INTRODUCTION TO ECONOMICS ASSIGNMENT

Introduction to Economics Assignment

Introduction to Economics Assignment

Introduction

The Bank's monetary policy objective is to deliver price stability - low inflation - and, subject to that, to support the Government's economic objectives including those for growth and employment. The inflation target is symmetric, and if the target is missed by more than 1 percentage point on either side

- i.e. if the annual rate of CPI inflation is more than 3% or less than 1% - the Governor of the Bank must write an open letter to the Chancellor explaining the reasons why inflation has increased or fallen to such an extent and what the Bank proposes to do to ensure inflation comes back to the target. This has happened only once so far, in March 2007. (Blanchflower 2007b:65-77)

Inflation in the United Kingdom was high and unstable in the 1970s and 1980s. Following the 1973 and 1979 oil price shocks, inflation was greater than 10% for much of the 1970s, with RPI reaching a high of just over 26% in 1975. Inflation targeting was adopted in the United Kingdom in 1992, and in 1997 the Bank of England was granted independence to set interest rates to meet the Government's inflation target. Since 1997, inflation in the United Kingdom has been relatively low and stable.

In recent months there has been strong upward pressure on UK inflation, because of higher global prices, particularly for energy and food. The price of oil has reached record highs of almost $120 a barrel for US light crude and annual food price inflation is currently estimated to be running at over 5%.

These higher global prices have been compounded by the recent fall in the sterling effective exchange rate.

The MPC's central projection is for CPI inflation to rise quite sharply in the short term, and be considerably above the 2% target for much of the rest of 2008. The reason for the projected increase in the short term is because commodity and import price increases are likely to work their way through the supply chain and may put upward pressure on prices beyond the energy and food sectors. Further ahead, the Bank expects inflation to fall back as commodity prices stabilise. (Blanchflower 2008:74-85)

There are considerable risks to this forecast. The risks to inflation on the downside are of more concern to me than those to the upside, and I think that the probability of having to write an open letter to the Chancellor because inflation has fallen below 1% at some point before the end of my present term on the MPC is rising. As I said in my recent testimony to the Treasury Select Committee, I am concerned about the possibility of seeing something 'horrible', which I think is more likely to arise in the real economy.

These risks to the downside have increased since the February

Inflation Report was published, as new data have come in suggesting that the prospects for the real economy have slipped, driven by declining house prices and limited credit ...