The MPC and setting of Interest rates in UK

Readers Question: To what extent does the government influence the monetary policy commitee when they set the interest rate?

• In the UK, The Monetary Policy Committee has independence in setting interest rates.
• The government appoint members to the MPC. In theory they could appoint members who are more sympathetic to the ‘government’s point of view’. In practice they don’t. Nor do the government threaten to remove members for choosing a certain monetary policy.
• The government set the inflation target currently CPI = 2% +/- 1. In theory the government could change the inflation target or remit of the MPC. In practise they haven’t. However, if there was a serious economic shock. e.g. rising oil prices causing cost push inflation (stagflation - rising inflation and rising unemployment) some governments may be tempted to raise the inflation target from say 2% to 4%. In effect this is telling the MPC not to increase interest rates. In practise I think governments would have difficulty getting away with this. - Markets would soon lose confidence in monetary policy.

• The Government’s could threaten to change fiscal policy. For example, if the MPC keep interest rates higher than the government like. They could threaten to use expansionary fiscal policy. - Cut taxes and increase spending. In practise the government hasn’t done this.
• The Letter of Explanation. If inflation misses the governments target greater than 3% or less than 1% they have to write a letter of explanation to the chancellor. The MPC has always sought to avoid this. However, in theory the MPC could ignore the government’s inflation target and just write letters saying we are sorry inflation is too high. Although, I doubt the MPC would do that.
• Note since independence in 1997, economic conditions have been relatively benign. The government have been quite pleased with the economic situation. Therefore, they have felt little need to interfere with the operation of monetary policy. However, if we experienced real economic hardship, things may change.

See also:

• How the MPC set interest rates 
• MPC and the control of interest rates