THE Governor of the Bank of England once famously said that monetary policy should be boring. In other words, monetary policy should be run in such a way that changes in interest rates are reasonably predictable, relatively infrequent and so that inflation and interest rates do not get out of hand.
Certainly, monetary policy is not nearly as "interesting" as it was 15 years ago when Britain was fighting to stay in the ERM, interest rates were routinely in double figures and bankruptcies were running at record levels. Nevertheless, recent rises in inflation and interest rates have led some people to worry about what lies ahead.
Although the particular measure of inflation that the Bank of England targets is three per cent, we should remember that the more general measure of inflation targeted by the Bank of England until the Chancellor changed the target for purely political reasons is running at 3.8 per cent. It is clear from the Bank of England's research and public pronouncements that it did not expect recent increases in inflation to happen.
So what has gone wrong?
We can get some clues by looking at the minutes of the Institute of Economic Affairs's Shadow Monetary Policy Committee. It has been well ahead of the Bank of England in being concerned about inflation and has wanted interest rates to rise for several months.
Like the Bank of England's Monetary Policy Committee (MPC), our group is also a committee so members do have different views. Some, such as Professor Patrick Minford, have a bias to cut rates in the near future. However, the majority have been concerned about inflation for some time. And they believe the danger signal is the growing money supply.
Mervyn King, Governor of the Bank of England, accepts Milton Friedman's old adage that "inflation is always and everywhere a monetary phenomenon", but most of the Bank of England's economists do not trust the monetary data enough to bring it into their models of future inflation.
Many of our members, on the other hand, became very worried when the growth rate of broad money rose from nine to 14 per cent in the two years to mid-2006. It is very difficult to model whether a 100mph gale will capsize a particular boat. But if there is a 100mph gale, you should react, probably by getting back to shore.
Similarly with the money supply data we might not know exactly how it feeds through into inflation but the MPC should have known that there would be problems ahead when money supply growth was rising, and should have raised rates earlier.
A number of the members of our group have been concerned that the growth in the money supply is feeding through into asset prices including house prices and that it will eventually affect inflation as people raise their levels of consumption on the back of rising housing wealth.
Given that our committee has anticipated, by a few months, the actions of the Bank of England in raising interest rates, what do they think now?
By a slim majority of five to four, they voted to hold rates this month. However, many members were concerned that, should inflation rise further, the Bank of England's credibility would be seriously breached, and people would stop believing that the Bank would hit its target.
This would lead to pay settlements rising. Increases in unemployment and further increases in inflation would follow. Even more significantly, three of the four members who voted to hold rates thought that interest rates should rise further this year. Thus a clear majority of this committee of leading monetary economists believe that interest rates should rise now or in the near future.