In October 1992, the UK adopted inflation targeting as its monetary framework after exiting the European Exchange Rate Mechanism –in an event that is known as Black Wednesday. Moreover, in 1998 the Bank of England’s Monetary Policy Committee (MPC) was given sole responsibility for setting interest rates to meet the Government’s Retail Prices Index (RPI) inflation target of 2.5%. This target changed to 2% in December 2003 when the Consumer Price Index (CPI) replaced the RPI as the UK’s inflation index.
Since then, the Governor of the Bank of England is required to write a letter to the Chancellor of the Exchequer whenever inflation goes below or above the target by more than 1%. In his letter, the governor has to provide the reasons for inflation being out of target, and outline a plan to remediate the situation.
As we know very well (since we are now painfully familiar with inflation being above target), a key part of inflation targeting is that the Monetary Policy Committee increases or decreases the Bank Rate in order to help inflation to come back to target. So, let’s take a look at the history of both the Consumer Price Index (CPI), and the Bank Rate focusing on the last 3 decades of inflation targeting.
Charts 1 and 2 show historical values (from 1989 to 2023) for the CPI and the Bank main rate, respectively. The dotted line in each decade represents the average value of inflation/interest-rate over the corresponding period of time. In the case of the CPI, we can see that inflation was very stable during the first decade of the inflation targeting* era. However average inflation has increased consistently since 2000. In contrast, average interest rates decreased consistently from the 90’s until last year.
* Note that during this period a 2.5% on RPI was used as the target instead of a 2% on CPI. However, they both tell the same story: inflation was very stable from 1992 to 2002. So stable that in 2002 Mervin King (Deputy Governor of the Bank of England at that time) declared that “price stability had become a reality” in a speech delivered to the London School of Economics to commemorate 10 years of the inflation targeting start.
Charts 3 and 4 show the historical CPI and the Bank rate values this time focusing on the periods of time defined by which political party has been in government.
These charts tell an interesting story but of course we have to remind ourselves that the Bank of England is an autonomous organism. In its own words:
“We are the UK’s central bank and are owned by the UK government. But we have specific statutory responsibilities for setting policy – for interest rates, for financial stability, and for the regulation of banks and insurance companies. And we carry those out, for the good of the people of the United Kingdom, within a framework set by Government but free from day-to-day political influence.”
Further Reading
- Mervyn King: The inflation target ten years on. Speech by Mr Mervyn King, Deputy Governor of the Bank of England, delivered to the London School of Economics, London, 19 November 2002.
- Consumer price inflation, UK: February 2023. Price indices, percentage changes, and weights for the different measures of consumer price inflation.
- The Choice of Inflation Target, Chapter 3 in the Monetary Policy Committee of the Bank of England – Report, 27 July 1999.
- Independence – 20 years on. The Independence Conference marked 20 years since the Bank of England was granted independence to set interest rates.