nf1139: er [0.4] in the course handout the overview for the whole course [0.6] 
er i included [0.4] er an outline of [0.2] the topics that i'm going to cover 
[1.1] and one of the major components is [0.3] comes under the basic heading 
inflation targetry [0.3] and that's what we're going to start [0.3] almost 
immediately today [1.1] now inflation targetry really [0.3] in my view covers 
[0.8] er [0.7] well basically all of the current macroeconomic monetary policy 
[0.3] er framework [0.2] and policy [0.4] and [0.2] er [0.3] basis in the U-K 
at the moment [0.6] and i think that's really important [0.2] not only because 
[0.3] it's important for the U-K but also the U-K's policy [0.3] has been 
extremely influential throughout the world [0.4] i mean a lot of countries [0.
2] refer to the U-K when they look at [0.2] how they should set out their 
monetary policy [0.4] we've just been very very influential [0.4] that's partly 
as we'll see because we started quite early [0.5] not necessarily through 
design [0.4] but partly through accident of nature [1.2] er so that's going to 
constitute [0.3] er at least half the 
course really discussing inflation targets [0.5] the the current policy regime 
[0.5] arguments for and against the this regime compared to other previous 
regimes [0.6] er [0.4] all of this is really tied in with er top-, topics that 
you may well have covered previously like central bank independence [0.5] just 
so i know [0.2] roughly where to pitch that sort of topic i'd be interested to 
know who did [0.4] ECAP- [0.5] two or the one that's taught by namex last year 
[0.4] can you just stick up your hand if you did that [1.7] okay how many 
people didn't then it's e-, going to be easier [0.2] just a few okay [0.8] okay 
so [0.2] you've already covered topics like central bank independence which 
which is going to be really really useful [0.3] and also hopefully what i'm 
going to say today and in f-, [0.3] er future lectures [0.3] relates to that [1.
3] er [1.1] okay we're al-, also going to talk about [0.3] other [0.2] what you 
[0.3] might think of in principle as general economic issues like [0.4] are 
there costs of inflation [0.5] but really i'm hoping to help you see that [0.3] 
that sort of 
question really underlies the design of policy it should really drive [0.4] er 
[0.7] what policy looks like in the U-K and beyond [1.3] okay [0.3] also once 
we've discussed [0.2] that sort of policy framework issue [0.3] we also are 
going to have to look at how monetary policy actually works [0.5] because we're 
going to move from assessing mo-, we just look at the Bank of England setting 
interest rates through [0.2] to affect policy [0.3] to [0.5] see how that 
actually affects the real the real economy [0.3] to how it how it actually 
affects inflation [0.3] and the paths through which it can act [0.5] because an 
understanding of that [0.6] is going to also influence how we think policy 
should be set up [2.2] then we've finished basically [0.2] that side of 
monetary policy [0.4] and then we move onto [0.2] EMU [0.4] as a topic which it 
i'm sure you're already familiar with but also [0.4] it's obviously of [0.2] 
great relevance today [0.6] er we'll look at the transition to EMU the costs 
and benefits [0.2] that sort of thing [0.3] and then we're going to end up 
talking about [0.5] an issue which has really i guess come to the fore over the 
last year [0.4] with crises in Asia [0.3] in Russia [0.4] and [0.2] you know 
potential
crises beyond that [0.2] in f-, in the financial world this is to do with [0.3] 
stock exchange market volatility [0.6] and exchange rate volatility [0.9] both 
of those [0.4] er [0.3] are potentially endemic problems and problems that [0.
3] at the moment don't look like they're going to wi-, go away [0.7] and also 
presenting real headaches for policy makers in t-, in terms of the designer 
institutions [0.6] are the I-M-F the World Bank current set-up are they 
sufficient to deal with these sorts of [0.4] relatively new problems which seem 
to have [0.4] arisen through [0.2] er the increased capital flows [1.6] now in 
terms of what we expect from you from this course [0.4] i guess Steve probably 
may have already given you [0.2] some idea [0.9] the course tries to tie in 
economic theory quite heavily with er [0.6] policy [0.6] and policy aspects [0.
3] so we will be using theoretical models quite [0.2] well quite a lot as i'm 
sure Steve's already done [0.6] but [0.6] in for example the assessments that 
you've got to do by the end of this term it [0.2] we don't necessarily 
require you to [0.3] er [0.6] be theoretical to use those sort of models [0.6] 
it is possible in this course [0.3] because it's a policy course [0.4] to [0.2] 
provide arguments in a non-mathematical manner [0.8] and for example [0.6] well 
the analysis one sometimes sees in the Economist [0.5] is [0.2] actually a go-, 
e-, e-, good example of economic analysis and that type of [0.4] argument 
although not necessarily potentially using economist language which some people 
[0.5] er don't don't like very much has its problem [0.6] that sort of analysis 
I-E verbal analysis of economic policy and economic theory is perfectly 
adequate [0.8] so i mean don't [0.5] if for those of you who don't like theory 
if i [0.4] put up a model i'm going to try and explain it intuitively [0.8] er 
to try and er to try and ensure that you know maths isn't [0.5] the overriding 
[0.2] er [0.7] thing that's important [2.0] er [0.3] what else to say [0.8] at 
the end of this lecture i'm going to try and finish a bit early so we can 
discuss [0.4] and get volunteers for seminars [0.6] and get times for seminars 
in particular Steve [0.3] Broadberry's 
already given you [0.2] the topics for his [0.2] his first seminar and he needs 
some volunteers for that but i'm going to deal deal with that at the end [2.2] 
right in terms of reading [0.4] you'll see in the handout that i've given for 
week one [0.2] it's relatively unusual in the sense that the reading list is is 
admittedly [0.6] er very long [0.9] but [0.3] er [0.2] one [0.2] you don't have 
to read [0.2] everything [0.5] two [0.4] a lot of the [0.3] er items are very 
very short they're one or two pages [0.3] particularly those published by the 
Bank of England which are descriptive of the current policy framework [1.5] er 
also it's actually quite interesting they are short and y-, really by going 
through them er [0.2] f-, [0.2] the first the first sort of sub-heading i put 
under reading [0.4] is institutional readings [0.4] er [0.7] i should point out 
that a lot of them do cos-, [0.2] contain a sort of assessment of the current 
framework [0.3] but they're in [0.3] inverse chronological order [0.2] so you 
start from the current [0.4] policy regime and go backwards [0.3] and they they 
finish [0.3] really [0.3] i guess at the first change in about nineteen-ninety-
f [0.7] er five [0.2] they should do [2.0] okay so reading those a lot of them 
are available on the web [0.4] on the Internet 'cause the bank [0.2] Bank of 
England's site's very good [0.4] at producing documents on the Internet [0.6] 
i've starred the ones that are most important i've i've only starred three [0.
