Interest rates 'kept too high

The Bank of England has kept interest rates higher than necessary to keep inflation safely below the government's 2.5% target, economic researchers claim today.

In a serious challenge to the Bank's handling of the economy, Christopher Martin and Costas Milas from Brunel University claim the Bank has a deflationary bias and takes overshooting the government's 2.5% inflation target more seriously than undershooting it.

When the chancellor, Gordon Brown, handed control over setting interest rates to the Bank's monetary policy committee in 1997, he insisted that they place equal weight on avoiding inflation being too low as too high. Senior Bank officials argue that they regard their target symmetrically even though in practice inflation has been below 2.5% for most of the last four years.

In a paper presented to the Royal Economic Society's annual conference which begins today at Warwick University, Mr Martin and Mr Milas claim that the evidence shows policymakers have been too cautious ever since Mr Brown's predecessor Norman Lamont first introduced the inflation target in 1992.

"Policymakers are not trying to hit the inflation target, they are attempting to keep inflation within the range of 1.4%-2.6% rather than pursuing a precise target of 2.5%," they said. "Inflation targeting in practice has been asymmetric."

Their research will boost the case of Sushil Wadhwani and his fellow doves on the Bank's monetary policy committee who believe that Threadneedle Street overestimates inflationary pressures in the economy.

Although the Bank is supposed to take the government's other economic goals into consideration when setting interest rates, the researchers say the level of unemployment does not affect their decisions. "Policymakers are only concerned with the inflation rate," they said.

Overall the researchers judge that inflation targeting has been a success in Britain and elsewhere. "Developed countries with inflation targets have largely succeeded in maintaining low inflation while also experiencing less output volatility."

In most countries, policymakers have been able to subdue inflation without having to drive their economies into recession.