Starting this week, The Times is running a fortnightly series of briefings to coincide with Target Two Point Zero, the Bank of England’s competition for sixth-formers run in conjunction with the newspaper. The contest challenges students across Britain to play the role of the Bank’s Monetary Policy Committee and recommend the best level for interest rates. Today, we begin by explaining the MPC’s role.

What is the Monetary Policy Committee? What does it do?
The MPC was created by Gordon Brown days after Labour took office in 1997. It is charged with setting interest rates, which determine both the cost of borrowing and the return on savings in Britain.

The creation of the MPC represented a fundamental shift in economic management. Before 1997, interest rates were set by the Chancellor, meaning that political considerations could be an influence. If an election was looming, Chancellors often cut rates to create a “feelgood factor”. Today, rates are set purely on economic grounds.

Does the MPC have ground rules for its decisions on interest rates?
The nine members are charged with setting rates to keep inflation on track for a target annual rate of 2.0 per cent, based on changes in prices measured by the European Union’s standardised consumer price index (CPI). How interest rates affect inflation is complex and is a subject to which these briefings will return.

How are MPC members chosen?
All members of the MPC must have proven expertise in economics. Of the nine members, five are top Bank officials: Mervyn King, the Governor; two deputy governors, Rachel Lomax and Sir John Gieve; Charles Bean, the chief economist; and Paul Tucker, the director for markets.

Four more “external” MPC members are appointed by the Chancellor for three-year terms. At present they are Kate Barker, now in her third term, Andrew Sentance, Tim Besley and David Blanchflower. All new members face unofficial confirmation hearings before MPs on the Commons Treasury Committee. The MPs have no power of veto, however.

Does the Government retain any further influence over the MPC?
Except in exceptional circumstances, the Government now has no influence on interest-rate decisions.

There are powers in the Bank of England Act for the Chancellor to set rates for a limited period in extreme circumstances, but these have never been used. A top Treasury official sits in on MPC meetings and keeps members informed about government tax and spending plans. They have no say on decisions. The Chancellor also sets the inflation target. This was changed controversially in 2003 from a rate of 2.5 per cent on the retail price index gauge of inflation, after excluding mortgage interest costs, to the present CPI target.

How do MPC meetings work?
The MPC holds a two-day meeting every month to assess the state of the economy. At the end of the meeting it votes on whether to change the rates and, if so, by how much. Each member has one vote and is individually accountable.

What happens if the MPC misses its inflation target?
The MPC is required by law to set rates to keep inflation at 2.0 per cent at all times. In practice, it is recognised that inflation will fluctuate around target from month to month. Making frequent, big changes in rates to try to keep inflation at exactly 2 per cent would lead to damaging volatility in the economy. So the MPC aims to keep inflation at target over a two-year horizon. If inflation is more than 1 per cent above or below target in any month, the Bank’s Governor must write an open letter to the Chancellor explaining why this occurred and what the MPC intends to do about it. This has happened only once since 1997, in March this year, when CPI inflation jumped to 3.1 per cent. It fell back to 1.8 per cent by August.

www.timesonline.co.uk/targettwopointzero
www.bankofengland.co.uk/education/targettwopointzero

Explore Economics

• Autumn Budget 2007

• Budget 2008

• World Economic Forum

• The Times MPC

Times Recommends

• Brown targets fat cats after nationalising banks
• US shares soar on global banking rescue
• Europe follows Brown to head off meltdown