6] but those three i really really recommend quite highly [0.4] not just for 
this lecture but for all the way through the course there's a Bank of England 
[0.4] what they call a fact sheet on monetary policy in the U-K [0.3] it's just 
a [0.2] a four three or four page [0.7] thing which goes through the policy 
framework [0.3] it actually goes through topics that we're going to be dealing 
with next [0.3] like [0.4] er [0.3] alternatives [0.5] er like the monetary 
aggregates which are alternative [0.2] er [0.3] policy frameworks [0.3] it goes 
through techniques like [0.3] what the Bank actually does in the money markets 
in order to set interest rates [0.5] which we also [0.2] look at and 
it basically gives you an overall [0.5] er picture of [0.3] monetary policy in 
the U-K over the last few years [1.1] the other thing that i really really very 
highly recommend [0.4] is this article by Mervyn King which he [0.5] gave at 
the L-S-E [0.4] last s-, [0.4] er September October i think [0.9] er The 
Inflation Target Five Years On [0.8] and Mervyn King is the chief economi-, 
well is the chief [0.7] used to be the Chief Economist is now Deputy [0.3] 
Governor at the Bank of England [0.4] and [0.2] he writes very well in that [0.
4] this article it's er twenty-something pages long [0.2] it really covers [0.
3] mm you could say maybe the first seven [0.3] or half the course really [0.2] 
all in one paper so [0.3] i really recommend that very highly [1.6] the other 
[0.6] thing i'm [0.2] going to recommend is [0.2] there's a one star next to 
the Bowen article in this book [0.3] now this is a book i recommended right in 
the first reading list Targeting Inflation [0.4] several copies available in 
the S-R-C [0.6] er [0.3] i-, [0.4] the only problem with the book [0.2] is [0.
6] that it's relatively old it's published ninety-five 
or at least it comes from a conference in ninety-five [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 [0.5] relates to [0.4] obviously quite a relatively old version of [0.
2] monetary policy [1.4] the Haldane article on the reading list is is equally 
if not [0.4] is equally good if not better than the Bowen [0.9] now that's from 
the Bank of England Quarterly Bulletin [0.6] just in case you're not aware 
[sniff] [0.3] well i'm going to be recommending a lot of readings from the Bank 
of England Quarterly Bulletin [0.7] the current year is available behind the 
counter in the S-R-C [0.5] previous years are filed with journals [0.9] so [0.
5] everything is reasonably readily acce-, accessible at the moment [0.9] 
[sniff] [0.3] [sniff] [1.6] right [0.5] if there are any questions about that 
[1.3] great okay well let's move straight on to [0.8] looking at the first 
topic then [1.0] inflation targetry [3.9] i'm not sure that i necessarily like 
the [0.4] like the term targetry but it was one [1.2] that [0.2] 
Alex Bowen [0.8] who i guess is quite quite important er figure in the Bank in 
terms of dealing with [0.7] er [0.4] [sniff] inflation targeting [0.4] he was 
one of the first people to [0.6] coin that phrase 
nf1139: now [1.0] the [3.0] inflation targeting in the U-K [0.6] dates from [0.
8] October nineteen-ninety-two [2.8] and although i haven't [0.3] er put 
anything on the handout about the circumstances [0.2] under which inflation 
targeting in the U-K was adopted [0.7] i think they are actually very important 
and also [0.5] you know provide an interesting background [0.4] to what's been 
happening in monetary policy [1.4] the U-K [0.3] left the exchange rate 
mechanism [0.3] on sixteenth of September nineteen-ninety-two [0.4] does anyone 
know what sixteenth September nineteen-ninety-two is known as [0.6] 
ss: Black Wednesday 
nf1139: Black Wednesday yeah [0.9] okay Black Wednesday [0.7] that as you may 
be aware was a [0.6] er dramatic day [0.5] in [0.4] the history of U-K monetary 
policy [1.2] it 
was the day when George Soros [0.2] manage-, manager of a [0.6] er [0.4] of of 
investment fund [0.4] decided that the U-K exchange rate was [0.3] 
unsustainably overvalued [1.0] so he took a massive gamble [0.6] er [0.5] 
virtually i think all of his [0.3] er funds [0.4] d-, er [0.2] numbering 
millions billions of dollars [0.4] was bet [0.4] against the pound [0.6] right 
[0.2] so basically he was er selling pounds [0.3] like mad [0.3] in favour of 
other countries [0.6] that put massive pressure on the U-K exchange rate which 
was currently fixed at [0.4] er [0.3] i think it was three-seventy-five [0.3] 
deutschmarks at that point [1.6] people er Soros was basically betting because 
[0.5] er [0.6] well the U-K currency was relative-, [0.6] relatively 
uncompetitive at that rate and it was wer-, quite well known and had been quite 
well known for a while that that was the case [0.3] but Soros at that point [0.
5] amidst [0.4] instability in general in the currency markets i mean Italy was 
also hit at that at the same time by [0.3] general exchange rate instability [0.
4] Soros took a bet against the U-K currency [1.2] and [0.2] er [0.2] i guess 
one of the 
reasons i'm i'm giving this course is that [0.2] i have a background in central 
banking [0.3] and i was working at the Bank of England at the time [0.9] i 
worked at the Bank of England for five years [0.9] it was just the most [0.3] 
remarkable day [0.3] i've [0.3] well one of the re-, most remarkable days i've 
i've encountered because [0.3] when i arrived at the Bank of England in the 
morning to discover that [0.3] interest rates had been put up [0.3] by three 
per cent already [0.4] and there was [0.4] basically panic in the corridors [0.
