Outlook: Setting rates is not an exact science

Setting rates is not an exact science

There's no pleasing all the people all the time. While carefully avoiding any probing of the possibility that the Monetary Policy Committee has been split over its decision to raise interest rates for a fifth time last month, Eddie George managed to demonstrate yesterday that setting rates is a matter of judgement over which reasonable people can and do disagree.

He was handed the opportunity when questioned by the Treasury Committee about the forecast for growth and inflation in Gordon Brown's Green Budget this week. The Chancellor is more optimistic than the Bank about growth next year but less optimistic about inflation and clearly feels there is enough momentum in the economy to encourage the Bank to hoist the cost of borrowing again in the new year. Mr George had no trouble agreeing forthrightly with this analysis.

The MPs, however, had already grilled the Bank's witnesses about whether the last rate rise was a move too far.

Did it not ignore the suffering of exporters under the burden of the strong pound? Had the Monetary Policy Committee not been split about the decision because some thought the economy had already slowed enough for inflation to be on target two years or so ahead?

It could not have been made clearer that setting interest rates is not an exact science.

As MPC member Willem Buiter put it, interest rates work on inflation "gradually and imprecisely" by making it more expensive for businesses and households to borrow, and by damping external demand through a stronger pound.

This is a useful lesson for the Bank to spell out. The new arrangements, whereby rates are set by an independent committee, will quite often lead to splits and disagreements - if they are doing their job properly.

If rates were far from where they needed to be, it would be easy for reasonable people to agree what to do. It is if they have got it almost right that they will disagree on the next move.

No doubt there will be much excitement when we get from minutes of the MPC meeting the first hard proof of a divergence of opinion. But remember: it is a sign the system is working well, not that it is failing. After all, Mr George and Gordon Brown certainly seem to differ.