An inflationary or an inflammatory letter?

The Governor may soon have to write a letter to the Chancellor apologising for the high rate of inflation and saying what if anything he needs to do about it. In a way it should be the Chancellor writing to the Governor, as the Treasury has been at the bottom of the economic mistakes that have led us to higher inflation, and the Treasury has had more power than the Bank in many of the important matters which guide our economy.

The Governor, in an honest letter, would say:

“Dear Chancellor,

I am writing to report that inflation is now above 3%. This has come about because we held interest rates too low in the period 2004-6, allowing a credit bubble to emerge. The government’s decision to switch target from RPI to CPI made our task more difficult, as the CPI at the time was lower than the RPI, and has since proved to be a very poor indicator of the overall inflation people are experiencing in their daily budgets. Indeed the gap between RPI and CPI has got larger, meaning our failure on inflation as measured by the old target is worse. We felt we had to respond to a lower, easier target once set.

The government’s love of PFI/PPP off balance sheet liabilities and its rapid expansion of public spending and borrowing made conditions far looser in credit markets than was desirable, but we did not feel we could take full action to offset the government’s own wish to expand borrowing so rapidly. We felt the Treasury clearly had good policy reasons for wanting to increase public sector costs and the size of the public sector as much as it did. It was not for us to try to throttle the economy with very high interest rates to offset this huge public sector expansion. I accept that this was wrong in retrospect.

We were also wrong to keep the markets so illiquid in August and September last year leading to the run on Northern Rock. Our options have now been narrowed by the decision to nationalise Northern Rock. This has proved expensive to the taxpayer, boosting public spending still more, and has meant thanks to EU competition law that we are having to run down a leading mortgage bank at a time of mortgage famine and credit squeeze.

What should we now do? The Bank’s options are very limited. If we chase the historic inflation with higher interest rates we will make the credit crunch worse, and cause a sharper slowdown or a recession which seems a bad idea. If we take no action commentators may well say we are neglecting the high and persistent inflationary problem. This is mainly the result now of excess liquidity elsewhere in the world creating strong upward pressure on commodity prices. There is little sign of this spilling over into wage increases at home which would give another twist to the inflationary spiral. In due course it is quite possible the speculative froth in commodities will be corrected and ease the inflationary impact.

However, it is unfair that all the pressure of adjustment to harder times is currently falling on the private sector, with housing and property at the eye of the storm. I am very conscious of the government’s ambitions and high targets for new housebuilding, which are currently unrealistic. If the government wishes to rebalance the economy and ease some of the unreasonable pressure on property and finance it needs to reduce its own claims on the economy. I suggest the government redoubles its efforts, begun with the Gershon Report, to eliminate waste and less desirable spending from the large public sector, to help the adjustment . I would be happy to assist with this process, and can see many easy targets.

Yours etc”

An honest Chancellor would write back:

“Dear Governor,

Thank you for your letter. I agree we have made mistakes together, and we need to reform our system for inflation control. I wish to discuss with you strengthening the role of the Bank in managing the money markets by restoring powers to you to monitor the clearing banks day by day and to run the government debt. Like you, I now realise the Northern Rock decisions were not well made, and we need to be careful how quickly we run the business off.

The government is concerned about the state of the housing market. We see now that getting prices down to make housing more affordable does not allow more people to buy if the mortgage market has dried up. Nor does it help if people generally decide to sit tight rather than change their houses, as it limits choice and increases the number of families living in less suitable accommodation.

It will not be easy with colleagues, but I do see the force of your argument that too much of the adjustment is being taken by the private sector in general, and by the property and mortgage sector in particular. I think there is scope to reduce public spending without in any way damaging services. You are right in hinting that public sector efficiency and productivity can and should be raised. I will take your letter to Cabinet along with spending suggestions the Chief Secretary has been preparing on a contingent basis and see what we can achieve.

I agree with you that putting up interest rates now would be an inappropriate knee jerk response. I just hope you are right and that commodity prices start to subside. It will be uncomfortable to live through much more of this commodity boom, but I see no alternative that is less damaging to UK jobs and output.