3] if one's just a general Bank of England worker there's [0.7] some [0.2] kind 
of [0.2] delay in the flow of information so actually [0.5] one of the people 
in my office got rung up by one of his friends who was a city dealer saying [0.
3] what on earth are you doing with the er interest rate you know if er you've 
just raised it five per cent what wh-, [0.2] what is going on [0.5] what was 
going on [0.3] was that the Bank was having to [0.4] buy pounds [0.4] in [0.2] 
vast quantities [0.5] i mean the Bank reserves i think at the start of that day 
were [0.2] in the 
region of fifty-billion [0.2] pounds [0.6] and we were in serious danger [0.5] 
at the rate of spending of [0.3] pound of of er [0.3] foreign ec-, foreign 
reserves [0.3] that we were having to undertake in order to [0.5] in effect in 
a sense counteract Soros and his cronies [0.5] er of losing all our reserves by 
the end of the day [1.5] now the only strategy that was open to the Bank [0.7] 
rather than selling [0.4] our foreign exchange reserves [0.2] was to put up 
interest rates [1.0] if you put up U-K interest rates obviously [0.2] people 
are going to want to invest [0.3] more [0.2] in the U-K pound because they get 
a higher return [0.6] so just [0.2] price and er [1.0] by demand and supply [0.
2] you'd hope by [0.4] raising the return on pounds people are going to stop 
selling [1.4] it didn't work [0.4] and where do i mean [0.3] how could it work 
we had just had [0.4] a speculator who'd decided i'm going to sell now [1.5] 
and er there's nothing you can do if they sell [0.2] in such large quantities 
[0.5] you've just got almost no time in which to react [0.5] so by twelve 
o'clock it was clear that the [0.2] rate [0.2] of interest 
increase that had happened already we'd [0.4] announced that the markets [0.5] 
that [0.6] we'd actually reset [0.2] minimum lending rate which is [0.6] almost 
an official interest rate which we don't normally set in the Bank of England [0.
4] it was set [1.0] at al-, almost to tell the markets [0.2] we know that we're 
in an emergency situation [0.3] and we we've got to tell you that this is the 
interest rate even if you want to l-, have a lower interest rate [0.3] we're 
going to [0.4] er not allow that we're going to have a higher interest rate [0.
8] so twelve per cent [0.3] we then decided to raise it to fifteen per cent [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 [0.7] we were talking 
in terms of [0.5] twenty per cent even fifty per cent [0.9] interest rates [0.
3] i mean just as a [0.3] almost as a signal to the markets that we were 
serious [0.5] obviously [0.3] that's going to cost us a huge amount if we set 
interest rates at fifty per cent [0.2] because someone's going to have to pay 
that 
interest rate [1.2] and it was undoubtedly going to have to be the government 
or the Bank of England [1.4] so we were all willing to adopt a relatively 
costly strategy [0.6] in order to try and defend our our status in the E-R-M [0.
3] er to defend the [0.3] the pound's exchange rate [1.8] but by [0.2] by the 
afternoon it was clear that even [0.2] that wasn't working [0.2] and the chan-, 
the Governor headed off [0.3] to the Treasury [0.4] to have a meeting with the 
Chancellor [0.6] and [0.4] amidst er [0.3] huge [0.4] massive embarrassment [0.
7] to monetary policy making in the U-K [0.4] we decided that we were going to 
have to [0.8] quit the E-R-M [0.7] and the the magnitude of that [0.8] should 
not be underestimated [0.3] it was the [0.4] it and had been for several years 
[0.3] the sole [0.5] er objective of monetary policy to maintain a fixed 
exchange rate particularly with the deutschmark [0.7] and to let that go [0.5] 
just almost in a day [0.3] is just [0.3] er really [0.2] highly embarrassing [0.
7] it meant that the Bank of England credibility [0.5] you know we'd promised 
to maintain that exchange rate the Bank of England credibility [0.4] 
was [0.2] was very very strongly damaged [3.0] so [0.2] amidst [0.4] huge [0.2] 
er panic [0.2] turmoil [0.4] and so on [0.7] we were left with nothing [0.9] 
absolutely nothing [0.8] we were left with [1.3] a policy [2.3] vacuum [3.2] we 
had nothing to hang monetary policy on [0.4] we had [0.3] er [0.2] in terms [0.
5] of the jargon [0.3] we had [1.2] no [0.2] nominal anchor [4.4] now what's a 
nominal anchor [1.3] er it's something that you can peg the value of the 
currency to [2.0] er it's something that will [0.3] er stabilize the value of 
the currency [0.3] one easy way to think of it [0.4] is that [0.5] in the 
nineteen-thirties or before the nineteen-thirties when we were on the gold 
standard [0.5] that was a r-, a monetary policy regime [0.4] whereby you could 
swap [0.8] er [0.5] money [0.4] notes and coin [0.3] for a certain amount of 
gold [0.4] well it's clear intuitively clear that that [0.4] the ability to 
swap is going to maintain a ver-, value of one's currency [1.7] er if you can 
obviously trade gold for money you know 
how much your [0.2] currency's worth [0.8] similarly in an exchange rate 
mechanism [0.6] you know how much deutschmarks your money's worth so you you 
you set the value of your own currency [0.3] but in the absence of that we had 
no [0.3] nominal anchor we had nothing to tie the value of money to [3.3] but i 
find it astonishing how quickly [0.3] we found some [0.2] some new policy [1.1] 
it was only a month or less than a month [0.6] er before we adopted an 
inflation target [0.4] which is [0.2] our current [0.2] nominal anchor [1.2] 
only a month to devise a whole new method of monetary policy a whole new [0.3] 
framework for monetary policy [1.5] and i i tha-, that's [0.6] really quite 
remarkable [1.2] we were helped [0.6] in [0.2] the sense that other countries 
had provided some sort of example [0.8] and who knows does anyone know who [0.
