II Assessing the performance of the MPC
THE ASSESSMENT CRITERIA
5. To assess the performance of the MPC it is necessary
to judge the actions both of the MPC as a whole and of individual
members. Judging the actions of the MPC is more complex than just
comparing inflation outturns against the target, as Professor
Charlie Bean, then a specialist adviser to this Committee, and
now Chief Economist at the Bank of England and member of the MPC,
explained in a memorandum to the Committee in 1998.
Professor Bean gave two reasons for this: first, the level of
inflation today is, amongst other things, the result of policy
decisions taken 18 months to two years ago; second, unanticipated
shocks to the economy may cause inflation to deviate significantly
from the target as a result of events which are beyond the policy
makers' control and which they cannot offset. Hence, whilst ultimately
the performance of MPC will be judged on how close inflation has
been to the target of 2½ per cent, we have made our assessment
bearing in mind the economic environment in which they have been
working and the time period for which they can be considered fully
accountable for the inflation outturn.
ASSESSMENT OF THE MPC AS A WHOLE
The economic conditions
6. Looking at the global economic conditions within
which the MPC has been working, we asked our expert advisers whether
the MPC had been properly tested. They were divided: Mr Ray Barrell,
of the National Institute for Economic and Social Research, told
us "the world environment has been very stable over the last
three years," which "would help any monetary policy
However, Professor Buiter, chief economist at the European Bank
for Reconstruction and Development and former member of the MPC,
disagreed, citing a number of instances where the MPC had been
tested including the "incipient financial crisis"
of 1998. Mr Roger Bootle, Managing Director of Capital Economics,
did not think this episode had been a "proper test"
but noted that at the time "the Committee was able to convey
the idea that if world conditions worsened further they would
act still more vigorously to forestall a recession in the UK."
As a result "the MPC contributed greatly to the subsequent
recovery of confidence."
We note that since their inception the MPC have been working
in a relatively benign economic environment; however, we also
recognise that they have played a part in helping achieve these
Performance against target
7. As we noted above, the primary test of how well
the MPC has performed is the actual rate of inflation relative
to the inflation target of 2½ per cent (see Figure 1). Since
the inception of the MPC the RPIX inflation measure has remained
within 0.7 percentage points of the target and averaged 2.4 per
cent. This, as our expert advisers agreed, is a highly creditable
performance, although the average rate of RPIX inflation in the
previous four years (1993-1997) was only 2.8 per cent, so it could
be argued that the MPC has simply maintained low inflation. Mr
Bootle said that "the sharp change in the inflation regime
in this country came not with the establishment of the MPC, but
rather in the aftermath of Britain's exit from the ERM"
and the introduction of inflation targeting.
Historically, however, inflation has been far more volatile, as
Mr Barrell pointed out: in "the past 25 years in the UK inflation
has varied between two and 20 [per cent]."
Given the volatility of inflation in the UK over the last 25
years, the MPC's record, as measured by their performance against
target, is impressive.
Undershooting the target
8. If we look solely at the inflation outturns for
which the MPC can be considered directly accountable, roughly
speaking since the beginning of 1999, RPIX inflation has averaged
2.2 per cent, and for the past 23 months it has been below target.
In addition the MPC has forecast RPIX to remain below target for
the next year and a half. This points towards monetary policy
having been set too tight, a view with which Sir Alan Budd, Provost
of Queen's College Oxford and a former member of the MPC, agreed,
telling us that "we know that the rate of inflation has,
for some time now been below the target. In some sense that indicates
the policy could have been more relaxed two years ago."
He did not intend this as a criticism of the MPC, pointing out
that "the correct way to judge this is whether they [the
MPC] were making the best possible decision given all the information
available at the time."
9. The Governor has explained the undershoot as being
due to the unexpected strength of sterling's effective exchange
This is a view with which our expert witnesses agreed. Mr John
Flemming, Warden of Wadham College Oxford and a former Chief Economist
at the Bank of England, told us "with hindsight the MPC made
a mistake, but its assumptions about the exchange rate movements
were perfectly reasonable assumptions."
