version of <pause dur="0.2"/> monetary policy <pause dur="1.4"/> the Haldane article on the reading list is is equally if not <pause dur="0.4"/> is equally good if not better than the Bowen <pause dur="0.9"/> now that's from the Bank of England Quarterly Bulletin <pause dur="0.6"/> just in case you're not aware <vocal desc="sniff" iterated="n"/><pause dur="0.3"/> well i'm going to be recommending a lot of readings from the Bank of England Quarterly Bulletin <pause dur="0.7"/> the current year is available behind the counter in the S-R-C <pause dur="0.5"/> previous years are filed with journals <pause dur="0.9"/> so <pause dur="0.5"/> everything is reasonably readily <trunc>acce</trunc> accessible at the moment <pause dur="0.9"/><vocal desc="sniff" iterated="n"/><pause dur="0.3"/><vocal desc="sniff" iterated="n"/><pause dur="1.6"/> right <pause dur="0.5"/> if there are any questions about that <pause dur="1.3"/> great okay well let's move straight on to <pause dur="0.8"/> looking at the first topic then <pause dur="1.0"/> inflation targetry <pause dur="3.9"/><event desc="puts on transparency" iterated="n"/> i'm not sure that i necessarily like the <pause dur="0.4"/> like the term targetry but it was one <pause dur="1.2"/> that <pause dur="0.2"/>

Alex Bowen <pause dur="0.8"/> who i guess is quite quite important # figure in the Bank in terms of dealing with <pause dur="0.7"/><kinesic desc="turns on overhead projector showing transparency" iterated="n"/> # <pause dur="0.4"/><vocal desc="sniff" iterated="n"/> inflation targeting <pause dur="0.4"/> he was one of the first people to <pause dur="0.6"/> coin that phrase </u><gap reason="break in recording" extent="uncertain"/> <u who="nf1139" trans="pause"> now <pause dur="1.0"/><kinesic desc="reveals covered part of transparency" iterated="n"/> the <pause dur="3.0"/> inflation targeting in the U-K <pause dur="0.6"/> dates from <pause dur="0.8"/> October nineteen-ninety-two <pause dur="2.8"/> and although i haven't <pause dur="0.3"/> # put anything on the handout about the circumstances <pause dur="0.2"/> under which inflation targeting in the U-K was adopted <pause dur="0.7"/> i think they are actually very important and also <pause dur="0.5"/> you know provide an interesting background <pause dur="0.4"/> to what's been happening in monetary policy <pause dur="1.4"/> the U-K <pause dur="0.3"/> left the exchange rate mechanism <pause dur="0.3"/> on sixteenth of September nineteen-ninety-two <pause dur="0.4"/> does anyone know what sixteenth September nineteen-ninety-two is known as </u><pause dur="0.6"/> <u who="ss" trans="pause"> Black Wednesday </u><u who="nf1139" trans="overlap"> Black Wednesday yeah <pause dur="0.9"/> okay Black Wednesday <pause dur="0.7"/> that as you may be aware was a <pause dur="0.6"/> # dramatic day <pause dur="0.5"/> in <pause dur="0.4"/> the history of U-K monetary policy <pause dur="1.2"/> it

was the day when George Soros <pause dur="0.2"/> <trunc>manage</trunc> manager of a <pause dur="0.6"/> # <pause dur="0.4"/> of of investment fund <pause dur="0.4"/> decided that the U-K exchange rate was <pause dur="0.3"/> unsustainably overvalued <pause dur="1.0"/> so he took a massive gamble <pause dur="0.6"/> # <pause dur="0.5"/> virtually i think all of his <pause dur="0.3"/> # funds <pause dur="0.4"/> <trunc>d</trunc> # <pause dur="0.2"/> numbering millions billions of dollars <pause dur="0.4"/> was bet <pause dur="0.4"/> against the pound <pause dur="0.6"/> right <pause dur="0.2"/> so basically he was # selling pounds <pause dur="0.3"/> like mad <pause dur="0.3"/> in favour of other countries <pause dur="0.6"/> that put massive pressure on the U-K exchange rate which was currently fixed at <pause dur="0.4"/> # <pause dur="0.3"/> i think it was three-seventy-five <pause dur="0.3"/> deutschmarks at that point <pause dur="1.6"/> people # Soros was basically betting because <pause dur="0.5"/> # <pause dur="0.6"/> well the U-K currency was <trunc>relative</trunc> <pause dur="0.6"/> relatively uncompetitive at that rate and it was <trunc>wer</trunc> quite well known and had been quite well known for a while that that was the case <pause dur="0.3"/> but Soros at that point <pause dur="0.5"/> amidst <pause dur="0.4"/> instability in general in the currency markets i mean Italy was also hit at that at the same time by <pause dur="0.3"/> general exchange rate instability <pause dur="0.4"/> Soros took a bet against the U-K currency <pause dur="1.2"/> and <pause dur="0.2"/> # <pause dur="0.2"/> i guess one of the

reasons i'm i'm giving this course is that <pause dur="0.2"/> i have a background in central banking <pause dur="0.3"/> and i was working at the Bank of England at the time <pause dur="0.9"/><vocal desc="clears throat" iterated="n"/> i worked at the Bank of England for five years <pause dur="0.9"/> it was just the most <pause dur="0.3"/> remarkable day <pause dur="0.3"/> i've <pause dur="0.3"/> well one of the <trunc>re</trunc> most remarkable days i've i've encountered because <pause dur="0.3"/> when i arrived at the Bank of England in the morning to discover that <pause dur="0.3"/> interest rates had been put up <pause dur="0.3"/> by three per cent already <pause dur="0.4"/> and there was <pause dur="0.4"/> basically panic in the corridors <pause dur="0.3"/> if one's just a general Bank of England worker there's <pause dur="0.7"/> some <pause dur="0.2"/> kind of <pause dur="0.2"/> delay in the flow of information so actually <pause dur="0.5"/> one of the people in my office got rung up by one of his friends who was a city dealer saying <pause dur="0.3"/> what on earth are you doing with the # interest rate you know if # you've just raised it five per cent what <trunc>wh</trunc> <pause dur="0.2"/> what is going on <pause dur="0.5"/> what was going on <pause dur="0.3"/> was that the Bank was having to <pause dur="0.4"/> buy pounds <pause dur="0.4"/> in <pause dur="0.2"/> vast quantities <pause dur="0.5"/> i mean the Bank reserves i think at the start of that day were <pause dur="0.2"/> in the

region of fifty-billion <pause dur="0.2"/> pounds <pause dur="0.6"/> and we were in serious danger <pause dur="0.5"/> at the rate of spending of <pause dur="0.3"/> pound of of # <pause dur="0.3"/> foreign <trunc>ec</trunc> foreign reserves <pause dur="0.3"/> that we were having to undertake in order to <pause dur="0.5"/> in effect in a sense counteract Soros and his cronies <pause dur="0.5"/> # of losing all our reserves by the end of the day <pause dur="1.5"/> now the only strategy that was open to the Bank <pause dur="0.7"/> rather than selling <pause dur="0.4"/> our foreign exchange reserves <pause dur="0.2"/> was to put up interest rates <pause dur="1.0"/> if you put up U-K interest rates obviously <pause dur="0.2"/> people are going to want to invest <pause dur="0.3"/> more <pause dur="0.2"/> in the U-K pound because they get a higher return <pause dur="0.6"/> so just <pause dur="0.2"/> price and # <pause dur="1.0"/> by demand and supply <pause dur="0.2"/> you'd hope by <pause dur="0.4"/> raising the return on pounds people are going to stop selling <pause dur="1.4"/> it didn't work <pause dur="0.4"/> and where do i mean <pause dur="0.3"/> how could it work we had just had <pause dur="0.4"/> a speculator who'd decided i'm <kinesic desc="clicks fingers" iterated="n"/> going to sell now <pause dur="1.5"/> and # there's nothing you can do if they sell <pause dur="0.2"/> in such large quantities <pause dur="0.5"/> you've just got almost no time in which to react <pause dur="0.5"/> so by twelve o'clock it was clear that the <pause dur="0.2"/> rate <pause dur="0.2"/> of interest