4] who we may have looked to [0.5] in terms of setting out an example for how 
to set monetary policy in a s-, in a in a sort of vacuum [0.8] 
sm1140: is it er New Zealand 
nf1139: yes [0.3] brilliant [0.6] New Zealand not the first country that one 
would have imme-, immediately thought of in 
terms of [0.4] er setting us an example [0.2] i mean [0.8] well it's you know 
[0.4] one of our old colonies a relatively small [0.2] country somewhere in the 
[0.6] er southern hemisphere [0.4] not very [0.2] high G-D-P hardly any people 
in it [0.7] but they'd adopted a an inflation target in [0.4] nineteen-ninety 
[1.6] to be followed by Canada in nineteen-ninety-one [1.3] so we had them to 
look look out to [0.2] in some ways the [0.2] the [0.9] er conservative regime 
which was [0.2] er [0.5] in power in n-, ninety-two was similar to the regime 
in New Zealand I-E [0.5] anti-inflation [0.3] conservative er [0.5] thing with 
a small capital C [0.4] a small C [2.4] so that was the background [1.2] [2.4] 
Norman Lamont was then Chancellor of the Exchequer [0.7] and he wrote a letter 
[0.2] which i'll just [0.3] read briefly to you [3.2] er this letter [0.3] was 
to the chairman of the T-S-C [0.6] er [0.6] er which is a relatively important 
[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 [0.4] see later on as well [0.7] 
Lamont's letter anyway says 
i believe we should set ourselves the specific aim [0.4] of bringing [0.2] 
underlying inflation in the ar-, U-K [0.2] measured by the change in retail 
prices excluding mortgage interest payments [0.7] down to levels to match the 
best in Europe [0.3] to achieve this i believe we need to aim at a rate of 
inflation [0.5] in the long term of two per cent or less [1.2] for the 
remainder of this Parliament i propose to set ourselves the objective of 
keeping underlying inflation within in a range [0.2] of one to four per cent [0.
7] and i believe that by the end of the Parliament we need to be in the lower 
part of the range [2.3] okay now what's what is underlying inflation [0.9] er 
who knows well it's R-P-I-X [0.3] right [0.5] that's what [0.2] underlying 
inflation is commonly known as [1.4] so this original target [0.5] then [0.7] 
was interpreted as having [0.7] three components [2.5] er [1.2] the first 
component [0.3] was a range [1.7] of between one and four per cent [0.9] until 
the end of the Parliament [2.6] the second co-, component was in a 
sense a modification of that range [0.3] in other words [0.2] towards the end 
of that period they wanted to be [0.5] in the in the lower half of that I-E 
only two-and-a-half per cent [1.1] and then [0.2] this objective of two per 
cent in the long term well [0.6] policy makers like the Bank of England [0.3] 
ignored that basically [0.6] ignored it i don't not entirely [0.3] clear [0.3] 
er under what grounds they ignored it but they did [3.4] now [0.5] [0.3] at 
this stage [0.5] the interest rate decisions I-E [0.5] you know [0.3] what what 
interest rates were actually going to be set at every month [0.5] was were made 
by the Chancellor [1.6] and [0.3] really [0.6] in a strange way the new policy 
framework [0.3] merely [0.2] formalized what had gone on before [0.6] because 
the Chancellor made interest rate decisions beforehand [0.4] and it also [0.5] 
the same as now [0.3] was advised by [0.3] the Governor of the Bank of England 
every every [0.3] month [0.3] they would have meetings at the Treasury [0.7] 
where the government Governor would say [0.3] well i think interest rates 
should be set at [0.5] so much per cent [0.5] because [0.2] economic conditions 
are such that [0.5] and he would elaborate on the economic conditions [1.4] and 
the Governor himself looking at it from the Bank of England's perspective [0.3] 
he was advised on what to say by [0.9] what was then known as the Monetary 
Review Committee [1.3] er it was just a monthly meeting of experts of 
economists [0.4] and the Bank of England [0.7] er [1.0] okay w-, so once once 
[0.2] once the Governor had met the Chancellor [0.5] in fact the Chancellor 
gave instructions to the Governor [0.2] as to what level of to set interest 
rate interest rates [0.2] and the Bank would operate in the money markets [0.6] 
to set those rates [1.6] so [0.9] the Governor-Chancellor meetings had gone on 
beforehand [0.2] really what this entailed was [0.4] an admission to the press 
that they had er because previously they tried to keep them a bit secret [0.4] 
i mean no information about them used to be released [1.7] er [0.2] they were 
formalized [0.8] [0.6] obviously now under this regime there was no targets for 
the exchange 
rates [0.3] nor were there any [0.2] money money growth or money supply targets 
[0.3] which we'd seen previously in the nineteen-eighties [0.5] they [0.3] did 
have monitoring ranges but really [0.4] the monitoring ranges were almost [0.3] 
ineffective because no nothing had to happen if the monitoring ranges were [0.
4] exceeded [5.0] so [0.3] why an inflation target then well apart from the 
fact that we needed something [0.2] we no longer had the E-R-M and we needed 
something to turn to [1.6] there was er a reasonably well founded view [1.1] 
that [1.0] money aggregates [0.4] er [0.2] and exchange rates [0.3] were [0.8] 
okay [0.7] in themselves but [0.3] were only part of the full picture [1.0] i 
mean if you think of it as [0.3] as to what information is important for 
monetary policy [0.5] monetary policy [0.7] er with a cup-, with an aim of 
affecting inflation in the long run [1.2] money is one thing the exchange rate 
is another thing [0.3] but there are so many other [0.4] items that one could 
look at in the economy like price surveys 
price expectation surveys [0.4] like [0.2] the unemployment rate like output 
like retail sales [0.9] all the things one sees analysed in the newspapers [0.
