Inflation Case

5) Assess the view that the Bank of England has been right to ignore surges in inflation created by successive waves of energy and commodity price inflation.

There have generally been views that agreed with the Bank of England in ignoring inflation surges whereas there have been some disagreements.

Adam Posen, a member of the MPC, was in agreement with the Bank of England, more worried about weak economic growth and gave more emphasis to the risks of a second recession and price deflation. He argued for expanding the monetary policy, quantitative easing (QE), to boost liquidity in the UK banking system and increase the funds available for lending. He believed that high temporary inflation rates would have little effect on expectations and that it should be ignored because depressed conditions in the UK labour market (in particular high and rising unemployment) meant that a price-wage spiral was unlikely. This was generally the view adopted by the Bank of England.

Another case that can be put forward in favour of the decision is that in reality, the UK is not a strong financial situation. Austerity cuts have meant that the government cannot afford higher wages and has had to freeze many public sector wages. Therefore, it is unlikely there will be a wage-price spiral anytime soon and it is alright to ignore inflation surges as it appears to be temporary.

However, the Bank of England has only been right to ignore these inflation surges to a certain extent. Andrew Sentence, another member of the MPC who argued against the normal flow of the Bank of England, believes that they ought to take decisive action to control inflation, instead of ignoring it, before it starts to kick into business and consumer thinking and causes a rise in inflation expectations. If expectations become stronger, workers will start to demand higher wages, businesses will have to increase fees and costs which may cause cost-push inflation and maybe lead to an inflationary spiral. (Diagram)

This view is backed up by the Fathom consultancy. They claimed that inflation is more long term due to supply shortages and lack of competitive forces in the UK economy. Therefore, AS falls and causes inflation. Furthermore, they say that this inflation is presently taking place and is contributing to the general UK economic problem that AD growth. This is because inflation mainly hits people's real disposable incomes and causes

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