increase that had happened already we'd <pause dur="0.4"/> announced that the markets <pause dur="0.5"/> that <pause dur="0.6"/> we'd actually reset <pause dur="0.2"/> minimum lending rate which is <pause dur="0.6"/> almost an official interest rate which we don't normally set in the Bank of England <pause dur="0.4"/> it was set <pause dur="1.0"/> at <trunc>al</trunc> almost to tell the markets <pause dur="0.2"/> we know that we're in an emergency situation <pause dur="0.3"/> and we we've got to tell you that this is the interest rate even if you want to <trunc>l</trunc> have a lower interest rate <pause dur="0.3"/> we're going to <pause dur="0.4"/> # not allow that we're going to have a higher interest rate <pause dur="0.8"/> so twelve per cent <pause dur="0.3"/> we then decided to raise it to fifteen per cent <pause dur="0.2"/> there was speculation that well it was clear actually in the amongst the Economics department that that wasn't going to be enough <pause dur="0.7"/> we were talking in terms of <pause dur="0.5"/> twenty per cent even fifty per cent <pause dur="0.9"/> interest rates <pause dur="0.3"/> i mean just as a <pause dur="0.3"/> almost as a signal to the markets that we were serious <pause dur="0.5"/> obviously <pause dur="0.3"/> that's going to cost us a huge amount if we set interest rates at fifty per cent <pause dur="0.2"/> because someone's going to have to pay that

interest rate <pause dur="1.2"/> and it was undoubtedly going to have to be the government or the Bank of England <pause dur="1.4"/> so we were all willing to adopt a relatively costly strategy <pause dur="0.6"/> in order to try and defend our our status in the E-R-M <pause dur="0.3"/> # to defend the <pause dur="0.3"/> the pound's exchange rate <pause dur="1.8"/> but by <pause dur="0.2"/> by the afternoon it was clear that even <pause dur="0.2"/> that wasn't working <pause dur="0.2"/> and the <trunc>chan</trunc> the Governor headed off <pause dur="0.3"/> to the Treasury <pause dur="0.4"/> to have a meeting with the Chancellor <pause dur="0.6"/> and <pause dur="0.4"/> amidst # <pause dur="0.3"/> huge <pause dur="0.4"/> massive embarrassment <pause dur="0.7"/> to monetary policy making in the U-K <pause dur="0.4"/> we decided that we were going to have to <pause dur="0.8"/> quit the E-R-M <pause dur="0.7"/> and the the magnitude of that <pause dur="0.8"/> should not be underestimated <pause dur="0.3"/> it was the <pause dur="0.4"/> it and had been for several years <pause dur="0.3"/> the sole <pause dur="0.5"/> # objective of monetary policy to maintain a fixed exchange rate particularly with the deutschmark <pause dur="0.7"/> and to let that go <pause dur="0.5"/> just almost in a day <pause dur="0.3"/> is just <pause dur="0.3"/> # really <pause dur="0.2"/> highly embarrassing <pause dur="0.7"/> it meant that the Bank of England credibility <pause dur="0.5"/> you know we'd promised to maintain that exchange rate the Bank of England credibility <pause dur="0.4"/>

was <pause dur="0.2"/> was very very strongly damaged <pause dur="3.0"/> so <pause dur="0.2"/> amidst <pause dur="0.4"/> huge <pause dur="0.2"/> # panic <pause dur="0.2"/> turmoil <pause dur="0.4"/> and so on <pause dur="0.7"/> we were left with nothing <pause dur="0.9"/> absolutely nothing <pause dur="0.8"/> we were left with <pause dur="1.3"/><kinesic desc="writes on transparency" iterated="y" dur="4"/> a policy <pause dur="2.3"/> vacuum <pause dur="3.2"/> we had nothing to hang monetary policy on <pause dur="0.4"/> we had <pause dur="0.3"/> # <pause dur="0.2"/> in terms <pause dur="0.5"/> of the jargon <pause dur="0.3"/> we had <pause dur="1.2"/><kinesic desc="writes on board" iterated="y" dur="4"/> no <pause dur="0.2"/> nominal anchor <pause dur="4.4"/> now what's a nominal anchor <pause dur="1.3"/> # it's something that you can peg the value of the currency to <pause dur="2.0"/> # it's something that will <pause dur="0.3"/> # stabilize the value of the currency <pause dur="0.3"/> one easy way to think of it <pause dur="0.4"/> is that <pause dur="0.5"/> in the nineteen-thirties or before the nineteen-thirties when we were on the gold standard <pause dur="0.5"/> that was a <trunc>r</trunc> a monetary policy regime <pause dur="0.4"/> whereby you could swap <pause dur="0.8"/> # <pause dur="0.5"/> money <pause dur="0.4"/> notes and coin <pause dur="0.3"/> for a certain amount of gold <pause dur="0.4"/> well it's clear intuitively clear that that <pause dur="0.4"/> the ability to swap is going to maintain a <trunc>ver</trunc> value of one's currency <pause dur="1.7"/> # if you can obviously trade gold for money you know

how much your <pause dur="0.2"/> currency's worth <pause dur="0.8"/> similarly in an exchange rate mechanism <pause dur="0.6"/> you know how much deutschmarks your money's worth so you you you set the value of your own currency <pause dur="0.3"/> but in the absence of that we had no <pause dur="0.3"/> nominal anchor we had nothing to tie the value of money to <pause dur="3.3"/> but i find it astonishing how quickly <pause dur="0.3"/> we found some <pause dur="0.2"/> some new policy <pause dur="1.1"/> it was only a month or less than a month <pause dur="0.6"/> # before we adopted an inflation target <pause dur="0.4"/> which is <pause dur="0.2"/> our current <pause dur="0.2"/> nominal anchor <pause dur="1.2"/> only a month to devise a whole new method of monetary policy a whole new <pause dur="0.3"/> framework for monetary policy <pause dur="1.5"/> and i i <trunc>tha</trunc> that's <pause dur="0.6"/> really quite remarkable <pause dur="1.2"/> we were helped <pause dur="0.6"/> in <pause dur="0.2"/> the sense that other countries had provided some sort of example <pause dur="0.8"/> and who knows does anyone know who <pause dur="0.4"/> who we may have looked to <pause dur="0.5"/> in terms of setting out an example for how to set monetary policy in a <trunc>s</trunc> in a in a sort of vacuum </u><pause dur="0.8"/> <u who="sm1140" trans="pause"> is it # New Zealand </u><u who="nf1139" trans="latching"> yes <pause dur="0.3"/> brilliant <pause dur="0.6"/> New Zealand not the first country that one would have <trunc>imme</trunc> immediately thought of in

