In Support the Bank of England on Monetary Policy

Posted on 28/03/2011

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While reading the Office for Budget Responsibility‘s United Kingdom Economic and Fiscal Outlook – March 2011 over the weekend (yes, I had that much fun), I noticed the chart below:


It shows the difference between the current rate of UK inflation (CPI) and an estimate of inflation had sales taxes (VAT and excise duty on fuel, alcohol and tobacco) remained constant over the period (CPIY).  It shows that CPI has been significantly higher than CPIY since the beginning of 2010, suggesting that tax changes have made a large positive contribution to the overall rate of inflation.  Given that the first-order effects of the VAT increase will drop-out of the CPI calculation in January 2012, there is a high probability that CPI will fall back to a level close to where CPIY currently is (~2.4%).  This does assume, of course, that there is no further depreciation in Sterling or any further increases in commodity prices.  However, this data does support the Bank of England‘s assertion that inflation is likely to fall back towards the target range.  As a consequence, this weakens the argument – which has recently been gaining strength – that the Bank of England’s Monetary Policy Committee should tighten policy to fight inflation.  The stabilisation of sales tax rates over time should achieve this aim with no further action.

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Posted in: Economy, My Thoughts