Coffee House

Brown’s wrong-headed faith in inflation targeting

27 January 2009

"Why did nobody notice it?" asked the Queen a few months ago, at the LSE. The simplest answer is that inflation targeting was a disaster. People wrongly thought that if you controlled the prices, all else would follow. This was wrong, hopelessly wrong, calamitously wrong. Everyone gushed about what a great idea Bank of England independence was. In fact, monetary policy management in the last ten years was a disaster. Inflation targetting was a false god. And the fact that no one says so now is a sign of just how far we are from understanding what happened in the last ten years.

As Friedman taught the world, controlling the supply of money is the key to stability. But the error was to think that inflation was a proxy for money supply. It was true when the Tories started inflation targeting, post the ERM debacle. But gloablisaion changed that: China prices provided a deflationary shock. The BoE was told by Brown to keep a symmetrical target of 2.5% RPI (2.0% CPI) – and this was ill conceived. The type of deflation that China brought was benign. It should have been allowed to run its course, increasing our buying power a little. Instead the BoE fought this by unleashing an avalanche of dangerously underpriced debt. All this extra money lifted the prices back to the BoE range – but this also loaded the public up with masses of debts. And while consumer prices were stable, asset prices certainly were not – everything from houses to antiques to fine wines went skywards. This is classic sign of a credit bubble, of excess money supply. But blinkered Brown only cared about CPI (and if the public were feeling rich because their house prices had doubled, so much the better!) Clever excuses were dreamed up to justify this new wave of debt.


Crucially, the international early warning alarm – the one Brown now pretends he wants to create – was sounding. But Brown and Greenspan weren’t listening. Take this April 2006 report, Is Price Stability Enough, by the Bank of International Settlements which advises central banks.  Its warning was there in black and white:

"Achieving near-term price stability might sometimes not be sufficient to avoid serious macroeconomic downturns … Persistently easy money conditions can lead to cumulative build-up over time of significant deviations from historical norms – whether in terms of debt levels, savings ratios, asset prices or other indicators of ‘imbalances’. The historical record indicates that mean reversion is a common outcome, with associated and negative implications for future demand".

Stating the bleeding obvious really: there was no inflationary boom in 1980s Japan, but it was followed by the 1990s. Nor in 1920s America. Inflation never was a guarantor of stability. Brown says he didnt foresee "market failure" in the banks – as if this was such a freak event that no one could have predicted how depraved these bankers would be. Nonsense. He didnt forsee a basic bubble, one pointed out to him by the BIS and a whole lot of others. Far more comfortable for Brown to blame complicted banks and CDOs.

So this wasnt "market failure" as Brown pretends, but government failure – the failure of government to regulate the supply of money.  The same basic failure that lay behind the entirely avoidable 1930s depression. Truth is that the BoE had the wrong instructions: inflation targeting was right for the 1990s when the Tories introduced it. But it was wrong after 2000. And it was Brown’s arrogant belief that he had cracked it, found the philosophers’ (or economists’) stone, that inflation targeting was the be-all-and-end-all, that led us into the economic calamity now unfolding.

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  • Ian C

    A nail hit very accurately on the head Fraser. Surprising thing is that noone has said this until now – and that it should come from a political journo. Congratulations.

    It has always been apparent that changing the RPI to the CPI was part of this problem, but where were the ‘no clothes’ messengers? Too busy shorting financial stocks and making money to let the rest of us in on it!! That’ll sound and look extremely good when they sit in front of Labour committee members and explain this…!

  • Augustus

    “The same basic failure that lay behind the entirely avoidable 1930s depression.”

    “Governments were either bemused as were the speculators,
    or they deemed it unwise to be sane at a time when sanity exposed one to ridicule, condemnation for spoiling the game, or the threat of severe political retribution.”
    (from: The Great Crash 1929 by J.K. Galbraith)

  • AngloWelshDragon

    Anybody who’s had a store card in the last 10 years won’t consider that debt ‘dangerously underpriced’ (hollow laugh!)

  • Ivy Eileen

    Agree entirely with Bluebottle – the man was feeding dope to the masses (“illusory feel-good factor”).

  • luke

    Its a really great post this fraser but is it necessary to lay on the Brown missed it emphasis quite so greatly?

    Truth is, almost noone saw this coming – western goevrnments around the world certainly didnt.

    Surely its better to really understand tehse things and let the public later decide for themselves what that means for which politicians they think should run the country?

  • luke

    No chuck. HM was more right than you. Noone noticed it, not just noone in any western government.

  • David

    Out of interest, how does this analysis explain the global financial crisis and economic slowdown?

  • David Bouvier

    John Moss – a brilliant terse summary, though I thought the wheels first wobbled about 2-3 years into Gordon’s reign.

    Forlonehope – lets credit (Charles) Goodhart for his law: “any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes” (1975)

    I sincerely hope that the BoE MPC was watching a broad array of monetary indicators to manage inflation overall, if if held accountable for CPI only. I don’t read the details enough to know.