3] which affects how the economy's [0.3] heading or how we think the economy's 
[0.3] going to look like in the future [3.9] now [0.3] [2.1] what do [2.3] what 
does policy look like now [1.3] well i'm going to jump a little bit [0.6] er 
i'm going to come back to talk about the inflation target [0.6] er [0.6] 
forecast later on on the inflation report [0.4] but [0.4] to er pre-empt that 
[0.4] one of the [0.2] [1.0] main [0.4] aspects of the inflation report [1.0] 
is this [3.4] between [1.2] no [0.2] this is the [0.9] actually the forecast 
from August ninety-seven [3.7] and right from when the inflation report [0.2] 
was first published [3.1] we er the Bank published a picture of what it thought 
[0.2] inflation was going to look like in [1.3] a number of years' time [1.6] 
in doing so [0.2] the Bank had to choose [0.9] an inflation horizon [0.3] 
because remember what inflation remember d-, [0.2] what the inflation target 
looks like [0.5] the inflation target [0.3] at that time although it's changed 
a bit [0.6] looked like [0.5] you've got to achieve inflation of [0.2] between 
one and four per cent [0.5] and [0.2] below two-and-a-half per cent over a 
number of years [2.6] there are several things the Bank could have done [0.2] 
in terms of trying to meet that [0.2] meet that er target [1.5] it could have 
looked at inflation now [0.7] and said [0.4] look inflation now is [0.3] er 
four per cent [0.7] as it was at that time roughly [0.2] four or five per cent 
[1.7] us trying to meet an inflation target of two-and-a-half per cent of the l-
, [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 [2.4] but the Bank [0.5] and [0.3] any 
monetary policy person will tell you that that's [0.2] that's wrong [1.3] 
that's wrong because [0.4] the Bank raising interest rates [0.4] has no effect 
on inflation now [0.5] it can't [0.5] i mean inflation now is already in the 
system [0.6] and interest rates [0.7] if you think of [0.2] almost a 
tree [0.7] er [0.2] interest rates are are right at the root of [0.2] or the 
root of the tree [0.9] at the end you've got inflation inflation's an outcome 
[0.7] it takes [1.6] a long time [0.4] for interest rates to have an effect [0.
2] working right the way through the economy [0.3] to affect inflation [0.6] so 
looking at inflation now [0.2] and basing interest rates decisions on that [0.
7] would have been [0.2] incorrect because [1.0] it well one just [0.2] almost 
doesn't know what the effect of interest rate decisions now [0.6] would be one 
doesn't know [0.8] very clear-, the lags between the changes in monetary policy 
I-E changes in interest rates [0.5] and final outcomes are notoriously [0.7] 
long and variable now Milton Friedman [0.2] i think was the first person to 
coin [0.4] the [0.5] long and variable lags in relation to monetary policy [2.
3] you change your tr-, interest rates now sometime in the future [0.4] through 
mil-, Milton Friedman's black box or through whatever [0.8] you're going to 
affect output and inflation [0.3] and the whole the rent economy and the money 
[2.8] so instead of 
looking at inflation now [0.2] the Bank obviously had to look at inflation in 
the future [0.6] but unfortunately that that means [0.3] that the Bank has to 
try and forecast [2.5] to an insider in the Bank of England the Bank [0.3] 
having to place a huge amount of emphasis on a forecast was actually quite 
funny [1.1] because Mervyn King [0.9] who had been a professor at the L-S-E and 
who'd er [0.2] been brought in [0.3] really with a history in terms of [0.6] er 
[0.4] almost [0.4] er corporate economics [0.4] the economics of the firm [0.4] 
he's famous for Kay and King about the tax system [0.3] he's he's a brilliant 
microeconomist [0.3] he'd for some reason been brought in as the Bank of 
England's Chief Economist [0.5] who [0.2] you normally think of as a 
macroeconomist [1.6] he he not being a macroeconomist [0.2] had a very very dim 
view of macroeconomics in general [0.7] and of economic forecasting in 
particular [1.3] he disliked [0.3] the large macroeconomic models that were 
current [0.4] at that time [0.4] and those macroeconomic models were really [0.
6] at that time the things that would have been [0.5] 
used to produce a forecast [0.2] there's no other way [0.3] that the Bank of 
England [0.2] at that time would have produced a forecast they would have [0.5] 
churned through the current situation in their model [0.3] and got and one of 
the model would predict inflation would be in two years' time [1.3] so Mervyn 
had arrived about two years before [0.4] they produced this forecast and had [0.
2] almost scrapped the forecasting division [1.2] so in this [0.2] in this [0.
