On the first count – why is inflation so high – the case for the defence has been advanced by a number of my colleagues in recent months and so hopefully will be familiar to many of you.1 Over the past few years, our economy has been hit by a series of large price level shocks – to oil and other commodity prices, to VAT, and to the sterling exchange rate – which have raised companies’ costs and put upward pressure on prices. Together these factors can more than account for the strength of inflation. 1  See for example the speeches by Bean (2011), King (2011), Miles (2011), and Posen (2011). BIS central bankers’ speeches  1  Indeed, recent analysis in the Bank’s Inflation Report suggests that these factors can account for a rise in the level of consumer prices since the beginning of 2007 of between 8–12%.2 This dwarfs the extent to which inflation has exceeded the 2% inflation target over the same period. Now, if we really were in a Court of Law, I fear the Judge may be looking down on me at this point with a degree of disdain, suggesting that this sounds like a series of excuses. “Inflation is inflation”, he or she may say, “whatever its cause. Your job is to keep inflation close to target”.
In particular, the risks from continuing global price pressures and the effects of the prolonged period of above target inflation meant that the level of demand consistent with achieving the inflation target had probably fallen. Nasty reasons rather than nice ones.15 I should stress that I’m not at all certain that this will turn out to have been the right policy decision. A key lesson I learnt from the financial crisis is that economists know a lot less about the economy and how the economy works than many would like to believe. Policymakers need to approach their task with humility and pragmatism. If growth turns out to be materially weaker than I anticipate or other medium-term pressures on inflation ease unexpectedly, I will reverse my decision. But with growth expected to be around its average historical rate, inflation likely to remain above 4% for the rest of this year and Bank Rate at record low levels, some withdrawal of policy stimulus seems sensible. The juxtaposition of high inflation and loose monetary policy means that there is an onus on the MPC to explain its actions. The case for the defence needs to be made. And we have a good story to tell. We can explain why inflation has been above target for much of the past few years. We think we understand – albeit with the benefit of hindsight – why we have been surprised by the strength of inflation. And we have learnt from those episodes.