Inflation Control by Government of UK Economy Essay

Inflation Control by Government of UK Economy - Essay Example The rate of overall fixed capital formation in the UK is depressed by the very low level of public investment. During the 1970s and much of the 1980s the UK endured persistently high inflation. Despite high levels of unemployment, wage increases in the 1980s exceeded productivity growth, provoking strong upward pressure on prices. The boom of the late 1980s created a new inflationary surge, painfully controlled only by high interest rates and the early 1990s recession. Since then, however, the UK's inflation performance has improved markedly. The government has preferred measure of inflation, the RPIX (which excludes mortgage interest payments), has fluctuated within a narrow range in recent years and even came in below the official central target of 2.5% in 1999-2001. Meanwhile, inflation as measured by the EU's harmonised index averaged just 1.2% over 2001, the lowest rate in the EU. Two aspects of the UK's recent inflation performance are worth recording, however. The first is that there has been a significant divergence since mid-1998 between goods and service sector inflation, with the latter accounting for most of the increase in the consumer price index. In fact, in many parts of the goods sector (notably clothing, footwear and audio-visual equipment); prices actually fell in 2000 and 2001. A second aspect worth noting is the sharp (and probably unsustainable) appreciation of sterling's trade-weighted exchange rate since 1996, which has exerted considerable downward pressure on import prices. This paper discusses the inflation control methodologies in United Kingdom from 1994 to 2004. It shall also discuss how UK has managed its inflation in the last few decades. The paper shall also provide recommendations for inflation control by effective governance. Historical Monetary and Fiscal policies of UK Monetary policy The UK has experimented with numerous frameworks for monetary policy over the past 15 years. In the 1980s, the Conservative government tried in vain to target various measures of the money supply, before deciding to target the exchange rate. After "tracking" the D-mark in the late 1980s, the UK joined the EU's exchange-rate mechanism (ERM) in October 1990, only to be ejected two years later, in September 1992, when speculative pressures forced sterling out of the ERM. Following its exit, the UK was one of the first OECD countries to adopt inflation control. An inflation target range of 1-4% was initially set, but responsibility for setting interest rates remained with the government. When the Labour government came to power in 1997, its first significant decision was to grant operational independence for setting interest rates to a newly constituted Monetary Policy Committee (MPC) within the Bank of England. The responsibility fo