Spencer Dale: The UK’s economic recovery – why now; will it last; and what next for monetary policy? Speech by Mr Spencer Dale, Executive Director, Monetary Policy, and Chief Economist of the Bank of England, at the Confederation of British Industry (CBI) East of England Midwinter Lunch, Newmarket, 13 December 2013. *  *  *  I would like to thank John Lewis, Matt Trott and Gavin Wallis for their considerable help in preparing this speech. The views expressed are my own and do not necessarily reflect those of other members of the Monetary Policy Committee. I thought I would start today with a short reminiscence about the late Eddie George, who was Governor of the Bank of England between 1993 and 2003. Soon after becoming Governor, Eddie gave an interview in which he was asked how he would judge the success of his Governorship. Now this was before the advent of the Monetary Policy Committee, so he couldn’t frame his response simply in terms of hitting the inflation target. Instead, Eddie replied that “My personal ambition is that the rate of growth of output should be above the rate of inflation for three years in a row”.1 At the time, this seemed a fairly tall order: prior to Eddie taking over, this hadn’t been achieved even once since the Second World War. But as it turned out, growth was stronger than inflation in every single year of Eddie’s 10-year reign. And that continued for the next few years after he’d retired.
There are also real economic costs when inflation is too low. To utilise resources most effectively, relative prices must be changed in pace with changes in production conditions and preferences. Some inflation will ensure that relative prices can be changed easily without substantial real economic costs. In the 1990s, the Norwegian economy expanded sharply, with considerable restructuring and substantial changes in relative wages and income, while inflation was low and stable, averaging about 2½ per cent. The wheels of the economy run smoothly when monetary policy is oriented towards an inflation target of 2½ per cent. Deflation may intensify periods of economic contraction. With deflation, the interest rate will no longer be an effective instrument for bringing the economy out of a cyclical downturn. As developments in Japan show, fiscal policy instruments are not necessarily effective either. Unemployment can remain high over a long period. Therefore, the best contribution monetary policy can make to the economy in the long term is to provide a nominal anchor. It is equally important to avoid an inflation rate that is too low, or deflation, as it is to avoid an inflation rate that is too high. In the short term, monetary policy can contribute to smoothing fluctuations, that is, fluctuations in demand and employment. If there is confidence in the nominal anchor, monetary policy will be a more effective instrument in short-term stabilisation policy. In the short term, there is a trade-off between variation in output and employment and variation in inflation around the inflation target.