Yours etc”


  1. Stuart Fairney
    June 17, 2008

    A nice idea but it assumes a competent chancellor who could contemplate a voluntary redcution in public spending. This seems a distant prospect at present

  2. Stan Francis(Bromsgr
    June 17, 2008

    Increasing mortgage rates to the individual forces owners to sell at a lower price or they go straight to court for immediate possession. This ends up in auction houses, some don't get that far as there is a 'list'…
    So the buy to let if you have the cash is back on the books, with developers now about to make massive earnings, same as the oil men in speculation, shortage of oil, rubbish!
    Developers then take massive amounts of cash in housing immigrants at our expense from the gov't, they also rent out to housing associations and opush up our council tax locally.
    B/Societies now do what they want with interest applied and charge what they want on setting up a loan, the BOE is now ignored….so where does that leave Joe Bloggs with inflation on everything now and we still only see 3%?….rubbish again, try taking other things into that assumption/analogy and you will see at least 8% inflation!…the theory of THE BOE is flawed and needs reassessing as to future adjustments in interest rates. People still have to live, they have to fed themselves and family, keep warm and occasional alcoholic drink to keep sane? The real UK is in meltdown, taxes should now be reduced, but it won't happen for we have a socilaist lot that run this country, it's not a monopoly board we all live on it's real time!

    1. stan francis
      December 18, 2008

      John, you said I was a 'blatherer' in a recent answer to your web site, but the letter i sent to you last June has come true has it not?..RECESSION!…YOU SHOULD try living with the people and not the rich, did you not answer this letter of mine due to you yourself making from the sale of houses that people could not afford to keep up, would be interesting to hear your view, but don't blather on please?-I support the PEOPLE, not party of FOOLS!-hoodies, bike rides, greenies, further I haven't got £50K to give to CAMERON TO GET MYSELF LISTENED TO, NIETHER HAS ANY OTHER WORKING MAN?-Attitude, yes a good one that's not blinkered!

  3. Tony Makara
    June 17, 2008

    "There is little sign of this spilling over into wage increases at home which would give another twist to the inflationary spiral. In due course it is quite possible the speculative froth in commodities will be corrected and ease the inflationary impact."

    Pressure on wages, particularly in the public sector is likely to grow if rates are cut, Sterling weakens against the Euro and the cost of food goes up even further.

    The flight into commodities is down to a severe lack of confidence in the Dollar and uncertainty about which direction the Fed is going to move in the immediate future. Currently the Fed seems to be vacillating and that sends out all the wrong signals. The Americans are stuck between dealing with their savage trade deficit at time of economic downturn or supporting the sinking Dollar and thereby increasing that deficit. Little wonder the smart money is chasing commodities.

  4. Acorn
    June 17, 2008

    Dear Chancellor
    Whoops, would you believe it, that bloody CPI thing has gone north of 3 percent; even though we designed the f****** thing not to go that high for any reason. Anyway, thanks to you lot dumbing down the education system, nobody understands it. The RPI thingy is even worse, fortunately the media don't know that you have to add both together to get the actual inflation rate; but, those buggers at the Daily Mail may have twigged it.

    That Redwood bloke was in here the other day, asking about something called the "balance of payments". I pushed him in Rachel's direction, she understands these things. Turns out that is pretty buggered as well. Watch out for that Redwood; Christ, I hope they don't make him Chancellor next time.

    The good news is the old petro-dollars are rolling in from our friends in the east. Rachel says that is the only thing keeping the currency afloat. She's pissed at me because she only got 1.20 Euro to the pound for her French holiday yesterday.

    Apparently, renaming the nations Capital Account as the Financial Account, hasn't fooled anybody in the city. But Rachel says we are not infringing the Trades Description Act anymore. That went over my head but she mentioned something called Enron several times.

    Got to sign off now, apparently there are some silly buggers on the roof protesting about the price of diesel, sounds like a job for Charlie Bean.

  5. Mark Wadsworth
    June 17, 2008

    They've already worked out how to fix all this! They'll just flip back from CPI to RPI, including a measure of house prices. With the land-price bubble now bursting, the RPI measure will be lower than CPI, inflation by this measure is then back under 3%, problem solved.

    Scroll down to the very end of this.

  6. Pete Wass
    June 17, 2008

    I had always considered John Redwood to be a voice of sense and reason, but in using the phrase "an honest chancellor" given the current regime shows him to be off among the clouds.

    Lets hope that normal service is soon resumed.

  7. Adrian Saunders
    June 17, 2008

    Its reassuring to reads your words Mr Redwood as some like myself who have said the same in private have felt rather alone as the madness continued unabated.

  8. Bill Quango MP
    June 17, 2008

    Acornon 17 Jun 2008 at 10:51 am

    Dear Governor,
    The Chancellor has quite wisely passed your letter on to me, the Prime Minister, for perusal. As this letter will become news for the media I wish for you to alter some inferences.
    Since the Chancellor and I are always in complete accord I have decided to respond for him.

