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