terms of <pause dur="0.4"/> # setting us an example <pause dur="0.2"/> i mean <pause dur="0.8"/> well it's you know <pause dur="0.4"/> one of our old colonies a relatively small <pause dur="0.2"/> country somewhere in the <pause dur="0.6"/> # southern hemisphere <pause dur="0.4"/> not very <pause dur="0.2"/> high G-D-P hardly any people in it <pause dur="0.7"/> but they'd adopted a an inflation target in <pause dur="0.4"/> nineteen-ninety <pause dur="1.6"/> to be followed by Canada in nineteen-ninety-one <pause dur="1.3"/> so we had them to look look out to <pause dur="0.2"/> in some ways the <pause dur="0.2"/> the <pause dur="0.9"/> # conservative regime which was <pause dur="0.2"/> # <pause dur="0.5"/> in power in <trunc>n</trunc> ninety-two was similar to the regime in New Zealand I-E <pause dur="0.5"/> anti-inflation <pause dur="0.3"/> conservative <kinesic desc="makes quotation mark gesture" iterated="n"/> # <pause dur="0.5"/> thing with a small capital C <pause dur="0.4"/> a small C <pause dur="2.4"/> so that was the background <pause dur="1.2"/><vocal desc="clears throat" iterated="n"/><pause dur="2.4"/> Norman Lamont was then Chancellor of the Exchequer <pause dur="0.7"/><kinesic desc="reveals covered part of transparency" iterated="n"/> and he wrote a letter <pause dur="0.2"/> which i'll just <pause dur="0.3"/> read briefly to you <pause dur="3.2"/> # this letter <pause dur="0.3"/> was to the chairman of the T-S-C <pause dur="0.6"/> # <pause dur="0.6"/> # which is a relatively important <pause dur="0.4"/> lots of lots of policy measures particularly when they're new seem to go through the channel of the T-S-C as we'll <pause dur="0.4"/> see later on as well <pause dur="0.7"/> Lamont's letter anyway says

<reading>i believe we should set ourselves the specific aim <pause dur="0.4"/> of bringing <pause dur="0.2"/> underlying inflation in the <trunc>ar</trunc> U-K <pause dur="0.2"/> measured by the change in retail prices excluding mortgage interest payments <pause dur="0.7"/> down to levels to match the best in Europe <pause dur="0.3"/> to achieve this i believe we need to aim at a rate of inflation <pause dur="0.5"/> in the long term of two per cent or less <pause dur="1.2"/> for the remainder of this Parliament i propose to set ourselves the objective of keeping underlying inflation within in a range <pause dur="0.2"/> of one to four per cent <pause dur="0.7"/> and i believe that by the end of the Parliament we need to be in the lower part of the range</reading> <pause dur="2.3"/> okay now what's what is underlying inflation <pause dur="0.9"/> # who knows well it's R-P-I-X <pause dur="0.3"/> right <pause dur="0.5"/> that's what <pause dur="0.2"/> underlying inflation is commonly known as <pause dur="1.4"/> so this original target <pause dur="0.5"/> then <pause dur="0.7"/> was interpreted as having <pause dur="0.7"/> three components <pause dur="2.5"/><kinesic desc="changes transparency" iterated="y" dur="4"/> # <pause dur="1.2"/> the first component <pause dur="0.3"/> was a range <pause dur="1.7"/> of between one and four per cent <pause dur="0.9"/> until the end of the Parliament <pause dur="2.6"/> the second <trunc>co</trunc> component was in a

sense a modification of that range <pause dur="0.3"/> in other words <pause dur="0.2"/> towards the end of that period they wanted to be <pause dur="0.5"/> in the in the lower half of that I-E only two-and-a-half per cent <pause dur="1.1"/> and then <pause dur="0.2"/> this objective of two per cent in the long term well <pause dur="0.6"/> policy makers like the Bank of England <pause dur="0.3"/> ignored that basically <pause dur="0.6"/> ignored it i don't not entirely <pause dur="0.3"/> clear <pause dur="0.3"/> # under what grounds they ignored it but they did <pause dur="3.4"/> now <pause dur="0.5"/><vocal desc="clears throat" iterated="n"/><pause dur="0.3"/> at this stage <pause dur="0.5"/> the interest rate decisions I-E <pause dur="0.5"/> you know <pause dur="0.3"/> what what interest rates were actually going to be set at every month <pause dur="0.5"/> was were made by the Chancellor <pause dur="1.6"/> and <pause dur="0.3"/> really <pause dur="0.6"/> in a strange way the new policy framework <pause dur="0.3"/> merely <pause dur="0.2"/> formalized what had gone on before <pause dur="0.6"/> because the Chancellor made interest rate decisions beforehand <pause dur="0.4"/> and it also <pause dur="0.5"/> the same as now <pause dur="0.3"/> was advised by <pause dur="0.3"/> the Governor of the Bank of England every every <pause dur="0.3"/> month <pause dur="0.3"/> they would have meetings at the Treasury <pause dur="0.7"/> where the government Governor would say <pause dur="0.3"/> well i think interest rates

should be set at <pause dur="0.5"/> so much per cent <pause dur="0.5"/> because <pause dur="0.2"/> economic conditions are such that <pause dur="0.5"/> and he would elaborate on the economic conditions <pause dur="1.4"/> and the Governor himself looking at it from the Bank of England's perspective <pause dur="0.3"/> he was advised on what to say by <pause dur="0.9"/> what was then known as the Monetary Review Committee <pause dur="1.3"/> # it was just a monthly meeting of experts of economists <pause dur="0.4"/> and the Bank of England <pause dur="0.7"/> # <pause dur="1.0"/> okay <trunc>w</trunc> so once once <pause dur="0.2"/> once the Governor had met the Chancellor <pause dur="0.5"/> in fact the Chancellor gave instructions to the Governor <pause dur="0.2"/> as to what level of to set interest rate interest rates <pause dur="0.2"/> and the Bank would operate in the money markets <pause dur="0.6"/> to set those rates <pause dur="1.6"/> so <pause dur="0.9"/> the Governor-Chancellor meetings had gone on beforehand <pause dur="0.2"/> really what this entailed was <pause dur="0.4"/> an admission to the press that they had <unclear>#</unclear> because previously they tried to keep them a bit secret <pause dur="0.4"/> i mean no information about them used to be released <pause dur="1.7"/> # <pause dur="0.2"/> they were formalized <pause dur="0.8"/><vocal desc="clears throat" iterated="n"/><pause dur="0.6"/> obviously now under this regime there was no targets for the exchange

rates <pause dur="0.3"/> nor were there any <pause dur="0.2"/> money money growth or money supply targets <pause dur="0.3"/> which we'd seen previously in the nineteen-eighties <pause dur="0.5"/> they <pause dur="0.3"/> did have monitoring ranges but really <pause dur="0.4"/> the monitoring ranges were almost <pause dur="0.3"/> ineffective because no nothing had to happen if the monitoring ranges were <pause dur="0.4"/> exceeded <pause dur="5.0"/><kinesic desc="puts on transparency" iterated="n"/> so <pause dur="0.3"/> why an inflation target then well apart from the fact that we needed something <pause dur="0.2"/> we no longer had the E-R-M and we needed something to turn to <pause dur="1.6"/> there was # a reasonably well founded view <pause dur="1.1"/> that <pause dur="1.0"/> money aggregates <pause dur="0.4"/> # <pause dur="0.2"/> and exchange rates <pause dur="0.3"/> were <pause dur="0.8"/> okay <pause dur="0.7"/> in themselves but <pause dur="0.3"/> were only part of the full picture <pause dur="1.0"/> i mean if you think of it as <pause dur="0.3"/> as to what information is important for monetary policy <pause dur="0.5"/> monetary policy <pause dur="0.7"/> # with a <trunc>cup</trunc> with an aim of affecting inflation in the long run <pause dur="1.2"/> money is one thing the exchange rate is another thing <pause dur="0.3"/> but there are so many other <pause dur="0.4"/> items that one could look at in the economy like price surveys

