SMPC Divided on Rate Cut Decision

Embargoed for 00.01 hours, Thursday 31st July 2003

Shadow MPC Divided on Rate Cut Decision

The Shadow Monetary Policy Committee (SMPC), a group of distinguished economists that meets quarterly at the Institute of Economic Affairs, fears that the recent rate cut on 10th July may have been a mistake but the uncertainties created by the effect of VAT fraud on official economic data and the unclear world background led to opinions being divided on the right course of action.

At their meeting on 17th July, the SMPC expressed reservations about the appropriateness of the 10th July UK base rate cut, with four members considering that it was a mistake - while three felt that it had been the correct course of action. One reason that the Committee was unable to come to a firmer conclusion was the huge impact of the VAT fraud, revealed on 9 July, on the balance of payments figures and national accounts. The extent of the distortions to the official statistics now make it very hard to know what has been happening to the UK economy. Another reason why the SMPC found it hard to reach a firmer conclusion with respect to base rates, was the mixed signals about the supply side of the economy. Some SMPC members suspected that the degradation in total supply caused by the government's tax-and-spend policies was proceeding faster than the deceleration in home demand, and feared that there was now a positive output gap in the UK, rather than the widely perceived negative one.

There was also considerable uncertainty surrounding the international outlook. Some SMPC members suggested that the pace of recovery was now picking up, after a relatively mild growth recession, but others feared that the monetary transmission mechanism had ceased to function, because bad debts had eroded the commercial banks' ability to create new money and credit. This was one reason why a rapid growth in base money had led to only relatively subdued growth in the broad money stock in countries such as Japan.

The SMPC was concerned by the proposed switch of the official inflation target away from RPIX to the HICP, and had doubts as to whether the HICP would have the same credibility with wage bargainers and the population in general. It would undo much of the work done by the MPC in establishing its reputation as a guardian of the currency, if the new HICP target lacked popular credibility.

Four of the members who attended the 17th July SMPC meeting believed that there should be no further rate cuts in the immediate future, while three members voted for an immediate reduction. Some of the four who voted for no change would be prepared to countenance a cut, if it became clear that credit growth had slowed and the housing market cooled down, however.

The Shadow Monetary Policy Committee, which has shadowed the MPC since its creation, has no relationship with the recently formed Times Shadow Monetary Policy Committee.

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