6] er situation where we [1.2] had to produce a forecast we had almost almost 
er [0.3] no means of doing so [0.8] they had to [0.3] reinvent [0.7] er [0.6] a 
forecasting mechanism quite quickly [2.2] they did so ba-, [0.3] er by the by 
by [0.6] er developing a [0.2] a much smaller macroeconomic model [0.3] er they 
call it a six equation macroeconomic model [0.6] it's an equation [0.3] or er a 
model which is [0.4] much more based on economic theory [0.4] like it has a 
labour market which looks like a labour market you see in economic theory 
models [0.4] and so on [0.9] so it was that that was initially used to generate 
the forecast [2.3] in terms of [0.2] the forecast 
horizon [0.4] right that's where [0.2] that's the point at which [0.3] the 
forecast is made and in this case it's August ninety-seven [0.8] what the 
forecast does is look at what inflation's going to look like [0.4] two years 
hence [1.1] so the two year period [0.4] is important [0.3] it's what the Bank 
chose as its best [0.7] notion [0.3] of the [0.4] time horizon of the effect of 
monetary policy [0.5] it chooses two years [0.3] it's important to remember 
that [0.4] in choosing those two years what the Bank's saying is [0.3] if we 
raise interest rates now [0.3] we think that that's going to have a maximum 
effect on inflation [0.5] in two years' time [3.2] i'm going to talk about the 
interpretation of this forecast [0.4] er a bit more in later lectures [0.4] but 
just er [0.3] to give you an idea [0.4] these [0.5] er [1.2] these bands [0.5] 
are for those anyone who did stats last year they're confidence intervals [0.2] 
right [0.6] the middle [0.3] point [0.7] is [1.2] the ten per cent [0.2] region 
[0.3] where inflation is most likely to be [0.5] and it goes out in ten per 
cent [0.5] intervals all the way so [0.3] this region [0.2] between 
here and here it would be [0.4] [0.2] twenty per cent [0.3] here [0.5] at the 
most these would be thirty and so on to ninety [5.5] the forecast is a bit odd 
[0.4] to be honest [0.7] because [0.4] like any forecast it's influenced by 
judgement [1.4] you can turn out [0.3] a forecast from a model but that isn't 
[0.8] this it forecast [0.2] now and even [0.2] initially [0.7] wasn't entirely 
model driven [0.4] it has some judgement incorporated in it which i want to 
talk about [0.6] a bit later [2.6] so [0.4] what we had now as a centrepiece 
for [0.5] er monetary policy making [0.3] is this inflation forecast [3.0] an 
inflation forecast [0.3] really now [0.2] now forms [2.3] the intermediate 
target [2.9] intermediate target [0.3] okay [0.2] we have a final target of 
inflation [1.8] we can't affect inflation directly [0.2] we need a means of 
doing so [0.5] and that means is the intermediate target [0.5] previous 
intermediate targets just [0.3] er [0.5] so you get the idea where the exchange 
rate under the E-R-M [0.4] and money [0.4] supply [0.3] under money [0.2] mon-, 
money target in the nineteen-eighties [2.7] so [1.3] as Mervyn [0.2] King wrote 
[0.3] quite early 
on [0.5] the most appropriate guide to monetary policy is the best obtainable 
forecast [0.3] of the probability distribution [0.2] which is those [0.4] kind 
of bands that i showed you [0.5] for inflation [0.3] over a time horizon 
defined by how long it takes er for a change in monetary policy to affect 
inflation [1.2] and monetary policy is to be adjusted to maximize the 
probability [0.5] of hitting the inflation target range [1.1] in two years' 
time [2.6] [0.3] so that was the situation [0.2] right from nineteen-ninety-two 
[0.7] some changes have taken place since then [1.0] in particular [1.7] a 
small change but a meaningful one [0.3] in nineteen-ninety-three [0.7] was that 
the Bank of England was given discretion [0.4] over the timing of interest rate 
changes [1.8] now what does that mean [0.3] well it means [0.8] not it means 
that the Bank was no longer constrained to make that change immediately after 
the Governor-Chancellor meeting [0.2] it can 
make it any time before the next meeting [0.9] and the point of this [0.3] it 
was it was actually ins-, ins-, [0.2] instituted [0.6] immediately after 
there'd been a furore in the press [0.8] about the timing of interest rate 
changes from in relation to some [0.3] local government elections [0.4] the 
Governor [0.4] was charged [0.4] with or it it was it was claimed that the [0.
3] Chancellor had decided not to raise interest rates [1.0] speci-, or and [0.
3] change the timing of interest rates specifically so they wouldn't rise just 
before some local government elections [0.9] so that was relatively minor but 
it meant that the Bank could only change them within a month [1.6] in fact [0.
5] er [0.3] the markets get very jittery [0.7] unless you tell them [0.2] what 
the interest rate decision is [0.7] er almost immediately after the meeting 
they start [0.7] er [0.6] they start their animal spirits going to quote 
Keynes' phrase [0.6] and er [0.3] get rather panicky if volatility rises so 
they have to really [0.4] make the changes really soon after a meeting [3.1] 
the next change was in [0.2] 
April ninety-four [1.0] this Treasury Select Committee the representatives of 
[0.2] the House of Parliament [0.2] had recommended that [1.0] er [0.4] really 
they sh-, the Bank should be more open [0.3] they should they should be more 
open about monetary policy [1.8] and they should publish the minutes of the 
Governor-Chancellor meeting [0.5] and they did so in ninety-four [0.9] with a 
six week delay [0.7] now previously [0.8] interest rate decisions [0.6] had not 
been made secret until after the [0.4] er thirty year rule [0.2] for [0.2] for 
er not being made public until after the thirty year rule [0.3] because they 
were regarded as secret [1.5] okay so [0.2] this was a big improvement in terms 
of transparency [0.3] in terms of the openness of decisions [3.3] the first [0.
3] then major [0.2] restatement of the [0.2] of the inflation target came in [0.
3] ninety-five [2.1] now the Mansion House speech is worth looking out for [0.
5] er [0.4] it's [0.4] is often [0.2] a scene for [0.8] er the announcements of 
large policy changes and it certainly was in ninety-five [1.4] [0.4] because [0.
6] the target was redefined [0.4] as two-point-five per cent or less [0.5] by 
spring 
ninety-seven [0.2] and beyond [3.0] really what this involved was a change of 
emphasis [0.5] remember the first thing that had been said in the previous [0.
3] incarnation of the target [0.3] that was really the range of one to four per 
cent [1.6] now [0.2] in order to [0.5] er i guess show that [0.2] that hadn't 
been a mistake [0.2] it was just [0.6] er [0.5] it was it that it hadn't been a 
s-, mistake to say one to four per cent [0.3] the Chancellor predicted that 
keeping inflation [0.4] at about [0.3] two-and-a-half per cent or less [0.4] 
meant that inflation was going to range [0.2] between one and four per cent [0.
4] over the long term [1.0] okay [0.6] it's important that y-, that you 
understand [0.4] a bit about how the Bank works the Bank [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 [0.9] it [0.4] it kind of restated it [0.4] putting much 
more of the emphasis on the mid-point [0.2] the two-and-a-half per cent [0.5] 
although it added the caveat or less [1.7] but keep it really almost scrapping 
the range just [0.9] keeping it as a almost a 
sideline [3.0] there are still questions a bit about the horizon [0.5] i mean 
if you think about what the Bank's trying to do [3.2] achieving an interest 
rate er an inflation rate [0.2] of any given per cent [1.0] is possible [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 [1.7] that's obviously going to take some changes in interest 
rates [0.9] if you pushed interest rates up to say fifteen per cent [0.4] it's 
much more likely that you're going to get to two-and-a-half per cent quicker [0.