    The question looking forward would have to be: is RPI (or some other measure) of inflation sufficient – or must be an explicit money supply measure o- or must there be two or more measures.

    Certainly in building business metrics for international organizations, it has often been clear to me that single metrics can be gamed by local management and that often you need a complementary metric that will show whether you are being gamed. See-saw swings are very different from both moving in the same direction. Perhaps consumable and asset prices are such a pair (any thoughts from a better macro-economist than me?)

  • HST

    Finally somone has pointed out the folly of central banking policy. Sadly, however, other countries can be tarred with the same brush – the finger can only be pointed at Brown over the choice of harmonised EU inflation as the target. (OK, and the tripartite nonsense)

    The whole world was moving towards inflation targeting as the holy grail…

    What should be the paradigm instead? Should there be a dual mandate such as the Fed, for growth and inflation? That is almost too open to manipulation, as the Greenspan put showed in the early 2000s.

  • cuffleyburgers

    My understanding was that CPI was used to put us in line with EU practice, and Brown was content to ignore the problems that created, or perhaps didn’t understand the differences (and certainly didn’t care as it brought electoral success).

    Inflation targeting has worked well enough in Euroland, or at least in Germany. Euroland’s problems are more to do with disparities in the economic cycle between different countries.

    The Economist for one has been sounding the alarum for years about Asset price inflation, and it was pure stupidity on the part of the government not to have insisted that the Bank factor that in to their Interest rate considerations.

    Finally, the really expensive failures have been those of bank regulation. And the blame for that rests squarely with McLunatic.

  • Johnathan Pearce

    Good article. The China aspect to this is interesting; I see that P. Hoskin linked yesterday to an item in the Washington Post about how China, with its fixed, artifically low exchange rate, built up massive surpluses of cash that were ploughed back into Western government bonds, which had the effect of boosting the money supply in the West, leading to the asset bubble, which encouraged even more purchases of Asian goods, and so on, in a cycle that eventually had to stop when house prices became unaffordable.

    The China link is in some ways at the heart of all this.

  • Fergus Pickering

    Mark frae Moray. You said a heaping mouthful, bo. That’s American, Verity. I just put it in for effect.

  • Alan Douglas

    O/T – I love reading your writers and the comments, but wonder if I can request a wider variety of pictures heading up the articles.

    Sadly, we already know what our glorious leader looks like, and the tone of the whole of Coffee House would rise through the roof !

    Alan Douglas

  • Sam

    100% correct.RIP Santaya,”those who forget History.. ”
    Anyone thinking about France/Germany/Belgium/Holland/Spain/ Italy..
    Any one in the Treasury who read History? Or remembered anything ?

  • Bluebottle

    Inflation targeting is at the heart of the confidence trick that is New Labour. That is why a false index (the CPI) was selected by Brown. Inflation, and as a result, interest rates, were kept artificially low for too long. This policy encouraged an illusory feel-good factor in in the electorate as the price of their houses went ever upward, so they wouldn’t notice (or be bothered by)Brown lifting increasing amounts of tax. At the same time they would continue to vote Labour. Consumers and the government went on a borrowing and spending binge not creating and spending wealth, but debt.

    As for Brown, he simply didn’t care: he was taxing, borrowing and squandering more than any previous chancellor, yet he was delivering election victories. That is the only reason New Labour ever existed; to get elected. They didn’t plan beyond the next headline or election and for 10 years it worked. What Brown probably didn’t foresee was that the banks (Brown’s own personal cash machines)would screw things up so royally. Without that New Labour’s comprehensive wrecking of Britain and squandering of its wealth might have continued for another electoral cycle with even a bigger bust at the end of it.

    Now, a little earlier than Brown anticipated, the sky grows dark with chickens coming home to roost.

  • John Moss

    Howe did th ehard work in ’79-83 by controlling the money supply. Lawson kept the faith for a few years, but was then seduced by the ERM and 3.0DM to the £. Lamont had to pick up the pieces, with a mix of inflation targetting and contracting money supply – easier in a recession – Clarke had a relatively easy ride on the far side of the devaluation post ERM. Brown took over at the point where monetary issues were just starting to re-appear, but ignored them, repeatedly over ten years.

    He’s reaping that whirlwind.

  • Hysteria

    @ Forlornehope “This principle is actually a general rule for any measure used for managing anything, which is why so much of the target management by this government goes awry”

    This is an interesting observation – normally in the “measurement business” we hear “if you can’t measure it you can’t manage it” and “what get’s measure gets done”

    I am not sure if the predictability of a trend is that essential anyway (read The Black Swan for more on that thought) – but I would disagree with the general comment you make.

    But in respect of the inflation target issue you are dead right – if you pick the wrong metric to measure you are in for a world of hurt

  • Andy

    It was the wrong sort of inflation that was being targeted, in my view. If you omit an overheating housing market from any measure of inflation, you get a housing bubble but no apparent need to raise interest rates to control borrowing.

