Politicians should set rates

This is my latest comment from Fund Strategy.

It is likely that, barring some kind of global turmoil, much attention will focus on the Bank of England’s Inflation Report this week.

For finance professionals it is easy to understand why they should care about inflation. But even ordinary members of the public, their real incomes eroded by rising prices, are likely to take an interest this time.

For the whole of 2010 the Consumer Prices Index (CPI) rate of inflation, the official target measure, was above the 3% maximum threshold.

Each time the governor of the Bank, Mervyn King, has had to write an open letter to the Chancellor explaining the failure to keep inflation within its target range.

Despite this indignity the governor, along with the majority of the Monetary Policy Committee (MPC), has resisted the temptation to raise rates. The MPC has argued that inflation is high because of a series of one-off effects, including the depreciation of sterling, increases in VAT and rising energy prices. Once these pass through the system, it is argued, inflation should move back towards its 2% target.

If the MPC’s argument is right then inflation should soon start to drift downwards again. If it is wrong then inflation will remain high or perhaps escalate further.

In the event of the latter a hard choice will need to be made. Should the Bank raise rates to curb the risk of rising inflation? Or should it keep them low to avoid choking the recovery?

For the sake of democracy the Bank should not be allowed to break its mandate by keeping interest rates low despite rampant inflation. The mandate was decided by an elected government and it is not for an unelected body to break it.

If the government believes the Bank should follow a different mandate it is up to politicians to devise it. The government should not let the MPC, either tacitly or overtly, break its own mandate.

Indeed it would be better still if the Bank returned to the pre-1997 arrangement in which the rate was decided directly by politicians. Political control means the decision is made by the elected representatives of the people. If they make what the public deems is the wrong decision they can be voted out.

Far too much power has been vested in unelected men in grey suits. Whether in Egypt’s presidential palace or Threadneedle Street this is wrong. Important decisions about the running of society should be made by elected politicians on behalf of the demos – the common people.