4] than if you pushed inflation in-, interest rates to nine per cent [1.6] okay 
[0.4] so you've got questions about the time horizon for policy [1.3] does 
policy [0.3] need to get there quicker [0.6] or [0.6] er [0.3] can we move more 
slowly [0.2] and more gently [2.0] it's quite likely that there's some sort of 
trade-off [0.4] in the sense that if you raise interest rates really high [0.6] 
you're going to lose [0.2] more output [0.3] there's more likely to be a 
recession [0.4] the faster [0.2] monetary policy moves [1.0] so the time 
horizon [0.3] over which [0.7] you have to 
achieve the target [0.2] is really important [0.5] can i leave it [0.3] two 
years before i get two-and-a-half per cent [1.3] Mervyn King interpreted this 
horizon to be over a long period [0.5] and indeed [0.6] often the word on 
average over a long period [0.2] was used [3.1] okay interest rate decisions at 
that time still taken by the Chancellor [2.2] the Labour government [2.7] 
changed all that [5.2] after only four days in office [0.7] shocking [0.6] er 
not [0.3] well shocking the press shocking the country [0.6] and shocking the 
Bank of England itself [1.8] Gordon Brown announced that they'd be independent 
[0.9] i mean this is this is really a quite a surprise [1.0] the Bank does have 
discussions with [0.3] the opposition [0.8] er [0.3] but i'm sure that even 
they didn't expect [0.6] to have that [0.5] presented to them quite so quickly 
[2.7] this is the current framework [1.7] the Bank has what's known as 
operational responsibility for interest rates [1.7] what does that mean well 
it's it has one form of independence it has operational independence [6.1] 
it has to [0.2] set interest rates [0.5] and it can decide what interest rates 
[0.2] it wants to set [1.2] but it has to set them conditional [0.3] on its 
expaysh-, ec-, its expectation that they're going to be consistent with [0.4] 
the government's inflation target [8.0] now if the Bank [0.4] had the 
possibility of setting the target as well [1.8] it would be goal independent [1.
2] but it doesn't [0.5] so it just has [0.3] operational independence it can 
decide what [0.3] what level to set the [0.6] er [0.5] interest rates at but it 
can't decide [0.3] what it's aiming at [4.0] the other new thing [0.3] is [0.2] 
that [0.7] er [1.2] in addition to the independence [1.3] the Bank was not 
required simply [0.3] to [0.6] follow an inflation target [0.9] but subject to 
that target it was required to [0.7] er [0.2] promote growth [0.2] promote 
growth and finance basically [2.0] there was also a restatement of the form of 
the target [1.3] okay [0.2] that two-and-a-half per cent [0.5] is contrasted 
with the two-and-a-half per cent or less [0.2] that was the [0.3] er [0.4] 
previous [0.8] inflation target for the nation [1.0] what's the difference here 
[0.9] 
well two-and-a-half per cent is basically [0.6] just a single point [0.7] what 
you had before [1.5] was [0.3] two-and-a-half per cent [1.6] or less in other 
words you could go lower [2.1] Labour [0.7] being slightly [0.3] more pro-
growth [0.2] than the Conservatives [0.3] thought it very important that the or 
less was scrapped [0.4] why was that [0.4] because it [0.3] thought that if the 
Bank [0.5] was run by someone who was very very hawkish [0.4] and very very 
risk-averse [0.5] the Bank would know [0.4] that [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 [0.8] so 
hence they could actually [0.2] the Bank under previous policy [0.4] could 
actually [7.4] could actually er have a much more deflatory policy than was 
actually good for the country [1.6] so just this point target without the or 
less [0.2] which is the current target [0.3] is symmetric [0.2] so the Bank has 
the same incentive to go above as it does below [2.4] it's not commonly stated 
these days 
but [0.5] a year ago [0.8] there er quite a lot was made of [1.0] er [0.3] this 
one percentage point higher or lower [0.6] than the target [0.4] so that's [0.
2] one-and-a-half to three [0.2] three-and-a-half per cent [1.2] if [0.2] those 
limits are exceeded [1.6] if inflation [0.4] range is [0.2] between one per 
cent [0.3] higher or lower than target [0.3] the Bank has to publish an open 
letter [1.5] supposedly to the Chancellor explaining why inflation has deviated 
from the target and what action it intends to take [2.9] that's [0.2] er [0.4] 
that's a really interesting move [0.3] and potentially [0.2] highly 
embarrassing [0.9] as Mervyn King [1.0] now [0.4] as mer-, Mervyn King reckons 
that this measure is quite likely to as he put it [0.3] restore the lost art of 
letter writing [0.2] to the British [0.7] er [0.8] people [0.9] because he 
reckons it's actually quite [0.2] likely [0.5] that the inflation target's 
going [0.3] er that inflation is going to be three-and-a-half [0.2] more than 
three-and-a-half or less than one-and-a-half per cent [1.2] so far it hasn't 
happened [0.2] remarkably [1.8] er [0.5] but if it did then the Bank would 
actually have to [0.9] set out several things in 
a letter [0.4] the way it's interpreted [0.2] this requirement [0.5] is that 
the Bank is going to have to say [0.4] why [0.2] inflation has gone higher than 
the [0.3] this [0.2] this range [0.7] in other words [0.3] what specific shock 
to the economy [0.5] it could be an exchange rate shock [0.4] it could be [1.0] 
er [0.2] really that's that's the main thing that's going to happen an exchange 
rate shock [1.2] that left [0.4] us [0.4] really [1.7] unable to keep inflation 
within the one one-and-a-half to three-and-a-half per cent [0.4] band [0.2] if 
you like to call it that [2.1] and also the Bank has to say [0.2] how long it's 
going to be before it reckons inflation's going to get back within the target 
[0.5] er range [1.5] but one one thing you've got to [0.8] i guess be aware 
about this this little one per cent either side [0.6] aspect is that they no 
longer call it a range it's not like the original one to four per cent [1.3] 
it's supposedly just [1.0] just a way of monitoring [0.4] er [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 [0.9] it's not like the Bank is going to be [0.4] 
excessively penalized [0.5] it's not going to be regarded as failing [0.4] in 
other words [0.4] if it exceeds [0.2] one-and-a-half [0.3] per cent or three-
and-a-half per cent [0.3] it's just that it has to explain why [2.6] so really 
there are no [0.3] there are no actual limits [0.4] to how far inflation goes 
[0.5] above two-and-a-half [0.4] or below two-and-a-half [2.7] which is 
different [2.9] an important thing about the new [0.5] regime [0.2] is that [0.
