NCPA - National Center for Policy Analysis

CHANGING UK'S INFLATION TARGETING POLICY DOES MORE HARM THAN GOOD

September 8, 2004

The United Kingdom's policy of "inflation targeting" informs the public what the desired level of inflation will be so households and businesses can plan their finances effectively, and sets policy to try and achieve the stated target.

In June 2003, UK Chancellor Gordon Brown announced that the United Kingdom would switch the inflation target away from the Retail Price Index (RPIX) excluding mortgage interest payments to the Harmonized Index of Consumer Prices (HICP).

HICP differs from RPIX primarily in that housing depreciation and the UK's local property tax are not included in the price level calculation. Economist Andrew Lilico says the drawbacks of changing policies are significant:

  • Housing costs are an extremely material (and volatile) part of UK living costs, representing about 20 percent of all living costs.
  • Research suggests that cycles in housing prices in the United Kingdom have historically driven changes in consumption patterns.
  • The change from the old standard to the new one brings uncertainty, which may reduce the market's confidence in future inflation rates and increase volatility in the inflation measures used in the private sector.

Ultimately, Lilico says it is not clear how switching from a target that everyone understands and that has worked well, to a target that few people understand, will help policy makers better communicate to the public about the state of the economy.

Source: Andrew Lilico, "The Measure of Inflation," Journal of the Institute of Economic Affairs, Vol. 24, No. 1, March 2004.

 

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