price expectation surveys <pause dur="0.4"/> like <pause dur="0.2"/> the unemployment rate like output like retail sales <pause dur="0.9"/> all the things one sees analysed in the newspapers <pause dur="0.3"/> which affects how the economy's <pause dur="0.3"/> heading or how we think the economy's <pause dur="0.3"/> going to look like in the future <pause dur="3.9"/> now <pause dur="0.3"/><vocal desc="clears throat" iterated="n"/><pause dur="2.1"/> what do <pause dur="2.3"/> what does policy look like now <pause dur="1.3"/> well i'm going to jump a little bit <pause dur="0.6"/> # i'm going to come back to talk about the inflation target <pause dur="0.6"/> # <pause dur="0.6"/> forecast later on on the inflation report <pause dur="0.4"/> but <pause dur="0.4"/> to # pre-empt that <pause dur="0.4"/><kinesic desc="changes transparency" iterated="y" dur="6"/> one of the <pause dur="0.2"/><vocal desc="clears throat" iterated="n"/><pause dur="1.0"/> main <pause dur="0.4"/> aspects of the inflation report <pause dur="1.0"/> is this <pause dur="3.4"/> <unclear>between</unclear> <pause dur="1.2"/> no <gap reason="inaudible" extent="1 sec"/><pause dur="0.2"/> this is the <pause dur="0.9"/> actually the forecast from August ninety-seven <pause dur="3.7"/> and right from when the inflation report <pause dur="0.2"/> was first published <pause dur="3.1"/> we # the Bank published a picture of what it thought <pause dur="0.2"/> inflation was going to look like in <pause dur="1.3"/> a number of years' time <pause dur="1.6"/> in doing so <pause dur="0.2"/> the Bank had to choose <pause dur="0.9"/> an inflation horizon <pause dur="0.3"/>

because remember what inflation remember <trunc>d</trunc> <pause dur="0.2"/> what the inflation target looks like <pause dur="0.5"/> the inflation target <pause dur="0.3"/> at that time although it's changed a bit <pause dur="0.6"/> looked like <pause dur="0.5"/> you've got to achieve inflation of <pause dur="0.2"/> between one and four per cent <pause dur="0.5"/> and <pause dur="0.2"/> below two-and-a-half per cent over a number of years <pause dur="2.6"/> there are several things the Bank could have done <pause dur="0.2"/> in terms of trying to meet that <pause dur="0.2"/> meet that # target <pause dur="1.5"/> it could have looked at inflation now <pause dur="0.7"/> and said <pause dur="0.4"/> look inflation now is <pause dur="0.3"/> # four per cent <pause dur="0.7"/> as it was at that time roughly <pause dur="0.2"/> four or five per cent <pause dur="1.7"/> us trying to meet an inflation target of two-and-a-half per cent of the <trunc>l</trunc> <pause dur="0.8"/> means that obviously inflation's too high we've got to try and bring it down so we need to raise interest rates <pause dur="2.4"/> but the Bank <pause dur="0.5"/> and <pause dur="0.3"/> any monetary policy person will tell you that that's <pause dur="0.2"/> that's wrong <pause dur="1.3"/> that's wrong because <pause dur="0.4"/> the Bank raising interest rates <pause dur="0.4"/> has no effect on inflation now <pause dur="0.5"/> it can't <pause dur="0.5"/> i mean inflation now is already in the system <pause dur="0.6"/> and interest rates <pause dur="0.7"/> if you think of <pause dur="0.2"/> almost a

tree <pause dur="0.7"/> # <pause dur="0.2"/> interest rates are are right at the root of <pause dur="0.2"/> or the root of the tree <pause dur="0.9"/> at the end you've got inflation inflation's an outcome <pause dur="0.7"/> it takes <pause dur="1.6"/> a long time <pause dur="0.4"/> for interest rates to have an effect <pause dur="0.2"/> working right the way through the economy <pause dur="0.3"/> to affect inflation <pause dur="0.6"/> so looking at inflation now <pause dur="0.2"/> and basing interest rates decisions on that <pause dur="0.7"/> would have been <pause dur="0.2"/> incorrect because <pause dur="1.0"/> it well one just <pause dur="0.2"/> almost doesn't know what the effect of interest rate decisions now <pause dur="0.6"/> would be one doesn't know <pause dur="0.8"/> very <trunc>clear</trunc> the lags between the changes in monetary policy I-E changes in interest rates <pause dur="0.5"/> and final outcomes are notoriously <pause dur="0.7"/> long and variable now Milton Friedman <pause dur="0.2"/> i think was the first person to coin <pause dur="0.4"/> the <pause dur="0.5"/> long and variable lags in relation to monetary policy <pause dur="2.3"/> you change your <trunc>tr</trunc> interest rates now sometime in the future <pause dur="0.4"/> through <trunc>mil</trunc> Milton Friedman's black box or through whatever <pause dur="0.8"/> you're going to affect output and inflation <pause dur="0.3"/> and the whole the <unclear>rent</unclear> economy and the money <pause dur="2.8"/> so instead of

looking at inflation now <pause dur="0.2"/> the Bank obviously had to look at inflation in the future <pause dur="0.6"/> but unfortunately that that means <pause dur="0.3"/> that the Bank has to try and forecast <pause dur="2.5"/> to an insider in the Bank of England the Bank <pause dur="0.3"/> having to place a huge amount of emphasis on a forecast was actually quite funny <pause dur="1.1"/> because Mervyn King <pause dur="0.9"/> who had been a professor at the L-S-E and who'd # <pause dur="0.2"/> been brought in <pause dur="0.3"/> really with a history in terms of <pause dur="0.6"/> # <pause dur="0.4"/> almost <pause dur="0.4"/> # corporate economics <pause dur="0.4"/> the economics of the firm <pause dur="0.4"/> he's famous for Kay and King about the tax system <pause dur="0.3"/> he's he's a brilliant microeconomist <pause dur="0.3"/> he'd for some reason been brought in as the Bank of England's Chief Economist <pause dur="0.5"/> who <pause dur="0.2"/> you normally think of as a macroeconomist <pause dur="1.6"/> he he not being a macroeconomist <pause dur="0.2"/> had a very very dim view of macroeconomics in general <pause dur="0.7"/> and of economic forecasting in particular <pause dur="1.3"/> he disliked <pause dur="0.3"/> the large macroeconomic models that were current <pause dur="0.4"/> at that time <pause dur="0.4"/> and those macroeconomic models were really <pause dur="0.6"/> at that time the things that would have been <pause dur="0.5"/>

used to produce a forecast <pause dur="0.2"/> there's no other way <pause dur="0.3"/> that the Bank of England <pause dur="0.2"/> at that time would have produced a forecast they would have <pause dur="0.5"/> churned through the current situation in their model <pause dur="0.3"/> and got and one of the model would predict inflation would be in two years' time <pause dur="1.3"/> so Mervyn had arrived about two years before <pause dur="0.4"/> they produced this forecast and had <pause dur="0.2"/> almost scrapped the forecasting division <pause dur="1.2"/> so in this <pause dur="0.2"/> in this <pause dur="0.6"/> # situation where we <pause dur="1.2"/> had to produce a forecast we had almost almost # <pause dur="0.3"/> no means of doing so <pause dur="0.8"/> they had to <pause dur="0.3"/> reinvent <pause dur="0.7"/> # <pause dur="0.6"/> a forecasting mechanism quite quickly <pause dur="2.2"/> they did so <trunc>ba</trunc> <pause dur="0.3"/> # by the by by <pause dur="0.6"/> # developing a <pause dur="0.2"/> a much smaller macroeconomic model <pause dur="0.3"/> # they call it a six equation macroeconomic model <pause dur="0.6"/> it's an equation <pause dur="0.3"/> or # a model which is <pause dur="0.4"/> much more based on economic theory <pause dur="0.4"/> like it has a labour market which looks like a labour market you see in economic theory models <pause dur="0.4"/> and so on <pause dur="0.9"/> so it was that that was initially used to generate the forecast <pause dur="2.3"/> in terms of <pause dur="0.2"/> the forecast

