Let’s take back control of the Bank of England
Outsourcing monetary policy to bureaucrats is bad for democracy.
Twenty years ago, in almost its first move, the newly elected Blair government granted operational independence to the Bank of England. By giving it responsibility for setting interest rates, Gordon Brown hoped to guarantee ‘high and stable levels of employment and growth’ and leave interest-rate policy ‘free of political manipulation’. In truth, this was meant to reassure the City that the Labour Party could be trusted with the economy, and thereby avoid a run on the pound. Or, as John McDonnell put it, ‘it was simply a whizzo scheme to stabilise their government’.
A decade of steady growth and low inflation appeared to underline the wisdom of Brown’s decision. At least it did until the crash of 2007. Specifically, as the Financial Times notes, ‘[Bank of England] independence had not enabled policymakers to spot the looming financial crisis, even if officials frequently discussed many of the warning signs’. The biggest asset bubble in almost 80 years had blown up under their noses and they didn’t see it.
Ironically, the bank emerged with its powers enhanced. The post-crash consensus placed the blame for not doing more at the door of Gordon Brown. New Labour’s ill-considered division of regulatory functions between the Bank of England – responsible for ‘the overall stability of the monetary system’ – the Financial Services Authority and the Treasury resulted in a breakdown of communication that the House of Lords later characterised as ‘jaw-dropping incompetence and chaos’. When the system was reformed under the coalition, George Osborne gave back the bank’s power to regulate the city, as well as granting it new ‘macro-prudential’ powers to control such things as how much you and I can borrow on a mortgage.
Fast forward over a decade of economic stagnation and mounting debt, and questions are finally being raised about Bank of England independence. The FT’s Chris Giles described its first 15 years as ‘a well-intentioned failure’ and called for sweeping reform. More recently, former Bank of England employee Theresa May made a hostile conference speech, which was widely interpreted as a veiled attack on the bank’s independence (something she later denied). William Hague was much more explicit, however, stating that unless central banks change course, ‘they will find their independence increasingly under attack’.
So is it time to take back control of interest rates from Threadneedle Street? The main justification for operational independence is that independent ‘experts’ get better results. As former governor Mervyn King – one of the many big guns lining up to defend the bank – wrote recently, ‘It is easy to forget that inflation had seemed an intractable problem in the 1970s’, but that with operational independence and inflation-targeting, ‘inflation has been removed as a major source of concern’. Politicians, he said, couldn’t help tinkering with interest rates in their own self-interest – lowering them after a successful budget, hiking them again after an election – and therefore can’t be trusted in the way that officials can.
Respected dance-show contestant Ed Balls also weighed into the debate recently. As the architect of the independence policy, he defended it. He supported his claim by correlating measures of central-bank independence with inflation in a number of advanced economies during the 1980s (when many central banks depended on national governments) and the 2000s (when most were independent). He concluded that ‘operational independence and inflation were strongly negatively related’: the more independence, the lower inflation.
The problem is that the figures are open to interpretation. Balls’ graphs show a sort of trend, but the differences are enormous. Eighties Finland with its rigidly controlled central bank, for example, enjoyed significantly lower inflation than highly independent Switzerland. Spain and Greece showed similar levels of operational independence while their inflation rates were worlds apart.
Ed Conway, Sky’s economics editor, has made the key point. He notes that ‘inflation was already brought under control well before independence’. Until the UK’s spectacular exit from the Exchange Rate Mechanism (ERM) in 1992, the value of sterling had been pegged to other European currencies. When Kenneth Clarke allowed the pound to float and instead targeted inflation, the results were instant – inflation between 1993 and 1997 averaged just 2.3 per cent, barely different from the 1.9 per cent of the years 1997 to 2016. ‘The real revolution’, Conway concludes, ‘was not Bank of England independence, but the decision to give up targeting currencies in 1992’. And it was a political decision taken by an elected chancellor.
If the Treasury regained power over interest-rate setting, it could have two positive effects. Firstly, just as splitting responsibility for regulating the city between three bodies resulted in catastrophic failures of communication, dividing control of macroeconomic policy between the Treasury and the Bank of England risks the same thing. If, for example, the government pursues austerity while the central bank favours an expansionist monetary policy (sound familiar?), then fiscal and monetary policies are working at cross purposes. Placing control in one set of hands should prevent that.
Secondly, and more importantly, it tells us where the buck stops. There is no such thing as a simple ‘national interest’ that can be captured by a figure like GDP or inflation. Nations contain different groups, and policies that help one will hurt another. High interest rates hurt borrowers but help savers; high inflation will eat away at a mortgage, benefiting young homebuyers, but cause problems for pensioners. Every monetary decision, then, is a political decision. As such, they should be taken by elected politicians who will then have to answer for them, not outsourced to unelected bureaucrats.
Rupert Cogan is a writer.