Professor Buiter agreed that there had been exchange rate surprises
but also raised two other factors: firstly that the MPC might
have underestimated the "extent to which the non-inflationary
rate of unemployment might have fallen," and secondly, that
there could be some policy bias, arguing that the MPC "are
not really targeting the 2.5 per cent symmetrically."
Mr Bootle shared this view, suggesting that "if the target
had been overshot this consistently, then the Committee
would have been more vigorous in seeking to bring it back."
However, Mervyn King, the Deputy Governor of the Bank of England
responsible for monetary policy, denied that there was any bias
to policy setting, assuring us that it "is not the view of
any member of the Committee, and it is not the remit we have been
given." He pointed out that whilst "it is true that
we have been below target for 22 months ... we were at or above
the target for 21 months before that."
It is debatable however how much influence the MPC had on the
inflation outturns for the preceding 21 months as much of this
period was before the actions of the MPC would have had their
full effect on inflation outturns, as explained in paragraph 5.
Performance against expectations
10. An alternative method of assessing the performance
of the MPC, and the wider monetary framework, is to look at forward
expectations of inflation. Such expectations are a measure of
the credibility of the MPC and will be based both on their performance
against target and on the transparency of the framework as a whole.
Looking at market expectations, the MPC has performed very well:
10 year government bonds have essentially converged with those
of our European neighbours, while longer bond yields have undershot
them. According to Mr Bootle "this is arguably one of the
most important indicators of the MPC's successdispelling
the long-held market view that the UK is an inflation-prone country."
A similar conclusion can be drawn from survey evidence. The most
recent Barclays Bank "Basix" survey shows that inflation
expectations of a range of experts have fallen to around the target
level, although the expectations of the general public remain
stuck at 1-1.5 percentage points above the target.
11. The credibility of the MPC is in part a result
of the actions which it has taken. Looking at the interest rate
path followed by the MPC (see Figure 2), we observe that the frequency
with which they have altered policy has slowed during the course
of this Parliament, as Mr King noted when introducing the November
2000 inflation report "... interest rates have been unchanged
for nine months. So suggestions that the MPC is excessively 'activist'
will no doubt shortly be replaced by the view that we are excessively
Mr King claimed that the interest rate path was simply a result
of the MPC responding to economic conditions. However, whilst
to a large degree this may be true, a number of our expert witnesses,
including Mr Flemming, thought that the MPC's initial policy responses
"showed a willingness to be pro-active in order to establish
a reputation." He explained that "once the reputation
is built and if the markets believe that the MPC is capable of
keeping inflation within a very narrow band around the target
then ... it [is] easier for the MPC to achieve it [the inflation
target] without being so fidgety."
12. We commend the MPC on establishing a high
level of credibility; however we are concerned that in an effort
to establish such credibility the MPC may have biased policy towards
undershooting the target. We would therefore remind the Governor
of his assurance to us, in November 1998, that the MPC will be
"just as active, rigorous [and] aggressive in pursuing inflation
at 2.5 per cent if there is a balance of risks on the downside
as we had been on the upside."
Performance against secondary objectives
13. The Bank of England Act states that, subject
to maintaining price stability, the Bank shall "support the
economic policy of Her Majesty's Government, including its objectives
for growth and employment."
The Treasury interpreted this objective more explicitly to be
"achieving the highest level of economic growth consistent
with keeping inflation at 2½ per cent."
14. We can assess the achievements of the MPC against
its secondary objectives by looking at the outturns of growth
and employment over the last four years. Since the MPC was set
up, in June 1997, the economy has grown by an average of 0.65
per cent per quarter and unemployment (based on the claimant count)
has fallen by a third from 1.5 million in the third quarter of
1997 to just under one million today. Our experts were agreed
that from the perspective of developments in the real economy
the MPC had a pretty good record. As Mr Bootle told us "It
is noteworthy that the MPC's inflation record has not been achieved
at the expense of weak growth, or even of considerable instability
in the real economy ... Accordingly ... the MPC has also achieved
a remarkable record with regard to its secondary objectives."
