The King Canute Theory of Inflation

Mervyn King
By Mervyn King
Central banks have been caught out by the sudden upturn in inflation. In the United States, CPI inflation is now 6.2%. The Federal Reserve’s preferred measure of inflation, core PCE, has risen to its highest level in 30 years. And inflation is well above target in many industrialized countries.

We are told that this burst of inflation is transitory. And for several years, central banks have been giving “forward guidance” that interest rates will remain close to or below zero for the indefinite future. This policy stance relies heavily on the assumptions that expectations drive inflation, and central banks drive expectations. In other words, longer-term inflation is determined by the official inflation target.

I recall that in the early days of the Bank of England’s Monetary Policy Committee, we pored over forecasts for inflation. No matter the path of interest rates that we simulated, inflation always returned to target. Why? Because in the models used to produce the forecasts, the only determinant of inflation in the medium term was the official target.

Read the full Bloomberg article.

Lord Mervyn King is the Alan Greenspan Professor of Economics and a professor of Economics and Law, a joint appointment with New York University School of Law.