2] it formalized [2.4] how the inflation targets came to be renewed [1.4] 
previously there'd just been the odd statement of what the target was [0.4] but 
now it's institutionalized that every budget [0.5] which occurs in [0.6] 
November every budget you're going to have a restatement of the target [0.6] 
but there was [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 [0.7] so you can expect [0.3] every 
government to come in will make a major restatement of the target [1.5] and 
then will [0.3] will carry on through that Parliament [3.0] in extreme 
circumstances the Treasury is allowed to overrule the Bank [0.2] but those 
extreme circumstances what would they be like [0.2] well they'd be like a war 
[0.5] like a major crash on European stock markets [0.6] maybe something like 
that [6.0] okay [0.4] now some institutional things had to change at the Bank 
obviously [0.3] 'cause the Bank was now [0.6] er given the task of setting 
interest rates itself it could decide what level of interest rates to set [0.8] 
the Bank's not [0.2] the Bank is a public [0.6] is a public institution it's 
not privately owned [0.3] but there was a need to control what the Bank did to 
monitor it [0.3] to make it accountable [0.7] and it wa-, that was done in 
various ways [0.6] one way in particular [0.4] was the setting up of the 
Monetary Policy 
Committee [1.6] now [0.8] this [0.7] is a bit it it kind of parallels the 
Governor-Chancellor [0.4] er [1.2] meetings [0.2] in the sense that [0.2] there 
are four people on it [0.4] who are appointed [2.8] by the Chancellor [2.8] and 
those people are supposed to be [0.2] experts [0.3] in fact they're all 
economists of one sort [0.9] Willem Buiter [0.3] is i think still possibly on 
leave from Cambridge University [0.4] Charles Goodhart from the L-S-E [0.2] and 
he used to be [0.2] Chief Economist at the Bank of England [0.2] er [0.7] 
DeAnne Julius [0.2] is the [1.7] honorary female on the committee [0.6] 
[laughter] she used to be [0.6] she used to be at British [0.2] Airways i think 
[0.6] and [1.1] she's supposed to be the industry representative on the 
committee [1.1] and Sir Alan Budd is an old mate of [0.2] Mervyn King's [0.3] 
he's from the Treasury he was the [0.2] er [0.3] Treasury [0.5] Chief Economist 
under [0.2] the previous government [2.5] so they all know each other pretty 
well [0.3] and to call them employments of the Chancellor is stretching it a 
bit because [0.2] well i mean [0.3] you know [1.0] anyway as well as them [0.3] 
[laughter] there's 
Eddie George the Governor [1.1] the two Deputy Governors [0.8] Clementi was 
appointed from the City [0.3] and his responsibility [0.2] is to look after [0.
9] really the markets [0.4] the Bank can be divided into two [0.3] you've got 
the m-, people who make monetary policy [0.3] and the people who deal with the 
markets [0.4] and the two are often at loggerheads [0.4] so you've got these 
two Deputy Governors [0.3] this this chap is going to be [0.2] be telling the 
committee [0.4] what the response of the markets is going to be to any given 
interest rate decision [0.3] and obviously that weighs heavily on the what the 
Bank's going to do [0.7] Mervyn King used to be Chief Economist [0.8] er but 
he's been promoted [0.4] er he's obviously [0.6] much more on on the economics 
side he's on the principal side he's also a [0.7] eminent [1.4] and enormously 
[0.4] er respected economist [0.7] Plenderleith again is on the market side 
Vickers is on the monetary policy side [0.3] Vickers again [0.3] is the current 
Vickers is the current Chief Economist [0.3] but again a really bizarre 
appointment [0.4] because this chap was from ox-, 
professor at Oxford University a very [0.5] bright young professor [0.5] but 
what's his what's his er background it's noth-, [0.2] it's not macroeconomics 
what is it it's game theory [1.1] [laughter] game theory [0.4] bizarre [0.6] 
but he's er again he's [0.2] he's a very [0.2] er [0.3] you know able [0.5] 
able person [3.2] so [1.5] right so that's the Monetary Policy Committee [0.2] 
they meet monthly [2.3] and again [0.8] we have the situation that they've made 
a change which institutionalizes er [0.3] things that were already happening [0.
4] because remember i told you that [0.3] every month in the Bank the Monetary 
Review Committee met [0.7] that Monetary Review Committee [0.3] often had an 
informal vote as to what it thought interest rates should do [1.2] that's been 
replaced by [0.7] these people at the top [0.9] okay these people at the top [0.
3] but [0.3] in the same way as they had before [0.3] these people are advised 
by [0.4] the economists in the Bank of England [1.0] so you've almost got the 
same thing happening in the Bank you've 
still got a load of economists [0.3] turning out what they think [0.2] er 
responding to the lat-, d-, latest data in the month turning out what they 
think's going to happen to the economies [0.4] and advising the people in the 
Bank [0.4] even these supposedly [0.4] external [0.3] appointed by the 
Chancellor experts [0.3] they all have [0.5] Bank [0.5] er workers [0.8] who 
are advising them as to what to think about the economy [1.2] so really this 
was a major move by the Chancellor [0.2] he's he's [0.2] given up his right to 
[0.8] right to set interest rates [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 
[2.9] right one person one vote the Chancellor ha-, the Governor has [0.3] an 
overriding vote a second vote if there's [0.7] a tie [0.5] then their 
decision's announced [0.2] well after one day effectively they meet they the 
meetings supposedly go on for two days but [0.3] on the morning of the second 
[0.4] they announce their decision [2.0] okay i'm i'm going to stop there [0.5] 
regarding this but [0.4] can you just er [0.6] hang on for one minute [0.3] 
'cause i need to set times