WITH inflation retreating from 4.5% to 4.1% the governor of the Bank of England has this morning sent his obligatory letter to the chancellor, Alistair Darling, and it contains an admission that much of the pressure on prices, upwards or downwards, is beyond the bank's control.
I've always been a little sceptical about the use of interest rates to control consumer spending. I doubt if many members of the public know the current rate and would be more influenced in their spending habits by how much disposable income t
hey have at the time. That is dictated by simple arithmetic: the size of their bills against their income.
What will further stop them spending is when they see how much they are putting on credit cards. It's the binge-spending that leads to self-restraint. Whether interest rates are high or low won't come into it.
The owner of one fashion chain, d2, once told me that his clientele were mainly young folk who received their wage packets on a Friday night and were out spending in the shops on Saturday morning. Many of them would not know the interest rate and few would be deterred from their trips to the malls if rates were raised by a quarter of a point. Shopping is a social activity as much as a monetary one.
All this leads me to question what the Monetary Policy Committee is actually achieving by its interest rate policy. Mervyn King says in his letter that in the long run inflation is determined by monetary policy.
In theory, it raises rates to control inflation and lowers them when inflation is conquered. Well, maintaining relatively high rates didn't stop inflation soaring in the autumn and now that we have extremely low interest rates inflation is coming down.
The problem for the MPC, as conceded in Mervyn King's letter, is that "in the short run, other factors both at home and abroad can have temporary implications for inflation". Indeed. It has risen sharply due to soaring commodity and food prices and hiking interest rates cannot stop these prices rising and falling and they will do so according to supply and demand. All that an interest rate does is add to the public's cost of living.
The good news is that King expects lower petrol, gas and electricty prices to flow through in 2009, so pushing inflation below the 2% target. Other factors will be slowing economic output, rising unemployment and the Chancellor's fiscal measures, notably the rate cut in Value Added Tax.
It seems as if the interest rate is being led by these trends rather than controlling them. As King says himself.."there is relatively little that the MPC can do to prevent inflation moving from above target now to below target during the course of 2009."
A much better way of controlling spending habits is restricting access to credit in the first place. Maybe we wouldn't be in our current mess if action had been taken on that front.
Terry Murden is Business and City Editor of Scotland on Sunday. You can read more of his blogs at the scotsman.com Business Club. Click here to find out more.
