Now, of course, it all depends on how badly you need that car, and in reality some price levels may stay elevated and some may not. Monetary policy should not respond to supply shocks which do not become generalised through their impact on inflation expectations. In more modern times, and certainly in the life of the MPC, supply shocks have tended to be temporary in terms of their impact on inflation. But if that is not likely to be the case in our assessment, we will step in and adjust policy as needed. Nothing has changed in our approach. To illustrate this approach, let me briefly summarise the announcement we made at the end of our meeting last week, drawing out the differences of view, which are very reasonable differences. The MPC emphasised that the inflation target applies at all times, with a clear focus on medium-term prospects for inflation rather than transient factors. The judgements required by this medium-term focus are particularly important and challenging at a time like this of very large shocks to the economy. For most members of the MPC, the outlook for the labour market – as I described earlier – is highly uncertain and to some degree likely to be resolved in fairly short order, and this justified a wait and see approach on policy in view of the continuing belief that higher inflation will be temporary.
The weakness of the recovery has led some people to suggest that we could increase the effectiveness of quantitative easing by directing the money used to buy the gilts to buying private sector assets instead, or else to inject purchasing power more directly by passing it directly to households in the manner of Friedman’s famous helicopter. Such options can always be split into two legs: a fiscal leg, involving some bond-financed public expenditure and which ought to be subject to the control of the Chancellor and the Treasury; followed by a second monetary, or financing, leg in which the Bank buys the corresponding quantity of government debt on the secondary market and is just conventional quantitative easing. Viewing it this way is, I believe, helpful as it allows one to focus on the merits of the alternative use to which the funds are put. For instance, the easiest way to implement a “helicopter drop” would be to increase tax allowances temporarily. But the life cycle/permanent income model of consumption behaviour suggests that one should expect the vast majority of such a temporary windfall to be saved rather than spent. It certainly is not the obvious way to try to boost demand, unless one can direct the additional income to credit-constrained consumers who are more likely to spend it. In any case, the design of any fiscal intervention does not need to be tied to the question of how the financing is split between money and bonds.