horizon <pause dur="0.4"/> right that's where <pause dur="0.2"/> that's the point at which <pause dur="0.3"/> the forecast is made and in this case it's August ninety-seven <pause dur="0.8"/> what the forecast does is look at what inflation's going to look like <pause dur="0.4"/> two years hence <pause dur="1.1"/> so the two year period <pause dur="0.4"/> is important <pause dur="0.3"/> it's what the Bank chose as its best <pause dur="0.7"/> notion <pause dur="0.3"/> of the <pause dur="0.4"/> time horizon of the effect of monetary policy <pause dur="0.5"/> it chooses two years <pause dur="0.3"/> it's important to remember that <pause dur="0.4"/> in choosing those two years what the Bank's saying is <pause dur="0.3"/> if we raise interest rates now <pause dur="0.3"/> we think that that's going to have a maximum effect on inflation <pause dur="0.5"/> in two years' time <pause dur="3.2"/> i'm going to talk about the interpretation of this forecast <pause dur="0.4"/> # a bit more in later lectures <pause dur="0.4"/> but just # <pause dur="0.3"/> to give you an idea <pause dur="0.4"/> these <pause dur="0.5"/> # <pause dur="1.2"/><kinesic desc="indicates point on transparency" iterated="n"/> these bands <pause dur="0.5"/> are for those anyone who did stats last year they're confidence intervals <pause dur="0.2"/> right <pause dur="0.6"/> the middle <pause dur="0.3"/> point <pause dur="0.7"/> is <pause dur="1.2"/> the ten per cent <pause dur="0.2"/> region <pause dur="0.3"/> where inflation is most likely to be <pause dur="0.5"/> and it goes out in ten per cent <pause dur="0.5"/> intervals all the way so <pause dur="0.3"/><kinesic desc="indicates point on transparency" iterated="n"/> this region <pause dur="0.2"/> between

here and here it <unclear>would be</unclear> <pause dur="0.4"/> <gap reason="inaudible" extent="1 sec"/> <pause dur="0.2"/> twenty per cent <pause dur="0.3"/> here <pause dur="0.5"/> at the most these would be thirty and so on to ninety <pause dur="5.5"/> the forecast is a bit odd <pause dur="0.4"/> to be honest <pause dur="0.7"/> because <pause dur="0.4"/> like any forecast it's influenced by judgement <pause dur="1.4"/> you can turn out <pause dur="0.3"/> a forecast from a model but that isn't <pause dur="0.8"/> this it forecast <pause dur="0.2"/> now and even <pause dur="0.2"/> initially <pause dur="0.7"/> wasn't entirely model driven <pause dur="0.4"/> it has some judgement incorporated in it which i want to talk about <pause dur="0.6"/> a bit later <pause dur="2.6"/> so <pause dur="0.4"/> what we had now as a centrepiece for <pause dur="0.5"/> # monetary policy making <pause dur="0.3"/> is this inflation forecast <pause dur="3.0"/><kinesic desc="changes transparency" iterated="y" dur="2"/> an inflation forecast <pause dur="0.3"/> really now <pause dur="0.2"/> now forms <pause dur="2.3"/> the intermediate target <pause dur="2.9"/> intermediate target <pause dur="0.3"/> okay <pause dur="0.2"/> we have a final target of inflation <pause dur="1.8"/> we can't affect inflation directly <pause dur="0.2"/> we need a means of doing so <pause dur="0.5"/> and that means is the intermediate target <pause dur="0.5"/> previous intermediate targets just <pause dur="0.3"/> # <pause dur="0.5"/> so you get the idea where the exchange rate under the E-R-M <pause dur="0.4"/> and money <pause dur="0.4"/> supply <pause dur="0.3"/> under money <pause dur="0.2"/> <trunc>mon</trunc> money target in the nineteen-eighties <pause dur="2.7"/> so <pause dur="1.3"/> as Mervyn <pause dur="0.2"/> King wrote <pause dur="0.3"/> quite early

on <pause dur="0.5"/> <reading>the most appropriate guide to monetary policy is the best obtainable forecast <pause dur="0.3"/> of the probability distribution</reading> <pause dur="0.2"/> which is those <pause dur="0.4"/> kind of bands that i showed you <pause dur="0.5"/> for inflation <pause dur="0.3"/> <reading>over a time horizon defined by how long it takes # for a change in monetary policy to affect inflation <pause dur="1.2"/> and monetary policy is to be adjusted to maximize the probability <pause dur="0.5"/> of hitting the inflation target range</reading> <pause dur="1.1"/> in two years' time <pause dur="2.6"/> <vocal desc="clears throat" iterated="n"/><pause dur="0.3"/> so that was the situation <pause dur="0.2"/> right from nineteen-ninety-two <pause dur="0.7"/> some changes have taken place since then <pause dur="1.0"/> in particular <pause dur="1.7"/> a small change but a meaningful one <pause dur="0.3"/> in nineteen-ninety-three <pause dur="0.7"/> was that the Bank of England was given discretion <pause dur="0.4"/> over the timing of interest rate changes <pause dur="1.8"/> now what does that mean <pause dur="0.3"/> well it means <pause dur="0.8"/> not it means that the Bank was no longer constrained to make that change immediately after the Governor-Chancellor meeting <pause dur="0.2"/> it can

make it any time before the next meeting <pause dur="0.9"/> and the point of this <pause dur="0.3"/> it was it was actually <trunc>ins</trunc> <trunc>ins</trunc> <pause dur="0.2"/> instituted <pause dur="0.6"/> immediately after there'd been a furore in the press <pause dur="0.8"/> about the timing of interest rate changes from in relation to some <pause dur="0.3"/> local government elections <pause dur="0.4"/> the Governor <pause dur="0.4"/> was charged <pause dur="0.4"/> with or it it was it was claimed that the <pause dur="0.3"/> Chancellor had decided not to raise interest rates <pause dur="1.0"/> <trunc>speci</trunc> or and <pause dur="0.3"/> change the timing of interest rates specifically so they wouldn't rise just before some local government elections <pause dur="0.9"/> so that was relatively minor but it meant that the Bank could only change them within a month <pause dur="1.6"/> in fact <pause dur="0.5"/> # <pause dur="0.3"/> the markets get very jittery <pause dur="0.7"/> unless you tell them <pause dur="0.2"/> what the interest rate decision is <pause dur="0.7"/> # almost immediately after the meeting they start <pause dur="0.7"/> # <pause dur="0.6"/> they start their animal spirits going to quote Keynes' phrase <pause dur="0.6"/> and # <pause dur="0.3"/> get rather panicky if volatility rises so they have to really <pause dur="0.4"/> make the changes really soon after a meeting <pause dur="3.1"/> the next change was in <pause dur="0.2"/>