    1) You simply have to get RPI/CPI back down to target levels. I don't care how. Change 'the basket', invent a new calculation , whatever. Just do it.
    We do not care what the real rate of inflation is, just what we say it is matters. In your letter explain that this current situation is temporary only.

    2) We no longer refer to "Balance of Payments" at all. We have successfully deflected the media, who in Tory days never stopped going on about it, from even knowing of it's existence.
    Never mention it again.

    3) You have failed to blame the USA. We always blame the USA.
    George has gone now and is not coming back. It is his fault.
    Might I suggest the phrase "The recent economic turmoil crossing the Atlantic from America has…."

    4) We also never refer to the exchange rate of £ to Euro.
    Always mention £ to $ only.

    5) I cannot find any reference to ENRON in any of my treasury notes. Please find out who he is.

    6) You appear to have not taken the full blame for inflation.
    Look back to your letter regarding Northern Rock [copy attached] where you made clear that it was your own failure to act sooner and to only give the treasury some 6 – 18 months warning that led to the problem.
    Please make clear that if you, as Governor, had given the government some warnings about a 'Housing price boom' 'credit liquidity, Inflationary pressures, commodity prices etc at some point within the last ten years then we would have reacted effectively and decisively.
    However you failed to warn us and so you must take a very very large measure of blame.

    7) End the letter with something like.."If only we at the Bank had listened to Gordon Brown this unfortunate situation would never have arisen."

    Gordon Brown.
    Prime Minister and appointer of the future Governor of the Bank of England.

  9. Derek
    June 17, 2008

    Just looking at the case of the tanker drivers it looks like the wages of any unionised workforce are going to be on an upward march.

    On a broader note with inflation. I'm a reasonable sized multiple retailer and for quite some time are cost of goods has been increasing. Up until now most of the increases have been absorbed to maintain price points at important levels like 99p. However, as it has now become impossible to do this we are tending to leapfrog figures like £1.09 and go straight to £1.49. A lot of this is a vicious circle where we are trying to pre-empt future wage and general overhead increase, but are in fact contributing towards them. I foresee a lot more inflation to come. I'm not sure if a domestic rate increase will quell imported inflation, but it seems too greater risk not to.

    It's a bit of a myth that people are paying more because of increased manufacturing costs in China alone. The bulk of the price you pay for anything is VAT, business rates, rent and wages. It's the increases in these that are really pushing up prices.

  10. Lord Asda
    June 17, 2008

    Rents and business rates. The death blows to retail.

    I particularly dislike business rates as it just a tax on .. being a business. you don't even get an extra bin for paying DOUBLE or TRIPLE what a homeowner in the same space might pay.

  11. mikestallard
    June 17, 2008

    Today we went out and bought a wind up electric light lantern for the winter when, I am sure, it will be needed when candles are sold out.

  12. Acorn
    June 17, 2008

    Dear Mr Bill Quango MP;

    The Governor has passed your letter to me for reply.

    I have been informed by the National Statistical Office that there is a serious error in the inflation calculation issued today. This was caused by the loss of some critical data. The item concerned is coded for security purposes as "seat-4b-10:42-to-Clapham-Junction". The NSO will publish a correction before PMQs tomorrow.

    I am advised that the Treasury no longer considers the "Balance of Payments" to have any economic significance; as they did for terms such as M3 Money Supply. The group that assembled this data has now been re-tasked to carry out an economic study of bananas for the government of the Bahamas; they are due to report their findings in 2018, but this may be delayed.

    The recent economic turmoil crossing the Atlantic from America has caused a phase shift in the economic cycle of the UK. The treasury assures me that this is purely a technical aberration that will be corrected by simply changing the dates of the economic cycle to align with government rhetoric.

    As a result of the Irish vote on the Lisbon Treaty, the relationship between the Pound Stirling and the Euro no longer has any economic significance. The Prime Minister will make this plain at PMQs shortly before we join the Eurozone of common unit of asset valuation and exchange mechanism.

    Apologies, the word Enron was a typo, no such organisation or individual has ever existed. The phrase "off balance sheet accounting" is a media fabrication.

    Finally, on behalf of the Governor, I must apologise for the nations current financial situation. If only we at the Bank had listened to Gordon Brown this unfortunate situation would never have arisen.

    The governor has been under considerable stress over the last 18 months and he apologises for the fact that he failed to give the government 10 years notice of a possible liquidity problem in certain financial institutions.

    The Governor has been my sole concern over this period and I noticed that he was becoming too dependant on me. He found himself between a NORTHERN ROCK and a hard place; dependant on me to make decisions for him, which I did, without a thought for myself as his possible successor. (My membership of the MPC expires in June 2008, I am available for re-appointment).


