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The Role of the MPC in Controlling Inflation in the UK

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The MPC is responsible for setting interest rates and trying to meet the govts target of CPI =2% +/- 1. As a secondary objective they also need to consider the impact of interest rates on the wider economy, notably output and unemployment.

Monetary policy is also pre emptive, this means they try to reduce inflationary pressures before they occur. Therefore the MPC look at a variety of economic indicators to be able to judge future inflation trends. In particular they look at the amount of spare capacity in the economy and the rate of growth compared to the Long Run trend rate. If inflationary pressures are increasing the bank will raise interest rates to reduce the growth of consumer spending and AD. The UK economy is very sensitive to interest rate changes this is because of high levels of debt, both mortgage and credit card debt. Therefore a moderate 0.5% increase in interest rates can have a significant effect in reducing demand.

Since the Bank of England was made independent in 1997 they have had full control of monetary policy and have been able to successfully keep inflation within the govts target. It appears the UK economy has been able to avoid the boom and bust economic cycles that characterized the post war period. By having an inflation target the MPC have been able to maintain a discipline of avoiding a booming economy.

In addition because the Bank of England is independent from political pressures they have generated and confidence in their low inflationary credentials. Therefore this has helped reduce inflationary expectations. This is very beneficial for reducing wage inflation and other cost push factors.

However although the Bank of England has played an important in reducing inflation, there are arguably other factors that are also very significant. Firstly Supply side policies such as privatisation and deregulation of markets have helped increased productivity and reduce inflation. Secondly global inflation has remained low due to a combination of factors but mainly due to technological improvements. It is worth noting that in the past 18 months there has been significant rises in oil prices and other commodities. If these continue it is likely to cause inflationary pressures within the UK which will make the job of the MPC more difficult.

Conclusion.

The MPC has been much more successful than previous inflation strategies. They have helped to break the cycle of boom and bust in the UK economy and reduced inflation expectations. However they have been helped by benign world inflation. This may change in the coming months.


About the Author

R.Pettinger is an Economics teacher at Oxford and writes  frequently on the UK economy and mortgages. He edits a site  about Mortgages including a guide to different types of  mortgages. http://www.mortgageguideuk.co.uk/.


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Article Published/Sorted/Amended on Scopulus 2007-04-01 23:54:06 in Economic Articles

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