British economic life has acquired a new ritual. Every three months the Governor of the Bank of England writes a letter to the Chancellor of the Exchequer explaining why he has missed the inflation target.
On the same day, the Chancellor responds and accepts the Governor's excuses without a word of criticism. In any normal business, if you gave up on hitting the target your employer set for you, you'd expect a roasting. Next time around, George Osborne should rip up the rule-book and write Mervyn King a proper letter. Here's what it should say.
"Dear Mervyn,
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"Thank you for your letter. I am disappointed that inflation has yet again significantly exceeded the target set for the Bank of England by the government. I should remind you that meeting this target is a legal requirement. I accept that a target won't be met every month. That is why some flexibility is allowed. But I'm worried that you're not really trying. And I am frankly puzzled by some of the arguments put forward in your letter. I believe there must be something wrong with the forecasting model the Bank is using. In the letters sent to me and to my predecessor, Mr Darling, you have consistently predicted that inflation will fall. For example, in your letter of 17 May last year, you argued that the rise in VAT and drop in the value of sterling were the main reasons why you'd missed the target. 'The effects on inflation can be expected to wane over time,' you stated. 'As this happens, the Monetary Policy Committee expects that inflation will fall back.'
"It didn't happen, did it? In fact, inflation has accelerated. If a model keeps producing the wrong forecasts, it's time to get a new model. I'd like you to ask the Bank's economists to start working on that and stop sending poor predictions.
"As for your explanations, they sound more like excuses. Stop going on about the 'output gap'. This is intellectual nonsense, and it is time you realised it. The idea that the Bank knows precisely the 'right' level of output for the British economy, and how much we are currently below it, is the kind of thing that even the Gosplan economists in Moscow in 1970 might have considered arrogant. In reality, we have no precise idea what Britain can produce, or how far below that we might be right now and certainly not to within a couple of percentage points. This so-called 'output gap' doesn't exist. It clearly isn't bearing down on inflation in any meaningful way. So stop talking about it.
"Next, stop blaming imported inflation. True, commodity prices are going up around the world mainly because your friend Ben Bernanke over in Washington is running the Fed in the same incompetent way that you're running the Bank.
Of course, global inflation affects us here in Britain. But it is mediated through the exchange rate. If sterling was stronger, then the rising price of oil wouldn't make any difference to the amount ordinary people have to pay at the pumps. Nor would the price of food or clothing be going up the way it is. The Bank can certainly influence the exchange rate. Higher interest rates would strengthen sterling and so change the inflation outlook. If you pledged that there would be no more quantitative easing, that too would help the pound. Both together would make sure we weren't importing inflation anymore.
"Finally, I would like you to read more widely. You used to be an academic economist (indeed, you were one of the 364 economists who famously attacked another new Conservative Chancellor in 1981). You must be aware that there is plenty of economic theory to suggest that running negative real interest rates of 3.5% and printing money by the barrow load is a sure way to create inflation. In your next letter, I'd like you to explain why the Bank's policies of ultra-low interest rates and quantitative easing are not responsible for today's inflation.
"Above all, I am worried by the air of defeatism that seems to have overcome you. Never believe that inflation is outside your control, or that it is an acceptable way of working our way out of our debts. In the inflationary 1970s, and early 1980s, when prices around the world were soaring ahead, and the price of oil more than quadrupled, one country never experienced any significant inflation: Germany. Even through the worst of the 1970s, the Bundesbank managed to keep the average German inflation rate at just 4.9% a year. In the 1980s, the average rate was just 2.1%. Please explain why the Bundesbank was able to achieve that in far more difficult global circumstances.
"I am prepared to give you one more chance. But the Governor of the Bank of England can't expect to be the only person in the country who is not judged by their results. Inflation makes life hard for ordinary people. Real wages are already falling. Families are struggling to make ends meet. The Bank is close to the point of losing credibility. Once that happens, there is a real risk of interest rates having to rise very sharply to bring prices under control again. So if you can't get the inflation rate back within the target, it is time we found someone who can.
"With best wishes, George."
