The MPC is accountable for hitting the inflation target. Developments in the rest of the world certainly affect us. And inflation will not always be close to target. But ultimately UK inflation is our responsibility: it is made and controlled in Threadneedle Street. The credibility of monetary policy relies on companies and households having confidence that the Committee will keep inflation close to target. After a series of failed monetary frameworks in the 1970s and 80s, the gains in credibility associated with the introduction of inflation targeting and the creation of an independent policy committee greatly improved the functioning of our economy. The task of maintaining low and stable inflation was made substantially easier, and we enjoyed a sustained period of economic stability. We lose those hard-fought gains at our peril. The MPC stands charged on four counts. Why is inflation so high? Why has inflation been so much higher than we expected? Could inflation remain high? And how is the current stance of policy consistent with the inflation outlook? My task today is to make the case for the defence. Why is inflation so high?
That uncertainty maps into differing views as to exactly how accommodative monetary policy needs to be. On the one hand, there is a risk that the strength and durability of the recovery may disappoint. Our economy still faces considerable headwinds, especially within the household sector, where real incomes have been squeezed and many families may not yet have adjusted fully to the implications of the substantial fiscal consolidation now in train. On the other hand – as I’ve discussed – there is a risk that inflation may remain higher for longer than currently expected. Either because global price pressures continue to add to domestic inflation or because the persistent period of above target inflation starts to become ingrained in wage and price setting behaviour. It is still too early to reach any firm conclusions, but it seems likely that the terrible events in Japan and the political upheaval in the Middle East and North Africa will add to both of these risks. The huge disruption in Japan and the uncertainty associated with events in Libya are likely to dampen global demand, at least in the short run. But the accompanying increases in energy prices are likely to add to domestic inflation. At the MPC meeting two weeks ago I voted to raise Bank Rate to 0.75%. Even with this increase in rates, the stance of monetary policy would remain highly stimulatory. Bank Rate would still be close to an historic low and the stimulus from our programme of quantitative easing would be unaffected.