Monetary Policy and the Behavior of the MPC Essay

Monetary Policy and the Behavior of the MPC - Essay Example The present policy mandate of the Bank of England, the UK’s central bank is dictated by the twin economic objectives of maintaining a high level of employment or low involuntary employment with promoting a high level of production of goods and services with rapid growth. Meanwhile, the latest available Inflation Report dated February 2011 shows that the Consumer Price Index (CPI) rose between 4 to 5 percent as against a target inflation rate of 2 percent. The main reasons for this were the increase in VAT since December 2010, an unprecedented rise of 15 percent in energy prices and 20 percent in food prices, and a fall of 25 percent in the value of UK Sterling. Meanwhile, unemployment remains at 8 percent and even the unexpected cold wave we have seen last winter has negatively affected productivity and the rate of output in the UK. The most realistic estimates by the Bank of England are that inflation will continue to remain at the 4 percent level till the end of 2011 and the n come back to the target of 2 percent being more realistic in the long run. In the process it is expected that exports will grow to the level that it supports monetary policy and exchange rates, bringing the economy back on track and at least out of the present crisis, which by the Governor of the Bank of England’s own admission is the worst we have faced since the Great Depression of the 1930s. (BOE, Q&A). The Importance of Central Bank Credibility The central bank of any nation has a key role in setting and controlling the money supply and controlling the rate of inflation in the country (Rosen,2004). The role of Mervyn King, the Governor of the Bank of England is just that and he does it with the help of a nine member Monetary Policy Committee. Of course, the estimates made by the MPC are hardly ever on target explicitly, but at least they give a sense of direction in which the economy is going. The inflation rate is not known to change rapidly- there is a lag between pri ce and output changes and the inflation rate, but at least we have an indication of whether it is going to be higher or lower than previously. What is worrying at present is how to stimulate the economy without raising the rate of inflation. At the same time, the rate of inflation is largely in control in Germany and USA, to name two of the UK’s best trading partners. It has been fortunate for them that their exchange rates have stabilized and had not been so adversely affected as in the UK. The Bank of England and the MPC wait and evaluate the events in the economy before making a decision on increase in Bank Rates, for example. They have to wait for shocks to be absorbed by the economy and allow for these in their estimates (McConnell & Brue, 2005). Being consistently wrong and off the target for key estimates