In the past, excess demand has led to the build up of inflationary pressures, which in turn led to rises in interest rates.

Since governments frequently tried to get the economic cycle to fit the political cycle, they often reacted too late to rising inflation, which meant that interest rates had to go up higher and were kept higher for longer than would otherwise have been necessary.

This exaggerated swings in the cycle and created enormous instability.

In addition, to keep the UK competitive internationally despite double-digit inflation, sterling was allowed to slide on the currency market.

When the pound was floated in 1972, there were eight deutchmarks (DM) to the pound but by 1990, there were just three.

This currency depreciation in turn helped underpin domestic inflation via the higher cost of imports, some 30% of GDP.

It follows from this that if inflation is low and stable, interest rates will be low and stable and sterling will be stable and competitive. It is this cocktail that will produce the benign economic environment that the private sector wants.

Compared with the ambitions of governments of the first 30 years of the post-1945 era, this is minimalist economic management, with policymakers focusing on creating a macro environment which will be an effective stimulus to private sector investment, employment and growth

In those days, the debate was about means rather than ends, and several methods were tried by the various Chancellors (money supply, shadowing the DM, ERM entry). Then, in 1992, a mechanism, borne out of a major failure proved to be the basis of a more permanent anti-inflation policy.

The UK’s humiliating exit from the Exchange Rate Mechanism (ERM) in September 1992 had several far-reaching implications. Perhaps the most important of these was to re-direct domestic economic policy.

Membership of the ERM meant interest rates had to be used to manage the exchange rate, regardless of what was happening in the domestic economy. The result was the nonsense of double-digit base rates and the economy in what was then the longest and deepest recession the UK had experienced since 1945.

After the departure from the ERM, interest rates were used to manage domestic activity, with the exchange rate left for the currency market to determine.

In the immediate post-ERM aftermath, an inflation target was set (1% - 4%, reaching the lower half of the band by the second half of the Parliament), (see Macroeconomic Policy 4.2 Monetary Policy – Indirect controls – policy strategies) and a panel (the ‘Seven Wise Men’) set up which the Chancellor would consult on interest rates. The final decision, however, rested with the Treasury.

This arrangement continued for the rest of the 1992-97 Parliament, under two Chancellors, Norman Lamont and Ken Clarke.

In his first month in office, the new Chancellor confirmed his commitment to low inflation, with a point target of 2.5% (See Macroeconomic Policy 4.2 Monetary Policy – The Bank of England takes full responsibility.)

Then he went further than the previous government by giving responsibility for managing inflation and interest rates to a new independent body, the Monetary Policy Committee (MPC), under the chairmanship of the Governor of the Bank of England, Eddie George. Following his retirement, the Deputy Governor and present incumbent, Mervyn King took over in July 2003. Just six months later, the Chancellor changed the inflation target to 2%, but measured by the European Consumer Prices Index.

The MPC meets monthly (usually the first week of each month) and publishes the minutes two weeks after the meeting.

There is now, therefore, more transparency about monetary policy and an end to any attempt to manipulate interest rates for political purposes.

By transferring responsibility for day-to-day economic management to the MPC, moreover, the Chancellor is now able to concentrate on the longer-term issues related to the performance of the economy. See 5.4 Microeconomic Policy since 1997.)