However, our experts again emphasised that macroeconomic policy
had been undertaken in a relatively favourable environment; Professor
David Miles, of Imperial College Business School, pointed out
that, although the "real economy performance of the UK since
1997 has been very good",
it was not substantially out of line with that of other industrial
countries. Mr Bootle also cautioned that, in his view, this performance
should not "be taken as an endorsement of the MPC ... for
we do not know what would have happened in the absence of the
MPC, nor if one or more interest rate decisions had been taken
15. On this point, the corollary to the criticism
that policy has been run too tightly is that the level of growth
has been less than it might otherwise have been. Sir Alan Budd
told us that "there has been a remarkably low level of unemployment
but ... since inflation has been lower than was expected or it
was required to be ... there would be an alternative state of
the world in which presumably unemployment would have been slightly
lower and inflation would have been high." However, he emphasised
that "the margins ... are extremely small" noting that
"the extraordinary thing is that they [the MPC] have kept
so close to their target while unemployment has been so encouragingly
Our experts were therefore agreed, as Mr Barrell put it, that
given the ability of policymakers to affect real economic variables,
whilst theoretically it was true to say that we might have had
a little more employment if monetary policy had been slightly
looser, "to the degree we can control things nobody would
say that the gains would be significant."
We note that the MPC has performed well in meeting its secondary
objectives of supporting the Government's policies for growth
ASSESSMENT OF INDIVIDUAL MPC MEMBERS
16. The Bank of England Act requires that the MPC
meeting minutes record "the voting preferences of members
who took part in the vote on the decision."
This published voting record enables our Committee to question
each MPC member about their decision and thereby hold them individually
to account. However, we cannot hold hearings with every member
of the MPC every month, and we consider this issue further in
paragraphs 21 and 43 below.
17. The correct way to judge each individual member,
as with the MPC as a whole, is to assess whether they were making
the best possible decision given all the information available
at the time. However, it may not always be clear in the record
of any given meeting why each member voted in the way they did.
In addition for those members who voted differently from the majority
it will be almost impossible to know the "counterfactual"the
path that inflation would have taken had their policy decision
been enactedand therefore make an assessment of whether
their favoured policy decision would have resulted in an outcome
closer to target than that achieved by the majority view.
18. Analysing the voting record of individual MPC
members it is noticeable how little discrepancy there has been
between members so far. As Mr King told the Committee, to date
there have only been "four occasions out of 45 meetings with
differences of view ... bigger than 25 basis points." In
his view the only differences between members had been about the
timing of an interest rate move: overall there had been "broad
unanimity on the Committee of everyone who served on it ... that
these broad pattern of interest rates ... served the economy well."
An examination of the Committee's voting record confirms Mr King's
point. Looking at the situation two years ago when, as we noted
in paragraph 8, current inflation outturns point towards policy
having then been set too tightly, the difference in policy stance
was mainly one of timing: one member of the Committee (Dr Julius)
advocated a loosening of policy for two months before the Committee
decided unanimously to cut rates. We believe it was correct
to require each individual vote to be recorded but note that so
far differences in the broad voting patterns are minor.
Report, Session 1997-98, Accountability of the Bank of England,
HC 282, Appendix 12. Back
3 Q 89. Back
4 Q 89. Back
7 An inflation
target range of 1-4% was introduced in October 1992. Back
8 Q 98. Back
9 Q 89. Back
10 Q 89. Back
speech, Yorkshire Forward, Bank of England Regional Dinner, 16
January 2001. Back
12 Q 98. Back
13 Q 98. Back
15 Q 320. Back
Report Press Conference, 16 November 2000, opening remarks by
Mr Mervyn King. Back
18 Q 103. Back
1998 Inflation Report hearing, HC (1998-99) 37-i & ii, Q 81. Back
of England Act 1998, section 11. Back
Treasury, Background notes, 13 June 1997: The Inflation Target
and Remit for the Monetary Policy Committee, para 34. Back
p 46. Back
25 Q 179. Back
26 Q 183. Back
of England Act, section 15(4). Back
28 Q 424. Back