THE Government should scrap the Bank of England’s inflation target and have it focus instead on the strength of demand, a free market think tank has said.
In a report by the Adam Smith Institute the organisation said the focus on a two per cent inflation rate increased the risk that the Bank would make decisions that would harm the economy.
It said policy measures intended to help ensure inflation remains on target such as changes to interest rates or quantitative easing, could result in damaging shocks to demand.
With inflation running at three per cent the Bank has signalled interest rates will be increased this year, from 0.5 per cent.
The report said the Bank would do better to focus on changes in demand itself, as measured by the total income generated in the economy, nominal gross domestic product.
In the report, Professor Anthony J. Evans of ESCP Europe Business School notes harmful effects of the loose monetary policy followed by the Bank of England since the financial crisis of 2008.
These include increases in pension deficits in the UK following falls in the returns achieved on bonds and destabilising capital flows to countries with higher interest rates.
“Adopting a Nominal GDP target is effective in good times and bad, and provides a coherent, rule-based framework for monetary stability,” said professor Evans.
He also criticised the system of stress tests devised by regulators to try to avoid a repeat of the financial crisis, claiming it is overly complex and could be gamed by banks.
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