Chart 2 shows that this has happened only 6 times since the MPC began controlling interest rates. In fact before 2007 there were no such occurrences. There are various other points worth noting to demonstrate the good performance of the MPC:
In the past decade, only Japan which has suffered from long period of deflation, has had lower average inflation than the UK, among the G7 economies . This contrasts the decade preceding that in which the UK had the second highest inflation rate in the G7.
UK interest rates have remained at an average of 5% since the MPC began compared to just over 9% in the previous economic cycle. This has subsequently allowed a long period of sustained low inflationary economic growth.
There are many references over the last decade in which they have reacted quickly to prevent inflation getting out of control. In fact, up till the middle of 1997, the MPC met 120 times and on 34 of such occasions, these meetings have resulted in a change of the base rate. It is clearly obvious to the general public, that the MPC change interest rates in response to economic events/outlook. The MPC has therefore reduced market expectations of inflation. Since the Bank is independent and has developed a good track record, people have confidence that inflation will remain low. Therefore wage demands are lower and it becomes easier to keep inflation low.
TABLE 1 UK Inflation Dynamics 1950 -2007
Jan 1950 - April 1997
May 1997 - March 2007
Effectiveness of MPC due to Interest rate cuts and External Factors
MPC has been effective in keeping the inflation low since the very beginning of its formation. We can analyse this better with the help of figure below, also the table given above proves the same point, as the mean inflation between 1997 and 2007 has been low at 1.5 percent, which is very much within the target of MPC.
(Impact of Credit Crunch on UK Interest Rates)
The diagrams above clearly show that inflation started picking up with the onset of 2007, whereas the interest rates was marginally raised between 2006-2007 from 5.25 percent to 5.75 percent, which is a 50 basis points cut. A 50 bps cut in an inflationary scenario was a very proactive step from the Bank of England, but the economic situation worsened because of a couple of factors like the Sub-prime mortgage crisis taking a toll on liquidity of the banks world over and also the high crude prices.
Sub-prime mortgage not only affected the US, but it marred the liquidity situation so badly that many prominent institutions in the US and UK went bust. The subprime crisis started with the subprime lenders lending at higher rates than usual to the borrowers with bad economic history and lesser ability to pay back. The subprime lending functions on the principle of no collateral and higher interests. There debt instruments are then traded and are passed on to other banks or institutions which are ready to take them for the higher interest they get out of them.
Effects on the US