Business

Bank of England rate policy 'risks higher inflation'

Prof Michael Woodford
Image caption Prof Woodford says the Bank of England could cause inflation to rise

The Bank of England's expected new policy of forward guidance risks increasing inflation, a leading expert has warned.

Forward guidance is expected to see the Bank pledge to keep interest rates low for an extended period of time.

New governor Mark Carney is expected to announce policy details in August.

But this could risk inflation running higher than the Bank's 2% target, says Prof Michael Woodford of the University of Columbia.

"If it's too successful, maybe it then pushes up inflation more than you want, and that's obviously a concern in the UK as the Bank of England has been overshooting its inflation target as it is," he told the BBC.

"But the view of undertaking such a policy is that you are concerned enough about undershooting in terms of the real economy that you do in fact want more stimulus, even if it nudges up inflation a little bit as the price of getting it."

The Bank of England's target for CPI inflation is 2%, but it has been above that figure since December 2009. The latest figure, for June, was 2.9%.

Prof Woodford is acknowledged as one of the leading experts on forward guidance, having written a number of influential academic papers on the subject.

'A little dangerous'

The Bank of England is expected to commit to keeping official interest rates low for a period of time.

This is meant to lead to reductions in interest rates for mortgages and business loans, and encourage companies and individuals to invest by giving them greater certainty over future conditions.

Forward guidance is currently being adopted by the US Federal Reserve and the European Central Bank. It was also deployed by Mark Carney in 2009, when he was governor of the Bank of Canada.

But Prof Woodford warned against implementing the policy in Britain as he did in Canada. "Announcing [that rates will stay low until] a specific date, as Canada did back in 2009, is a little dangerous, and would not be the best way to attempt the forward guidance.

"The ideal thing would be to talk about specific economic conditions and say interest rates will stay where they are until certain conditions that are not currently satisfied are reached. And to define those conditions in such a way that if inflation did start shooting up faster than you expected, then that would bring the date forward."

But Prof Woodford believes the Bank of England is right to adopt some form of forward guidance. "I would encourage them that they should be trying to use it. It's certainly easy to get it wrong, but I wouldn't take the view that it's easier to keep your mouth shut."

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