The initial years after the Financial Crisis saw inflation in the UK stubbornly hovering well above the 2.0 per cent target, before slowing considerably and languishing around zero throughout 2015 and into 2016. Pressure from fuel prices pushed inflation above 4.0 per cent for a while, but the CPI came back to target in the latter part of 2018 and the early part of 2019. Despite inflation rising to 4.3 per cent in 2010 and staying above target until 2013, interest rates in the UK remained at 0.5 per cent into 2016 until being reduced to 0.25 per cent in August of that year when inflation stood at 1.0 per cent.
In July 2013, the Bank of England got a new governor, Mark Carney. Giving evidence before a Treasury Select Committee in February 2013, Carney noted that under his watch, the Bank of England would follow in the footsteps of the US Federal Reserve in keeping interest rates low to ensure economic recovery was firmly underway, and if that meant higher inflation in the process then that would be a price worth paying. Was this a sign that inflation targeting had been abandoned in favour of NGDP targeting? The Bank claimed that inflation targeting had not been abandoned, but as inflation remained subdued and unemployment fell, some economists suggested that the Phillips curve relationship had broken down.

In early 2016, Professor Anthony J. Evans, of ESCP Europe Business School, published a paper entitled ‘Sound Money: An Austrian Proposal for Free Banking, NGDP Targets, and OMO Reforms’. In the paper, Evans suggests that the use of QE was in effect a means by which central banks expanded the money supply through open market operations, while setting interest rates affects the price of money. This could be argued to be compromising the policy of inflation targeting, since central banks cannot control both the money supply and interest rates at the same time.
Evans goes on to argue that the MPC of the Bank of England should be disbanded, and that the bank should shift to targeting not inflation but NGDP through the use of QE. This, Evans argues, would contribute to a more stable economy over time. However, Evans proposes even more radical reforms which he accepts are not likely in the foreseeable future but worth debating, nevertheless. These reforms include abolishing the Bank of England and creating ‘free banks’. The idea of free banking is not new – it has been a feature of Austrian economics for some time. Essentially, banks would be free to print their own money and set their own interest rates without any intervention by government or monetary authorities. The absence of a ‘lender of last resort’ (i.e. a central bank) would provide the necessary discipline for free banks, in that if imprudent practices were followed, bankruptcy would be a possibility and moral hazard would be reduced.
Critical Thinking Questions
1 Do you think that central banks such as the Bank of England, the ECB and the Federal Reserve target inflation or is this just smoke and mirrors hiding other policy objectives? What evidence would you use to support your argument either way?
2 How successful do you think central banks such as the Bank of England have been in achieving their inflation targets in the last 10 years? Justify your view.
3 How would a central bank go about setting policies designed to target nominal GDP at a growth rate of (say)
6 per cent?
4 Given falling unemployment, reasonable growth and inflation not accelerating as expected, do you think the Phillips curve relationship is now well and truly ‘broken’? Explain.
5 Comment on the idea of ‘free banking’. To what extent do you think that free banking would result in a more stable economic environment in comparison to an economy in which central banks intervene to set monetary policy, have a monopoly on printing money and act as a lender of last resort?