April ninety-four <pause dur="1.0"/> this Treasury Select Committee the representatives of <pause dur="0.2"/> the House of Parliament <pause dur="0.2"/> had recommended that <pause dur="1.0"/> # <pause dur="0.4"/> really they <trunc>sh</trunc> the Bank should be more open <pause dur="0.3"/> they should they should be more open about monetary policy <pause dur="1.8"/> and they should publish the minutes of the Governor-Chancellor meeting <pause dur="0.5"/> and they did so in ninety-four <pause dur="0.9"/> with a six week delay <pause dur="0.7"/> now previously <pause dur="0.8"/> interest rate decisions <pause dur="0.6"/> had not been made secret until after the <pause dur="0.4"/> # thirty year rule <pause dur="0.2"/> for <pause dur="0.2"/> for # not being made public until after the thirty year rule <pause dur="0.3"/> because they were regarded as secret <pause dur="1.5"/> okay so <pause dur="0.2"/> this was a big improvement in terms of transparency <pause dur="0.3"/> in terms of the openness of decisions <pause dur="3.3"/> the first <pause dur="0.3"/> then major <pause dur="0.2"/> restatement of the <pause dur="0.2"/> of the inflation target came in <pause dur="0.3"/> ninety-five <pause dur="2.1"/><kinesic desc="puts on transparency" iterated="n"/> now the Mansion House speech is worth looking out for <pause dur="0.5"/> # <pause dur="0.4"/> it's <pause dur="0.4"/> is often <pause dur="0.2"/> a scene for <pause dur="0.8"/> # the announcements of large policy changes and it certainly was in ninety-five <pause dur="1.4"/><vocal desc="clears throat" iterated="n"/><pause dur="0.4"/> because <pause dur="0.6"/> the target was redefined <pause dur="0.4"/> as two-point-five per cent or less <pause dur="0.5"/> by spring

ninety-seven <pause dur="0.2"/> and beyond <pause dur="3.0"/> really what this involved was a change of emphasis <pause dur="0.5"/> remember the first thing that had been said in the previous <pause dur="0.3"/> incarnation of the target <pause dur="0.3"/> that was really the range of one to four per cent <pause dur="1.6"/> now <pause dur="0.2"/> in order to <pause dur="0.5"/> # i guess show that <pause dur="0.2"/> that hadn't been a mistake <pause dur="0.2"/> it was just <pause dur="0.6"/> # <pause dur="0.5"/> it was it that it hadn't been a <trunc>s</trunc> mistake to say one to four per cent <pause dur="0.3"/> the Chancellor predicted that keeping inflation <pause dur="0.4"/> at about <pause dur="0.3"/> two-and-a-half per cent or less <pause dur="0.4"/> meant that inflation was going to range <pause dur="0.2"/> between one and four per cent <pause dur="0.4"/> over the long term <pause dur="1.0"/> okay <pause dur="0.6"/> it's important that <trunc>y</trunc> that you understand <pause dur="0.4"/> a bit about how the Bank works the Bank <pause dur="0.9"/> the Bank doesn't like to lose face so it didn't want to admit that it was wrong in setting one to four per cent range <pause dur="0.9"/> it <pause dur="0.4"/> it kind of restated it <pause dur="0.4"/> putting much more of the emphasis on the mid-point <pause dur="0.2"/> the two-and-a-half per cent <pause dur="0.5"/> although it added the caveat or less <pause dur="1.7"/> but keep it really almost scrapping the range just <pause dur="0.9"/> keeping it as a almost a

sideline <pause dur="3.0"/> there are still questions a bit about the horizon <pause dur="0.5"/> i mean if you think about what the Bank's trying to do <pause dur="3.2"/> achieving an interest rate # an inflation rate <pause dur="0.2"/> of any given per cent <pause dur="1.0"/> is possible <pause dur="1.8"/> say if you want to if you say if you want to move from four per cent to two-and-a-half per cent <pause dur="1.7"/> that's obviously going to take some changes in interest rates <pause dur="0.9"/> if you pushed interest rates up to say fifteen per cent <pause dur="0.4"/> it's much more likely that you're going to get to two-and-a-half per cent quicker <pause dur="0.4"/> than if you pushed inflation <trunc>in</trunc> interest rates to nine per cent <pause dur="1.6"/> okay <pause dur="0.4"/> so you've got questions about the time horizon for policy <pause dur="1.3"/> does policy <pause dur="0.3"/> need to get there quicker <pause dur="0.6"/> or <pause dur="0.6"/> # <pause dur="0.3"/> can we move more slowly <pause dur="0.2"/> and more gently <pause dur="2.0"/> it's quite likely that there's some sort of trade-off <pause dur="0.4"/> in the sense that if you raise interest rates really high <pause dur="0.6"/> you're going to lose <pause dur="0.2"/> more output <pause dur="0.3"/> there's more likely to be a recession <pause dur="0.4"/> the faster <pause dur="0.2"/> monetary policy moves <pause dur="1.0"/> so the time horizon <pause dur="0.3"/> over which <pause dur="0.7"/> you have to

achieve the target <pause dur="0.2"/> is really important <pause dur="0.5"/> can i leave it <pause dur="0.3"/> two years before i get two-and-a-half per cent <pause dur="1.3"/> Mervyn King interpreted this horizon to be over a long period <pause dur="0.5"/> and indeed <pause dur="0.6"/> often the word on average over a long period <pause dur="0.2"/> was used <pause dur="3.1"/> okay interest rate decisions at that time still taken by the Chancellor <pause dur="2.2"/> the Labour government <pause dur="2.7"/> changed all that <pause dur="5.2"/><kinesic desc="writes on transparency" iterated="n"/> after only four days in office <pause dur="0.7"/> shocking <pause dur="0.6"/> # not <pause dur="0.3"/> well shocking the press shocking the country <pause dur="0.6"/> and shocking the Bank of England itself <pause dur="1.8"/> Gordon Brown announced that they'd be independent <pause dur="0.9"/> i mean this is this is really a quite a surprise <pause dur="1.0"/> the Bank does have discussions with <pause dur="0.3"/> the opposition <pause dur="0.8"/> # <pause dur="0.3"/> but i'm sure that even they didn't expect <pause dur="0.6"/> to have that <pause dur="0.5"/> presented to them quite so quickly <pause dur="2.7"/> this is the current framework <pause dur="1.7"/> the Bank has what's known as operational responsibility for interest rates <pause dur="1.7"/> what does that mean well it's it has one form of independence it has operational independence <pause dur="6.1"/><kinesic desc="writes on transparency" iterated="n"/>

it has to <pause dur="0.2"/> set interest rates <pause dur="0.5"/> and it can decide what interest rates <pause dur="0.2"/> it wants to set <pause dur="1.2"/> but it has to set them conditional <pause dur="0.3"/> on its <trunc>expaysh</trunc> <trunc>ec</trunc> its expectation that they're going to be consistent with <pause dur="0.4"/> the government's inflation target <pause dur="8.0"/><kinesic desc="writes on transparency" iterated="y" dur="8"/> now if the Bank <pause dur="0.4"/> had the possibility of setting the target as well <pause dur="1.8"/> it would be goal independent <pause dur="1.2"/> but it doesn't <pause dur="0.5"/> so it just has <pause dur="0.3"/> operational independence it can decide what <pause dur="0.3"/> what level to set the <pause dur="0.6"/> # <pause dur="0.5"/> interest rates at but it can't decide <pause dur="0.3"/> what it's aiming at <pause dur="4.0"/> the other new thing <pause dur="0.3"/> is <pause dur="0.2"/> that <pause dur="0.7"/> # <pause dur="1.2"/> in addition to the independence <pause dur="1.3"/> the Bank was not required simply <pause dur="0.3"/> to <pause dur="0.6"/> follow an inflation target <pause dur="0.9"/> but subject to that target it was required to <pause dur="0.7"/> # <pause dur="0.2"/> promote growth <pause dur="0.2"/> promote growth and finance basically <pause dur="2.0"/> there was also a restatement of the form of the target <pause dur="1.3"/><kinesic desc="writes on board" iterated="n"/> okay <pause dur="0.2"/> that two-and-a-half per cent <pause dur="0.5"/> is contrasted with the two-and-a-half per cent or less <pause dur="0.2"/> that was the <pause dur="0.3"/> # <pause dur="0.4"/> previous <pause dur="0.8"/> inflation target for the nation <pause dur="1.0"/> what's the difference here <pause dur="0.9"/>

