Mervyn King: The institutions of monetary policy Lecture by Mr Mervyn King,1 Governor of the Bank of England, at the American Economic Association Annual Meeting, San Diego, 4 January 2004. The references can be found on the Bank of England’s website (www.bankofengland.co.uk)  *  *  *  President, Ladies and Gentlemen, To have one central bank governor address you today may be regarded as a misfortune, but to invite two looks like carelessness! It is a great honour to be invited by this year’s President-Elect, Marty Feldstein, to deliver the Ely lecture. Marty has been my teacher, mentor, colleague and friend for over thirty years, and I never cease to be amazed by the energy and imagination which he devotes to the study of economic problems. I got to know Marty during my time as a Kennedy Scholar at Harvard in 1971. The Kennedy Scholarships form one part of Britain’s national memorial to President Kennedy. The other part is an acre of land, now American territory, at Runnymede. At the ceremony to open the Runnymede memorial in 1965, Prime Minister Harold Wilson remarked about President Kennedy that “his eyes were on the horizon, but his feet were on the ground”. Almost thirty years earlier Richard T. Ely published his autobiography entitled “Ground under Our Feet”. Whereas I found the experience of coming from Europe to the United States intellectually liberating and exhilarating, a hundred years earlier Ely found academic freedom by making the reverse journey.
Massive speculation on that day led to the announcement in the morning of a 2 percentage points rise in interest rates and, when that failed to dampen the pressure on sterling, of a further 3 percentage points rise in rates. That second announcement, far from bolstering the exchange rate, merely convinced financial markets that Britain’s membership of the ERM could no longer be sustained politically. The strong political commitment to joining European monetary union, which was the effective support for other currencies in the ERM, was absent in the United Kingdom. Following its departure from the ERM, the UK introduced an inflation target regime for monetary policy. It succeeded in bringing inflation down to around 2½ percent (see chart 2). 6  BIS Review 5/2004  Chart 2: UK inflation and inflation expectations, Oct 1991-Oct 2003 Per cent 7  Implied inflation (a ) from IGs RPIX inflation rate  6 5 4 3 2 1 0 Oct-91  Inflation target announced  Bank independence  Oct-93  Oct-95  Oct-97  Oct-99  Oct-01  Oct-03  (a )  Implied average inflation expectations from 5 to 10 years ahead, derived from index-linked gilts. Source: Bank of England, ONS  But long-term inflation expectations did not fall as quickly. Only after the announcement in May 1997 by the new Labour government that the Bank of England would be made independent did inflation expectations fall quickly to the target level, as can be seen from chart 2.