Testing time for Gordon’s strategy

Aug 21 2008 by Peter Jackson, The Journal

GORDON Brown’s decision to hand over the setting of interest rates to the Bank of England was universally hailed as a brilliant move.

And, ever since, even his fiercest critics have said it was the best – or only good – thing he ever did.

But it was hardly a difficult idea, and if so brilliant, why had nobody done it before? Probably because the setting of rates is such a powerful tool in controlling the economy, or at least monetary policy, that no previous chancellor would willingly relinquish it.

Now, however, the policy is meeting its first real test and, as we sail into choppy economic waters, maybe even Gordon is having second thoughts.

It is worth reminding ourselves how the process works. The Bank of England’s monetary policy objective is to deliver low inflation and, subject to that, to support the Government’s economic objectives, including those for growth and employment.

This is important: the MPC’s primary role is to keep inflation low and afterwards need it worry about joblessness or growth, so, when inflation threatens, interest rates will be high, even if this causes slow down or recession.

The Government’s target inflation rate is 2% and, if this is missed by more than one percentage point on either side, the Bank of England Governor has to write to the Chancellor to explain why. With the current rate at 4.4% and rising, Mervyn King will be writing more letters than Pliny the Younger and Henry Root combined.

In May, Peter Spencer, chief economist of the Ernst & Young Item Club suggested we change the measure of inflation to “core inflation”, excluding food and energy prices and currently running at only about 1.5%.

That’s one solution; another lies in the 1998 Bank of England Act that says , in extreme circumstances, if the national interest demands it, the Government can instruct the Bank on interest rates for a limited period.

Will Gordon be tempted?