Sir Mervyn's date with history

Little did anyone know then that he would preside over 81 more of them, first as the Bank's first chief economist, then its deputy governor, and finally as governor. Wednesday sees press conference number 82. Also Sir Mervyn's last.

I wasn't at that first conference. But as a student intern at the Financial Times I did go to the third one, in August of 1993. I remember being suitably awed by my surroundings, and impressed by the then chief economist's willingness to answer our questions and also his apparent desire to explain the Bank's policy rather than simply repeat it.

Back then, Sir Mervyn reminded me of my university economics tutors - unsurprisingly, given that he had been a professor at the LSE before joining the Bank.

Twenty years on, the economic journalists who make their quarterly pilgrimage to this event are not so awestruck. You could say the relationship has 'matured'. He would say we were less respectful - downright rude, on occasion. For our part we hacks might say he was now a bit too defensive, a bit too unwilling ever to admit a mistake.

Time for a change, maybe. The inflation target and the Inflation Report itself are now under review, the Chancellor having asked the Bank's policymakers to consider whether and how the system could work better after the new governor, Mark Carney, takes over in July.

But as Mr Carney has said himself, in 1993 the Inflation Report and the UK inflation target were "state of the art". And it is not too much of a stretch to say that they helped to change the world. They certainly changed the world of central banking.

Greater transparency

Like the inflation target - devised by Chancellor Norman Lamont in October 1993, after Britain's exit from the ERM - the Inflation Report was part of a global shift in central banking which the UK helped to lead. By making policy more transparent - and the people making it more accountable - the Bank's quarterly reports and press conferences also helped paved the way to central bank independence in 1997.

That greater transparency had a practical purpose: if the public understood the target and how the bank planned to achieve it, the idea was that households and wage earners would be more likely to believe in it - and if they believed in the new inflation target, it would be an awful lot easier to achieve.

To use the jargon, it was all about 'anchoring expectations'. And in that key respect you would have to say that the system that the UK helped to pioneer in the 1990s was a remarkable success - not just in the nice times before the crisis but pretty nasty ones

As you know, inflation expectations fell rapidly from the early 1990s onwards, in Britain and around the world. Inflation also fell, and became more stable. The one aided and abetted the other. What is interesting is that expectations have remained quite stable, even when inflation has been anything but.

At the time, many were astonished that the RPIX measure of inflation averaged just over 2.5% in the ten years from October 1999 - exactly on target. Sir Mervyn became Governor in the summer of 2003, the year when the Bank was asked to target a CPI inflation rate of 2%. in his first five year term, inflation averaged precisely that: 2%.

Since then, the average has been 3.2% - and inflation has been more than 1 percentage point above the target, more often than not. In fact, if the latest Bank forecasts are right, there will only be three quarters in the decade after 2005 when inflation was not above the Bank's target.

Why and how the Bank of England has been so wrong, for so long, has been the subject of much vigorous debate at these press conferences (and also in this blog).


Image copyright Getty Images
Image caption In press conferences, critics can get short shrift from Sir Mervyn.

You'll remember that Sir Mervyn tends to deploy two rather different lines of defence: the first is that the inflation overshoots have largely come from unexpected factors like higher energy prices or the rise in VAT, which the Bank could not have been expected to predict - and, he will add, most city forecasters didn't either.

His second argument is that even if the Bank had expected that higher inflation, it would not have chosen to do anything about it, because tackling that kind of externally generated inflation would have done too much extra damage to the domestic economy.

Critics say he can't have both - either the Bank knowingly set out to miss the target, or it didn't. In the quarterly press conferences, such critics tend to get short shrift.

The inflation debate among academic economists in Europe and the US is somewhat different. There the surprise has been, not that inflation has been so high, but why it has not fallen into negative territory, despite the depressed state of the economy and persistently high unemployment (see, for example, this paper from the IMF). I hope to say more on that in a future post.

But for central bankers and economists here and around the world, it's worth saying that what has NOT happened to inflation expectations in the past five years is almost as interesting as what has happened to inflation itself.

As the chart shows - long-term expectations of inflation in the UK have barely budged in the past decade, despite several years, before the crisis when inflation came in below target, and many since when inflation has come in too high.

Banks have failed. The global financial system has teetered on the brink of collapse. And consumers have seen the effect, month after month, in shrinking real pay packets and spiralling bills. But through all that, the average person in the UK has continued to expect the Bank to do its job - and continued to expect that inflation will eventually come back down.

There are lots of reasons why our expectations have remained so well 'anchored' - against the odds. But perhaps posterity will say that Sir Mervyn presided over 82 of them.