  • Chuck Unsworth

    Incisive comment from HM. Why indeed did nobody ‘notice it’ nobody in Government, that is.

  • Tiberius

    “There was nothing you could have ever said to me that I would have believed”, or some such thing.

    Because Brown has always been cuckoo or headless or perhaps both.

    We made three people redundant today; cost savings essential to compensate for the fall in the exchange rate.

  • Tim Hedges

    It’s not so much infltion targeting as working out what inflation is. Brown defined this too tightly – of course if house prices are rising that is inflation: it was an ‘inconvenient truth’

  • Mark frae Moray

    I always thought that Gordon Brown possessed a lethal mix of economic incompetence, arrogance, aloofness, social awkwardness, unreconstructed socialist ideals, blind ambition and a willingness to deceive to achieve his own misplaced ends … all primarily in pursuit of high office. Having made it to the top job – by hook or by crook and, moreover, without the people’s explicit consent – I’ll wager that he’ll go down in history as the worst prime minister we’ve ever had. Sweet justice as far as I’m concerned.

  • Hysteria

    nice analysis post-facto

    But who around 2000 said inflation targeting was incorrect? I don’t recall any commentary to the effect we were chasing the wrong target. No – the concerns were about HOW the inflation target was calculated (excluding mortgages etc) – there was no serious opposition to the prnciple…or did I miss that?

  • bill


    As a school kid in the 70s I learnt the importance of the money supply. As a broker in the 80s I experienced the Japanese bubble. And I looked on aghast as pundits and work colleagues celebrated as the UK economy was bound by the ERM strait jacket. Once that disastrous decision was reversed, there followed a steady recovery. But since Labour came to power it has been like watching a nation sleep walking to disaster. You did not need to be an expert to see what was happening. I am surprised the Queen had to ask the question.

  • chris southern

    wait until the pensions pyramid collapses, that’s the next stage.
    this bank bailout isn’t solving any of the problems, it’s only delaying them.

  • Joe Mooney

    Excellent article Mr Nelson. GB trying to blame the markets and the banks wont wash with the British people.

    You correctly put the blame on this Government for this mess and the sooner they go the better.

    As regards the BOE I remember what I think was called the Ken and Eddie show which I thought worked well in helping to keep the economy from over heating.

    We now have Ken back but where is old Eddie. Get him back too.

  • ID

    “Everyone gushed about what a great idea Bank of England independence was” – just for the sake of clarity, ‘everyone’ very much included one Nelson, F. Since when you ‘gushed’ then, you were, you now say, “wrong, hopelessly wrong, calamitously wrong”, remind me, why are you right when you spout now?

  • Andrew Lilico

    Of course, a number of us were arguing for a switch to price-level targeting from 1999 onwards. Inflation targeting is, I think, more than merely impotent in the face of these kind of asset price bubbles. Given long enough and high enough credibility, I now think that inflation targeting almost inevitably *creates* these bubbles, as I set out here a while ago:

  • Rex Burr

    Clearly labour’s tenure has been a lost decade.
    In view of falling wages and therefore purchasing power when labour took over, what course of action should brown have taken to prevent the economy from doing then, what it is doing now?
    The answer to that question will give some guidance to whoever takes over when the present dust storm settles.

  • Forlornehope

    One of the rules of monetary policy was that any monetary measure ceases to have predictive value once it is used for setting policy. The mistake was to fail to see that inflation targeting was simply another monetary measure.

    This principle is actually a general rule for any measure used for managing anything, which is why so much of the target management by this government goes awry.

  • mitch

    Brown is barking mad and should be sectioned.

  • Pete

    Brown will pursue his mendacious version of history but what was the alternative and what country chose it? The political reality was that our interest rates were higher than the Eurozone and the voters wouldn’t have stood for higher rates.

  • Wildcat

    Well done Fraser, as always you have hit the Brown nail squarely on the head. No doubt Sky’s Adam Boulton would say it was far too ‘pointy headed’ – but in the current crisis the country needs well researched, incisive, intelligent journalism – it’s just a pity that the comments of politicians who are thought of as experts on the economy (yes Vince Cable I am looking at you) aren’t as clear and convincing as the above piece of Brown myth deconstruction.

  • strapworld

    Mr Nelson, as you say and Kinglear points out. We have yet to reach the halfway point in this disaster tale.

    Thank goodness Kenneth Clarke is now ‘at em!!’

  • Patrickinken

    Yes. Spot on. You could add: (i) the Bank’s Financial Stability report documented the warning signs of the bust that was to come; (ii) the Governor warned that the “NICE” era was ending before the crunch hit in August 2007; and (iii) the tri-partite structure confused responsibilities for financial stability – though the Treasury claimed overall responsibility.

  • kinglear

    Fraser, the critical bit is ” now unfolding” I think you are right in saying there is a considerable distance to go – as reagan said ” You aint seen nothing yet”

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