NEW YORK/LONDON (Reuters) - The Bank of England’s quantitative easing has been effective, but the subsequent recovery in nominal demand has created a situation where inflation is too high, Bank Deputy Governor Charles Bean said on Friday.
Some economists who doubt the Bank’s commitment to tackling inflation have accused it of focussing behind closed doors on nominal growth — the sum of real economic growth and inflation — rather than its primary goal of 2 percent inflation.
Bean himself did not blame the Bank’s QE policy directly for inflation that is now at 4 percent, saying higher global commodity prices, a rise in value-added tax and a drop in sterling in 2007-08 were mostly to blame.
Britain’s nominal GDP growth, or rate of growth in output in cash terms, averaged 5 percent before the financial crisis, a level consistent with sustainable real economic growth and inflation at the Bank’s 2 percent target, Bean said.
Nominal GDP growth fell sharply during the recession, and recovered only after the BoE bought more than 200 billion pounds of assets, overwhelmingly government bonds.
“By that standard, it looks like policy has been effective, though of course other factors besides monetary policy have certainly also been at work,” Bean said in a speech at a University of Chicago monetary policy conference in New York.
However, the improvement in nominal GDP was driven by an undesirable increase in inflation rather than by real GDP, Bean said.
“While the overall rate of nominal demand growth has been satisfactory, the split between inflation and activity has certainly not been everything we would wish,” he said.
Bean did not say how the BoE should deal with above-target inflation while supporting growth. He voted to maintain interest rates at their record low 0.5 percent this month as part of a 6-3 majority in favour of keeping rates on hold.
Economists expect the central bank to raise rates gradually later this year, and money markets predict the first rise will come in May.
Bean said that interest rates rather than quantitative easing should be a central banker’s main tool during normal economic circumstances.
The effect of interest rates on the economy was much better understood than that of quantitative easing, which could prove less effective during normal times when traders had access to capital to arbitrage against a central bank, Bean said.
Moreover, continued quantitative easing purchases during normal times risked giving the impression that a central bank was subsidising the cost of government borrowing, he added.
“Aside from giving rise to doubts about the central bank’s independence, it could also lead to higher inflation expectations and long-term nominal interest rates,” he said.
In a question and answer session after his speech, Bean said that core inflation, which strips out energy and food prices, did not always give a good guide to longer-term inflation trends at times of price shocks.
“If say, you have an oil price shock ... and that does lead to inflation expectations moving up, pay growth moving up, significant second-round effects being embedded and so forth, what would happen, of course, in the medium term is core inflation would move up to the headline inflation, not the other way around,” he said.
Bank policymaker David Miles said on Wednesday that inflation was close to zero once the effect of January’s rise in VAT and higher commodity prices was stripped out. And several policymakers believe the labour market is too weak for there to be much risk of a wage-price spiral.