RIGHT now there is an interesting clash of judgments emerging on the monetary policy committee (MPC) of the Bank of England. Steve Nickell, one of the four external members, has voted for two months to cut rates from the current 4.5% level. None of the others has joined him.

In a speech last week he explained the reasons for voting to reduce rates and also provided an excellent explanation of how the MPC works, which students of UK monetary policy would do well to read. (See Bankofengland.co.uk.)

It is a common view that, because the Bank has an inflation target it should not concern itself with growth. But, as Nickell patiently explained in his speech, the Bank has to take a view on growth to form a judgment on inflation. “The factor driving changes in inflation over the longer term is the level of demand in the economy relative to the potential supply,” he said. “If the former exceeds the latter, we may expect inflation to be rising, and vice versa.

“It’s plain that if you’re trying to hit an inflation target, you have to form a judgment about the level of demand in the economy relative to potential supply . . . this must, among other things, involve making judgments about growth prospects, not for their own sake but because they’re vital when it comes to understanding the prospects for inflation.”

Of course, as he noted, the Bank cannot ignore direct influences on inflation such as last year’s rise in oil prices, and has to be sure these do not result in second-round effects through higher wages. MPC members are also concerned about gas prices, which have yet to show through fully in inflation.

But the key relationship is between growth, the amount of spare capacity and inflation. He thinks there is some spare capacity, for which rising unemployment provides supporting evidence, and although growth in the final quarter of last year was a close-to-trend 0.6%, he doesn’t see it getting much stronger. So spare capacity will remain, and inflation — now 2% in line with the target — will fall.

Nickell appears to have some support for his view on the MPC. “You’re starting from a position where to keep inflation on track in the longer term you do need to have growth picking up,” said Kate Barker, another member. “There are question marks about whether the pace of growth is going to prove strong enough.”

He also has support on the “shadow” MPC, which meets under the auspices of the Institute of Economic Affairs, and which provides even more convincing proof that when there is scope for economists to disagree they will do so. Three members of the shadow MPC think there should be an immediate quarter-point cut in base rate, two want a rise of a similar amount and four are happy to leave it where it is.

The cutters, like Nickell, are concerned about growth and its likely impact on inflation. Roger Bootle believes that “economic growth will continue below trend”, Anne Sibert cites “signs of labour-market weakening” that are consistent with subdued pay pressures, while Peter Warburton thinks the private sector is facing real interest rates that are too high. That helps to explain the weakness of business investment.

What about the views on a rate rise? Gordon Pepper is concerned about asset-price inflation, and cites the current “bubble” in index-linked gilts. Philip Booth worries about rapid money-supply growth. Last year’s slowdown in the economy, he said, could reflect the damage wrought by the government’s tax and spending policies, and it is no business of the MPC to try to counteract such weakness.

This is the nub of it. It would be a big surprise if the Bank were to do anything this week, but the jury is out on what will happen in the coming months. Several City firms have pencilled in a rate cut for May, while others think that is when the Bank will start raising.

If Nickell’s view is to prevail, two things will have to happen. First, growth doesn’t pick up and a more subdued consumer, alongside weak exports and investment, leaves the economy expanding at a below-trend rate. Second, committee members will have to be confident of what the trend rate of growth is. The Bank and the Treasury work on the basis that the economy’s trend, or long-term, growth rate is about 2.75% a year. It is possible, however, that this — while close to the average of recent years — flatters it. What if the economy has benefited from a series of favourable factors that are now fading? What if the true story of the economy’s growth potential is reflected — as in the end it should be — in the productivity numbers?

Productivity growth since 1997 has averaged 1.6% a year. Add half a percentage point for workforce growth (largely due to immigration) and you do not get much more than a 2% trend growth rate.

This is a big issue, of relevance not just to the next move in interest rates but to Britain’s long-term prosperity. I share, just, Nickell’s view that a small rate cut will be needed. The larger question is what will be needed to improve the economy’s long-term performance.

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