Hows and Whys of the Bank of England’s MPC

Adapted from The Times article dated Monday September 19 2005

What is the Monetary Policy Committee? What does it do?

The MPC was created by Gordon Brown in 1997 which sets interest rates, determines the cost of borrowing and the return on savings in Britain. Before 1997, interest rates were set by the Chancellor resulting in changes due to political influences rather than pure economic grounds.

Does the MPC have ground rules for its decisions on interest rates?

The nine members of the committee aim to keep annual rate of inflation according to consumer price index (CPI) at a rate of 2.0 %. The CPI is also used as a benchmark for the European Union for inflation.

How are the members of the MPC chosen?

All the members must have proven expertise in economics. Of the nine members, five are bank officials and four ‘external’ MPC members are appointed by the Chancellor.

Does the Government retain any further influence over the MPC?

The government has no influence on the MPC except for exceptional circumstances. There are powers in the Bank of England Act which grant power for a short period of time to the Chancellor in extreme economic situations, but have never been used. A Treasury representative attends the meetings informing the members informed about government tax and spending plans but has no say in the MPC’s decision.

The Chancellor retains responsibility for the MPC’s inflation target. It was changed from the retail price index gauge to the consumer price index benchmarks in 2003.

How do MPC meetings work?

The MPC holds a two day meeting every month to discuss whether the economy requires a change in interest rates and if so, by how much. Each member has one vote each.

What happens if the MPC misses its inflation target?

The MPC is formally required to maintain the inflation target at 2.0% at all times. But it is recognised that it will fluctuate. Making frequent, big changes would lead to a volatile economy and so the MPC aims to keep inflation at the target over a two-year horizon. If the inflation rate is 1 percent above or below the target, the Governor is obliged to write a letter to the Chancellor explaining why this has occurred and what the MPC aims to do about it.