  13. Adrian Peirson
    June 17, 2008

    £100 Billion spent on Non Jobs & Quangos, £1Billion sent to India. £20 Billion Net payment to the EU. £25 Billion interest on repayment on Gilts.

    Our Industries sold off, Our fishing grounds Plundered, We are now past Peak Oil, our Farming demolished with F&M, Bluetongue bird .
    Flu, Two Wars being fought on a Peacetime Budget, A big Pile of Gold swapped for a big pile of…..paper.

    All of these are Avoidable expenditures. I am an engineer not an economist, so perhaps I may be mistaken but it looks to me like Great Britain is being Deliberately Gutted.

  14. a very public sociol
    June 17, 2008

    Perhaps a bit of honesty regards the measurement of inflation wouldn't go amiss too! These last few months approx £4-5 have been added on my £40 a week shopping bill. I'd say that's a little more than 3.3%!

  15. William B.
    June 18, 2008

    I believe the bowler known as inflation is only at the start of its run-up. It's not Monty Panesar coming in off 4 paces, with any luck it won't be Michael Holding at his peak (starting in the members' car park and taking the long route through the stands), but it is certainly at least Ryan Sidebottom. He starts slowly, progresses steadily and by the time he has hit his peak he is lethal.

    Inflation always hits the lower paid first, especially those on fixed incomes such as the retired. We can talk of CPI and 3% or 4% but for those most vulnerable the effective rate is several times that.

    This is a matter on which I believe the Conservative Party should take a clear and unequivocal stand. We know Labour will continue to spout the sad old rhetoric of "they are only interested in the toffs, the poor will suffer". We also know that some will believe them. Although not a member of any party, I do not believe them either as a matter of principle or as a result of actual policies when in government.

    I believe the principles of the Conservative party in this respect are two-fold, first that those who succeed should not be punished and secondly that those on lower incomes should have their incomes protected by government policies not plundered.

    Furthermore, radical reductions in the lower rates of income tax from 1979-1997 put a lie to the Labour claim.

    The first essential policy is a commitment to increasing personal allowances in line with (or above) the real level of inflation for those on average incomes and below (obviously the precise measure is a matter for debate but it is the principle that counts). The next two years threaten to be quite punishing for the less-well-off, an immediate substantial increase in personal allowances in 2010 can restore real incomes to what they are now without stoking an artificial consumer boom.

    This must, of course, go hand-in-hand with a regular theme on these pages, namely a substantial reduction of the overall tax burden.

    It's not just a matter of making a promise to get votes, it's about being fair and doing the right thing by everyone in the country.

  16. Stuart Fairney
    June 18, 2008

    As many contributors have noted, government claims in various sectors seem to have less and less bearing on reality, for example;

    "The UK is well placed to deal with the credit crunch" ~ most commentators and international organisations seem to see this as a straight falsehood

    "Crime is falling" ~ well it maybe falling if you only go out with a six police escort and a stab vest like the Home Secretary, but for the rest of us, the figures simply don't respect the lawless anarchy that is a UK town centre on a weekend evening. People seem to have lost faith in the politicised police actually being able to deal with offences and so REPORTED crime is falling

    "Inflation is 3.3%" Probably the most non-sensical of all when you look at fuel and food prices.

    It really is starting to resemble the former soviet union when government stats showed that their economy was a glorious success (as long as you were a member of the inner party!)

  17. bill Quango mp
    June 18, 2008

    # Acornon 17 Jun 2008 at 6:51 pm

    The Prime Minister has asked me to commend your recent fair, balanced and truthful letter and wishes me to convey his approval of said letter being released to the media immediately.

    On an unrelated note Gordon Brown is also keen to reappoint some members to the MPC and is considering the possibility of a new highly paid Banking Czar, a high profile post with wide ranging, largely illusory powers.
    He invites you to attend an informal meeting with him at No 11 to discuss this proposal.
    The PM's Secretary, Mr Darling, will be happy to make an appointment for you at your convenience.

  18. Acorn
    June 18, 2008

    Dear Mr Bill Quango MP.

    I thank you for your kind letter of the 17th inst. I shall be pleased to attend. I have authorised my letter to you to be published in time for the six o'clock news on a slow news day, for maximum impact.

    I understand we may get to meet soon when Mr John Redwood MP, invites his bloggers to tea on the House of Commons Terrace. [hint – Ed]

    I remain, sir, your humble servant.

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