well two-and-a-half per cent is basically <pause dur="0.6"/> just a single point <pause dur="0.7"/> what you had before <pause dur="1.5"/> was <pause dur="0.3"/> two-and-a-half per cent <pause dur="1.6"/><kinesic desc="writes on board" iterated="y" dur="2"/> or less in other words you could go lower <pause dur="2.1"/> Labour <pause dur="0.7"/> being slightly <pause dur="0.3"/> more pro-growth <pause dur="0.2"/> than the Conservatives <pause dur="0.3"/> thought it very important that the or less was scrapped <pause dur="0.4"/> why was that <pause dur="0.4"/> because it <pause dur="0.3"/> thought that if the Bank <pause dur="0.5"/> was run by someone who was very very hawkish <pause dur="0.4"/> and very very risk-averse <pause dur="0.5"/> the Bank would know <pause dur="0.4"/> that <pause dur="0.3"/> they couldn't go above two-and-a-half per cent but they could definitely go below and they'd still get a tick they'd still get a gold star for achieving their objective <pause dur="0.8"/> so hence they could actually <pause dur="0.2"/> the Bank under previous policy <pause dur="0.4"/> could actually <pause dur="7.4"/><kinesic desc="writes on board" iterated="y" dur="6"/> could actually # have a much more deflatory policy than was actually good for the country <pause dur="1.6"/> so just <kinesic desc="indicates point on transparency" iterated="n"/> this point target without the or less <pause dur="0.2"/> which is the current target <pause dur="0.3"/> is symmetric <pause dur="0.2"/> so the Bank has the same incentive to go above as it does below <pause dur="2.4"/> it's not commonly stated these days

but <pause dur="0.5"/> a year ago <pause dur="0.8"/> there # quite a lot was made of <pause dur="1.0"/> # <pause dur="0.3"/> this <kinesic desc="writes on board" iterated="n"/><kinesic desc="indicates point on transparency" iterated="n"/> one percentage point higher or lower <pause dur="0.6"/> than the target <pause dur="0.4"/> so that's <pause dur="0.2"/> one-and-a-half to three <pause dur="0.2"/> three-and-a-half per cent <pause dur="1.2"/> if <pause dur="0.2"/> those limits are exceeded <pause dur="1.6"/> if inflation <pause dur="0.4"/> range is <pause dur="0.2"/> between one per cent <pause dur="0.3"/> higher or lower than target <pause dur="0.3"/> the <reading>Bank has to publish an open letter</reading><pause dur="1.5"/> supposedly to the Chancellor <reading>explaining why inflation has deviated from the target and what action it intends to take</reading> <pause dur="2.9"/> that's <pause dur="0.2"/> # <pause dur="0.4"/> that's a really interesting move <pause dur="0.3"/> and potentially <pause dur="0.2"/> highly embarrassing <pause dur="0.9"/> as Mervyn King <pause dur="1.0"/> now <pause dur="0.4"/> as <trunc>mer</trunc> Mervyn King reckons that this measure is quite likely to as he put it <pause dur="0.3"/> restore the lost art of letter writing <pause dur="0.2"/> to the British <pause dur="0.7"/> # <pause dur="0.8"/> people <pause dur="0.9"/> because he reckons it's actually quite <pause dur="0.2"/> likely <pause dur="0.5"/> that the inflation target's going <pause dur="0.3"/> # that inflation is going to be three-and-a-half <pause dur="0.2"/> more than three-and-a-half or less than one-and-a-half per cent <pause dur="1.2"/> so far it hasn't happened <pause dur="0.2"/> remarkably <pause dur="1.8"/> # <pause dur="0.5"/> but if it did then the Bank would actually have to <pause dur="0.9"/> set out several things in

a letter <pause dur="0.4"/> the way it's interpreted <pause dur="0.2"/><kinesic desc="indicates point on transparency" iterated="n"/> this requirement <pause dur="0.5"/> is that the Bank is going to have to say <pause dur="0.4"/> why <pause dur="0.2"/> inflation has gone higher than the <pause dur="0.3"/> this <pause dur="0.2"/> this range <pause dur="0.7"/> in other words <pause dur="0.3"/> what specific shock to the economy <pause dur="0.5"/> it could be an exchange rate shock <pause dur="0.4"/> it could be <pause dur="1.0"/> # <pause dur="0.2"/> really that's that's the main thing that's going to happen an exchange rate shock <pause dur="1.2"/> that left <pause dur="0.4"/> us <pause dur="0.4"/> really <pause dur="1.7"/> unable to keep inflation within the one one-and-a-half to three-and-a-half per cent <pause dur="0.4"/> band <pause dur="0.2"/> if you like to call it that <pause dur="2.1"/> and also the Bank has to say <pause dur="0.2"/> how long it's going to be before it reckons inflation's going to get back within the target <pause dur="0.5"/> # range <pause dur="1.5"/> but one one thing you've got to <pause dur="0.8"/> i guess be aware about this this little one per cent either side <pause dur="0.6"/> aspect is that they no longer call it a range it's not like the original one to four per cent <pause dur="1.3"/> it's supposedly just <pause dur="1.0"/> just a way of monitoring <pause dur="0.4"/> # <pause dur="0.2"/> the specifics of what the Bank actually does it's it's not it's not part of the target the target is actually regarded as

two-and-a-half per cent <pause dur="0.9"/> it's not like the Bank is going to be <pause dur="0.4"/> excessively penalized <pause dur="0.5"/> it's not going to be regarded as failing <pause dur="0.4"/> in other words <pause dur="0.4"/> if it exceeds <pause dur="0.2"/> one-and-a-half <pause dur="0.3"/> per cent or three-and-a-half per cent <pause dur="0.3"/> it's just that it has to explain why <pause dur="2.6"/> so really there are no <pause dur="0.3"/> there are no actual limits <pause dur="0.4"/> to how far inflation goes <pause dur="0.5"/> above two-and-a-half <pause dur="0.4"/> or below two-and-a-half <pause dur="2.7"/><kinesic desc="changes transparency" iterated="y" dur="5"/> which is different <pause dur="2.9"/> an important thing about the new <pause dur="0.5"/> regime <pause dur="0.2"/> is that <pause dur="0.2"/> it formalized <pause dur="2.4"/> how the inflation targets came to be renewed <pause dur="1.4"/> previously there'd just been the odd statement of what the target was <pause dur="0.4"/> but now it's institutionalized that every budget <pause dur="0.5"/> which occurs in <pause dur="0.6"/> November every budget you're going to have a restatement of the target <pause dur="0.6"/> but there was <pause dur="0.3"/> you know addendum that the there was no expectation that the two-and-a-half per cent will remain in force

for at least the current current Parliament <pause dur="0.7"/> so you can expect <pause dur="0.3"/> every government to come in will make a major restatement of the target <pause dur="1.5"/> and then will <pause dur="0.3"/> will carry on through that Parliament <pause dur="3.0"/> in extreme circumstances the Treasury is allowed to overrule the Bank <pause dur="0.2"/> but those extreme circumstances what would they be like <pause dur="0.2"/> well they'd be like a war <pause dur="0.5"/> like a major crash on European stock markets <pause dur="0.6"/> maybe something like that <pause dur="6.0"/><kinesic desc="reveals covered part of transparency" iterated="n"/> okay <pause dur="0.4"/> now some institutional things had to change at the Bank obviously <pause dur="0.3"/> 'cause the Bank was now <pause dur="0.6"/> # given the task of setting interest rates itself it could decide what level of interest rates to set <pause dur="0.8"/> the Bank's not <pause dur="0.2"/> the Bank is a public <pause dur="0.6"/> is a public institution it's not privately owned <pause dur="0.3"/> but there was a need to control what the Bank did to monitor it <pause dur="0.3"/> to make it accountable <pause dur="0.7"/> and it <trunc>wa</trunc> that was done in various ways <pause dur="0.6"/> one way in particular <pause dur="0.4"/> was the setting up of the Monetary Policy

