Media Briefings

Economic Forecasters Remain Confident In The Bank Of England’s Ability To Control Inflation

  • Published Date: July 2008

When the Bank of England was given operational independence to set monetary
policy in 1997, it quickly gained the credibility to fight inflation and thereby reduced
economic uncertainty. That is the central finding of new research by Dr Gianna
, Dr Jeremy Smith and Professor Kenneth Wallis, published in the July 2008
issue of The Economic Journal.
What’s more, the report shows how, after an initial period in which the Monetary
Policy Committee (MPC) gained credibility, the Bank of England was perceived by
independent forecasters as being more credible than the US Federal Reserve about
its commitment to tackling inflation.
As inflation reaches levels not experienced for several years, the MPC’s credibility to
meet its inflation target will be tested. But this report shows that forecasters still trust
the central bank to tackle inflation. In the Bank’s most recent quarterly survey (May
2008), expected inflation remains within the range experienced over the last
nine years.
The report shows how expected inflation does not respond to actual levels of
inflation but remains close to the Bank of England’s target. This means that the City
(and others) believe that the MPC is committed to fighting inflation. If so, the MPC
may not need to raise interest rates to bring inflation back to its target of 2%.
This is important since if inflation expectations are moderate, then wage claims and
price increases will be less severe than they would otherwise be. So controlling
inflation expectations is crucial to controlling inflation itself.
Since 1996, the Bank of England has carried out a quarterly survey of economic
forecasters from the City and independent think-tanks. This assesses how they think
inflation will develop in the future, and summary results are published in the Bank’s
quarterly Inflation Report.
Because the survey asks respondents for their views on the probability that inflation
will be within a variety of different ranges (for example, between 1% and 1.5%, 1.5%
and 2%, etc.), it can be used to assess uncertainty about future inflation.
The report uses individual responses to the Bank’s survey from 1996-2005. It shows
how the MPC, newly established following Labour’s victory in the May 1997 general
election, quickly obtained credibility.
Figure 1b below shows how the survey average forecast of inflation two years ahead
stayed close to the official inflation target, irrespective of the actual inflation being
experienced at the time the forecast was made. (The inflation variable shown is the
official targeted variable at the time: the retail prices index, RPIX, target 2.5%, until
end-2003; and the consumer prices index, CPI, target 2%, thereafter.)
The new findings and survey-based measures of uncertainty reported in this article
extend the evidence. Figure 2b shows how the uncertainty about inflation prospects
two years ahead was sharply reduced after an initial period of learning and gaining
credibility on the commitment of the MPC, and has been remarkably undisturbed
since the turn of the century.
Comparisons with a similar source of data on US inflation expectations show that,
after this initial credibility-gaining period, UK uncertainty about inflation prospects is
below the US level.
This provides further evidence that ‘inflation targeting has helped to confer tangible
benefits’, as argued by the Governor of the Bank of England in his 2005 Mais
lecture. He cites the falling volatility of expected UK short-term nominal interest rates
over this period, relative to the United States, as evidence that inflation expectations
are better anchored under inflation targeting than they were before.
Although the actual report is based on a period that ends in November 2005, the
figures below use the most recent information available (up to May 2008). They
show no diminution in the forecasters’ confidence in the MPC’s ability to
control inflation.
Over the last seven surveys, up to the survey reported in the May 2008 Inflation
, Figure 2b shows a tendency towards increasing uncertainty, but this remains
within the range experienced over the last nine years.
Notes for editors
: ‘Uncertainty and Disagreement in Economic Prediction: The Bank
of England Survey of External Forecasters’ by Gianna Boero, Jeremy Smith and
Kenneth Wallis is published in the July 2008 issue of The Economic Journal.
The authors are at the University of Warwick
For further information: contact Kenneth Wallis on 024 7652 3026 or 024 7641
4271 (email:; or Romesh Vaitilingam on 07768 661095