Left a Bit. Right a Bit. the Mysteries of Inflation Targeting and Bob Monkhouse's 'Golden Shot' ; Where Should Central Banks Aim Their Monetary Arrows?

By King, Stephen | The Independent (London, England), January 16, 2006 | Go to article overview
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Left a Bit. Right a Bit. the Mysteries of Inflation Targeting and Bob Monkhouse's 'Golden Shot' ; Where Should Central Banks Aim Their Monetary Arrows?


King, Stephen, The Independent (London, England)


Inflation targeting is complicated by the number of different measures available

I can't quite remember watching the late Bob Monkhouse's The Golden Shot: I was probably too busy playing with my Corgi toys. I can, however, recall his anecdote - possibly apocryphal - about Bernie the Bolt.

As he explained it - during a speech at the end of a rather boozy dinner I happened to be attending, so I may not have captured all the relevant nuances -The Golden Shot, broadcast live to the nation, required viewers to phone in to the studio and, using the image on their televisions at home, to instruct Bernie the cameraman to aim his camera - with crossbow attached -at a target. "Left a bit, right a bit ... fire". On one occasion, though, the viewer on the end of the line was behaving a little strangely. Right a bit, right a bit... right a bit more ... until the target has disappeared altogether. Monk-house couldn't understand what was going on. It was only then that the contestant admitted that he was in a phone box and could only vaguely see through the window of the TV shop across the road.

All of which tells you that targets are not always easy to hit, either because the connection between instrument and target is a little vague or, alternatively, because the target is insufficiently well-defined. For economists, the obvious parallel with The Golden Shot is inflation targeting. Central bankers know in theory the inflation rate they're aiming at - either because they have selected the rate themselves, in line with the European Central Bank's approach, or because it's been imposed upon them from on high, as with the Bank of England - but they may not always know how to get there. And even if they do get there, they might wonder whether they really and truly have achieved their objective.

Part of the problem is Bernie the Bolt. Central banks are like the man in the phone box. They know what they want to achieve but they cannot be sure of how to achieve it. They are, if you like, dependent on the behaviour of others. And that behaviour, of course, changes. No one, least of all the Bank of England, thought that base rates would peak at 4.75 per cent in the latest interest rate cycle and then come down: they did, though, because the housing market responded in a very different way from previous episodes to changes in interest rates.

For central banks, though, there is a further problem. It's all very well defining a target but inflation targets are a lot less stable than those you attempt to hit with a crossbow. Indeed, central banks can't even agree with each other on the kind of target that should be hit. For the European Central Bank and the Bank of England, the inflation target is so-called "headline" inflation: it includes all those volatile components like food and energy. For the Federal Reserve, there is no formal target at all - although if Ben Bernanke, the incoming Fed chairman, is to have his way, a target might eventually emerge. His preference is for a "core" target that excludes things like food and energy.

At this point, your minds might be drifting towards related subjects - trains and anoraks, per-haps-but, duringperiodsof sustained oil price increases, the difference between these two approaches to inflation targeting becomes a bit more interesting: higher oil prices will raise headline inflation relative to its target but need not raise core inflation relative to target unless, say, wages start to rise in response to the initial hikes in oil prices. In other words, the pressure on the ECB and Bank of England to raise interest rates might, in these circumstances, be greater than for the Federal Reserve: same shock, if you like, but a very different reaction.

Central bankers would probably object to this rather simple description. They would argue, instead, that the choice of headline or core inflation is a secondary consideration: what really matters is not so much the monthly inflation rate and its occasional oscillations but, rather, the stability or otherwise of inflation expectations.

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