Committee <pause dur="1.6"/> now <pause dur="0.8"/> this <pause dur="0.7"/> is a bit it it kind of parallels the Governor-Chancellor <pause dur="0.4"/> # <pause dur="1.2"/> meetings <pause dur="0.2"/><kinesic desc="writes on transparency" iterated="n"/> in the sense that <pause dur="0.2"/> there are four people on it <pause dur="0.4"/><kinesic desc="writes on transparency" iterated="y" dur="6"/> who are appointed <pause dur="2.8"/> by the Chancellor <pause dur="2.8"/> and those people are supposed to be <pause dur="0.2"/> experts <pause dur="0.3"/> in fact they're all economists of one sort <pause dur="0.9"/> Willem Buiter <pause dur="0.3"/> is i think still possibly on leave from Cambridge University <pause dur="0.4"/> Charles Goodhart from the L-S-E <pause dur="0.2"/> and he used to be <pause dur="0.2"/> Chief Economist at the Bank of England <pause dur="0.2"/> <unclear>#</unclear> <pause dur="0.7"/> DeAnne Julius <pause dur="0.2"/> is the <pause dur="1.7"/> honorary female on the committee <pause dur="0.6"/><vocal desc="laughter" iterated="y" n="ss" dur="1"/> she used to be <pause dur="0.6"/> she used to be at British <pause dur="0.2"/> Airways i think <pause dur="0.6"/> and <pause dur="1.1"/> she's supposed to be the industry representative on the committee <pause dur="1.1"/> and Sir Alan Budd is an old mate of <pause dur="0.2"/> Mervyn King's <pause dur="0.3"/> he's from the Treasury he was the <pause dur="0.2"/> # <pause dur="0.3"/> Treasury <pause dur="0.5"/> Chief Economist under <pause dur="0.2"/> the previous government <pause dur="2.5"/> so they all know each other pretty well <pause dur="0.3"/> and to call them employments of the Chancellor is stretching it a bit because <pause dur="0.2"/> well i mean <pause dur="0.3"/> you know <pause dur="1.0"/> anyway as well as them <pause dur="0.3"/><vocal desc="laughter" iterated="y" n="ss" dur="1"/> there's

Eddie George the Governor <pause dur="1.1"/> the two Deputy Governors <pause dur="0.8"/> Clementi was appointed from the City <pause dur="0.3"/> and his responsibility <pause dur="0.2"/> is to look after <pause dur="0.9"/> really the markets <pause dur="0.4"/> the Bank can be divided into two <pause dur="0.3"/> you've got the <trunc>m</trunc> people who make monetary policy <pause dur="0.3"/> and the people who deal with the markets <pause dur="0.4"/> and the two are often at loggerheads <pause dur="0.4"/> so you've got these two Deputy Governors <pause dur="0.3"/><kinesic desc="indicates point on transparency" iterated="n"/> this this chap is going to be <pause dur="0.2"/> be telling the committee <pause dur="0.4"/> what the response of the markets is going to be to any given interest rate decision <pause dur="0.3"/> and obviously that weighs heavily on the what the Bank's going to do <pause dur="0.7"/> Mervyn King used to be Chief Economist <pause dur="0.8"/> # but he's been promoted <pause dur="0.4"/> # he's obviously <pause dur="0.6"/> much more on on the economics side he's on the principal side he's also a <pause dur="0.7"/> eminent <pause dur="1.4"/> and enormously <pause dur="0.4"/> # respected economist <pause dur="0.7"/> Plenderleith again is on the market side Vickers is on the monetary policy side <pause dur="0.3"/> Vickers again <pause dur="0.3"/> is the current Vickers is the current Chief Economist <pause dur="0.3"/> but again a really bizarre appointment <pause dur="0.4"/> because <kinesic desc="indicates point on transparency" iterated="n"/> this chap was from <trunc>ox</trunc>

professor at Oxford University a very <pause dur="0.5"/> bright young professor <pause dur="0.5"/> but what's his what's his # background it's <trunc>noth</trunc> <pause dur="0.2"/> it's not macroeconomics what is it it's game theory <pause dur="1.1"/><vocal desc="laughter" iterated="y" n="ss" dur="1"/> game theory <pause dur="0.4"/> bizarre <pause dur="0.6"/> but he's # again he's <pause dur="0.2"/> he's a very <pause dur="0.2"/> # <pause dur="0.3"/> you know able <pause dur="0.5"/> able person <pause dur="3.2"/> so <pause dur="1.5"/> right so that's the Monetary Policy Committee <pause dur="0.2"/> they meet monthly <pause dur="2.3"/> and again <pause dur="0.8"/> we have the situation that they've made a change which institutionalizes # <pause dur="0.3"/> things that were already happening <pause dur="0.4"/> because remember i told you that <pause dur="0.3"/> every month in the Bank the Monetary Review Committee met <pause dur="0.7"/> that Monetary Review Committee <pause dur="0.3"/> often had an informal vote as to what it thought interest rates should do <pause dur="1.2"/> that's been replaced by <pause dur="0.7"/><kinesic desc="indicates point on transparency" iterated="n"/> these people at the top <pause dur="0.9"/> okay these people at the top <pause dur="0.3"/> but <pause dur="0.3"/> in the same way as they had before <pause dur="0.3"/> these people are advised by <pause dur="0.4"/> the economists in the Bank of England <pause dur="1.0"/> so you've almost got the same thing happening in the Bank you've

still got a load of economists <pause dur="0.3"/> turning out what they think <pause dur="0.2"/> # responding to the <trunc>lat</trunc> <trunc>d</trunc> latest data in the month turning out what they think's going to happen to the economies <pause dur="0.4"/> and advising the people in the Bank <pause dur="0.4"/><kinesic desc="indicates point on transparency" iterated="n"/> even these supposedly <pause dur="0.4"/> external <pause dur="0.3"/> appointed by the Chancellor experts <pause dur="0.3"/> they all have <pause dur="0.5"/> Bank <pause dur="0.5"/> # workers <pause dur="0.8"/> who are advising them as to what to think about the economy <pause dur="1.2"/> so really this was a major move by the Chancellor <pause dur="0.2"/> he's he's <pause dur="0.2"/> given up his right to <pause dur="0.8"/> right to set interest rates <pause dur="0.3"/> and given it almost totally to the Bank who are operating in a very similar system to the what they used to do before <pause dur="2.9"/> right one person one vote the Chancellor <trunc>ha</trunc> the Governor has <pause dur="0.3"/> an overriding vote a second vote if there's <pause dur="0.7"/> a tie <pause dur="0.5"/> then their decision's announced <pause dur="0.2"/> well after one day effectively they meet they the meetings supposedly go on for two days but <pause dur="0.3"/> on the morning of the second <pause dur="0.4"/> they announce their decision <pause dur="2.0"/> okay i'm i'm going to stop there <pause dur="0.5"/> regarding this but <pause dur="0.4"/> can you just # <pause dur="0.6"/> hang on for one minute <pause dur="0.3"/> 'cause i need to set times