Since then the Bank, and its monetary policy committee (MPC) has had its ups and downs. Mostly, though, it has been up, this being the most successful period for UK monetary policy in living memory.
True, independence came at a good time. Ken Rogoff, former IMF chief economist, told central bankers at their annual symposium at Jackson Hole, Wyoming, last month that they were lucky to have benefited so much from the anti- inflationary impact of globalisation: the China effect. But the MPC has also made its own luck.
Now, however, the Bank faces a problem, arguably its most serious yet. There are doubts, not just about its ability to control inflation in future, but if it is under control now. Those doubts stem from scepticism about whether the consumer prices index (CPI), the Bank’s target inflation measure, accurately reflects people’s genuine experiences.
This is a serious matter, as Bank insiders are aware. If people stop believing the inflation numbers, the credibility of monetary policy suffers. That could begin the slippery slope to economic anarchy.
What is the CPI, and is inflation now 2.4% as it says? The CPI became the Bank’s target in 2003. It was Brown’s sop to Tony Blair when the Treasury rejected euro entry. The new index, constructed on the same basis throughout Europe, was his way of showing willing. Crucially, it does not include house prices or council tax. At the time I wrote that the new measure would be seen as misleading and that changing to it was a mistake. Mervyn King, the Bank governor, was also unhappy.
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“When defending a free kick from David Beckham, you don’t expect somebody to move the goalposts,” he said. But the change happened.
Had it not, I doubt we would have had this outbreak of scepticism. The retail prices index (RPI), one of our oldest official statistics, has inflation at 3.3%. The RPI excluding mortgage-interest payments, the Bank’s old target, puts inflation at 3.1%. Nobody would have had serious cause to challenge them.
Instead, the switch to the CPI, and the highly visible rise in energy prices, has led to silly suggestions that “true” inflation is nearer 10%. It has also produced accusations that the CPI is really a “chav” price index — measuring inflation for those who buy (imported) branded sportswear and electronic products — leaving the middle-classes to bear the brunt of inflation.
In fact, the evidence is that people who suffer most from inflation driven by higher energy and food prices are those on lower incomes, particularly pensioners, because these items make up a higher proportion of their spending. Pensioner inflation, on reasonable assumptions, is nearly 4%.
Some middle-class families face big increases in independent school fees but that is nothing new — they have increased by 8% annually for the past five years. University tuition fees, since their introduction eight years ago, have risen roughly 2.5% a year and so have not contributed much to inflation. The new, £3,000- a-year fees will add to CPI inflation when introduced this autumn, though their real impact comes later; top-up fees are not payable upfront.
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What is the real rate of inflation? “Core” inflation, excluding energy and seasonal food from the CPI, is just 1.1%. For many people, however, the things excluded from core inflation — life’s necessities — give the true measure.
Charlie Bean, the Bank’s chief economist, recently rejected core inflation, saying it was not of any real use. Using figures from the RPI, I constructed a “necessities” index consisting of housing, domestic fuel bills, motoring expenditure, fares and food — nearly 60% of all spending. The result was a “necessities” inflation rate of 4.8%. The biggest contributor is energy, up 29% in the past 12 months.
But inflation measures are constructed as they are for good reason, reflecting our spending patterns. Is it reasonable to exclude clothing and footwear, falling 4% a year? No family with children could do so. We have to buy some furniture, furnishings and durables, if only for replacement purposes.
Contrary to popular myth, consumer-electronic products are not prominent in the CPI, and have a weight of just 27 parts in 1,000. I still have problems with the index but accept that either of the RPI measures gives us something like “true” inflation — in other words between 3% and 3.5%.
If you really want to know why true inflation isn’t 5%, 6% or 10%, look at spending. The CBI reported last week that August was the best month for retailers since December 2004. There is a caveat — the survey straddled the base-rate rise — but there was undoubted strength. That simply would not be happening if prices were rising faster than, or as fast as, earnings, currently increasing by just over 4%. We would be in the deepest of consumer recessions.
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The Bank’s real problem comes from sharply rising energy prices. It has had to deal with food-price inflation before; during 2001 it hit 7%. It has not had to deal with a surge in energy prices or the folk memory that such surges have been associated with very high inflation.
What should the MPC do to convince people it has inflation under control? The “shadow” MPC, which meets under the auspices of the Institute of Economic Affairs, anticipated last month’s rate hike from 4.5% to 4.75%. Three members, Tim Congdon, Andrew Lilico and Gordon Pepper, think the Bank should hammer home its advantage with another hike this week. That would certainly make people sit up and take notice. The other six shadow MPC members vote to leave rates on hold, although three have a bias to raise rates further soon. Inflicting pain is the usual route central banks adopt to convince sceptics they mean business.
There is, however, another way. The Bank’s inflation problem is largely an energy problem. Even if people are sceptical about the CPI, they appear to accept that this is not, yet, a general inflation problem. Public inflation expectations have risen, though only a little. Wage settlements remain subdued. All that needs to happen for the energy effect on inflation to subside is that prices stop rising; they do not have to fall.
The Bank could do more to explain this. It has an interest in inflation staying low. If it overreacts, it runs the risk of convincing everybody that old-style inflation is back — and that would be disastrous.
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PS: Before I went on holiday (airport chaos, lost luggage, virulent foreign bug), I suggested scaffolding could be a useful new economic indicator. These days it appears to be popping up everywhere, even for simple household maintenance tasks.
Little did I realise what a Pandora’s box this was. The scaffolding boom, it seems, owes everything to bureaucracy, particularly the Work at Height Regulations 2005, which came into effect in April last year.
These rules, which had their origins in Brussels, define “at height” as any place where a person could be injured falling. In practice, work above two metres appears to require scaffolding. If your window cleaner is hanging precariously from his ladder, he could be breaking the law.
Some other titbits — all provided by readers. Why does scaffolding stay up so long? Because many smaller scaffolding firms have nowhere to store it, so they leave it until it can be moved to the next job. There’s also what may be an urban myth; that many scaffolding firms started life by dismantling somebody else’s poles and planks and claiming them as their own. I’ll stick to my tried-and-trusted skip index.