How independent is the Bank of England? How good is our control of inflation and interest rates?

Gordon Brown has dined out on his success in making the Bank of England independent. Many give him credit for this and assume it has led to a uniquely favourable out-turn for interest rates and inflation.

In practise the UK has continued to pay a price. Our interest rates have been continuously higher than US, Japanese and Euro rates throughout the period. Japan’s rates have typically been under 1%, ECB rates around 2% and US rates around 3% compared with 4% plus for the UK since "independence".

Now our inflation rate, always well above Japan’s, is also above Euroland’s and the US, so the extra pain of higher rates is not giving us the gain of lower inflation.

In parctise there has been plenty of political intervention in the workings of the Bank. The msot notorious was the foolish decision to shift the target rate from the RPI to the CPI in 2003. This was a deliberate and misguided politcal decision to try to bring us more in line with the Euro. From this point onwards our path has diverged from Euroland as our inflation rate has accelerated, and our growth advantage has eroded. It seems to have encouraged easy money for a bit at the Bank, when they cut interest rates before inflation was under control. It is all part of the continuing price we pay for the Euro dream – just as the Bank of England and Gordon Brown were keen advocates of the ERM and have never said sorry for their mistake, shared with the Conservative government of the day.

In addition Gordon Brown appoints a majority of the members of the Bank of England, and Ed Balls clearly takes a close interest in what they do. The Chancellor has both delayed appointments unreasonably, and made some controversial choices.

The Bank has been thrown off course by the CPI switch and are now having to inflict higher rates on us to rein things back. The Bank and the system are not independent enough, and Gordon’s infallible knack for making the wrong call, as he did with the ERM, has not deserted him.

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6 Comments

  1. Posted January 23, 2007 at 2:07 pm | Permalink

    The argument that over plays the significance of Bank of England independence, also ignores another important issue. If Gordon is playing fast and loose with Our Cash, inflationary pressures build, which forces the BofE to raise rates. Only a combination of an independent central bank and a prudent government can give low inflation plus growth. One on its own is not good enough.

  2. Marek
    Posted January 23, 2007 at 7:29 pm | Permalink

    The logic in your argument is very confused.

    For example, we all know that the Japanese economy suffered from severe deflation in the 1990's and that growth was very poor indeed and still is. Simply to compare the level of Japanes interest rates with that of the UK establishes absolutely nothing of interest.

    Again, comparing UK interest rates unfavourably to Euro rates and then later criticising the government for adopting the same targets as the ECB also makes no sense in the development of your argument. The ECB must be doing something right if, as you say, they are succeeding better than we are.

    Your argument seems to be that the Bank of England made a mistake by not interpreting the new inflation target well enough and by initially setting interest rates too low. To go from this to say that higher interest rates are the result of some foolish Euro dream simply does not follow!

    In fact your argument is so long on bias and short on logic that one wonders whether your credentials as a Eurosceptic have any valid economic underpinning. I'm actually a radical Eurosceptic because I believe that while the Euro iself will be a long term success we already benefit from the fact that most of the continent has adopted it and we need deal only with one currency in our business with european nations. By staying out we retain that advantage while being free to fine tune our economy as we wish. This, of course, depends on how well we fine tune and ,in this regard, your criticism of the BofE may have merit.

    On a general point, why do Eurosceptics like you never criticise the USA for having one currency? Wouldn't California be better of with its own currency, or New York or Alaska? The answer is that, of course, it works there. However, the USA is also a unified political state. I think that many Eurosceptics see the Euro as the thin edge of the political wedge. This is a perfectly valid objection to the Euro but it is not helped by spurious economic analysis in its support.

  3. Posted January 24, 2007 at 2:53 pm | Permalink

    Marek – the ECB and the BoE are not using the same target. The BoE has to target inflation at CPI 2% +/- 1%. The ECB is supposed to keep inflation BELOW 2%. Effectively what Brown has said to the BoE is "keep inflation at below CPI 3%", with the result that our inflation is 50% higher than in the eurozone.

  4. Marek
    Posted January 24, 2007 at 7:31 pm | Permalink

    Dear Ed

    I was lazy in my typing. I was picking up on John's point – "the foolish decision to shift the target rate from the RPI to the CPI in 2003. This was a deliberate and misguided politcal decision to try to bring us more in line with the Euro".

    As for the actual percentage targets, I agree that's another matter. But the fact that our targets are higher than Europe's with consequently adverse effects on our inflation rate neither supports nor undermines John's thesis.

  5. Chris Dixon
    Posted October 17, 2007 at 1:34 pm | Permalink

    The BofE is not independent. It is given the level of inflation to work to and the measure of inflation to use.

    In 2003 the measure was changed from the RPI to CPI, to be more in tune with Europe. We are not in the Eurozone.
    In fact, I thought that one of the reasons that we did not adopt the Euro was that we would not be able to set our own interest rates!

    I believe that the use of CPI gave rise to incorrectly low interest rates, which was the main fuel for our overpriced housing market. And we have not even begun to account for house price depreciation (the amount that houses have actually gone up in value).

    A generation of young people will not be able to owntheir own property, and remember, rents go up in line with property prices. A young person in our so called 'full empoyment' earning the average wage will be now paying two thirds of their income in rent.

    A final sobering thought; in my own case I was forced to sell my house in 1997. I am now paying twice what my mortgage would now have been. This is mainly accounted for in increase of house prices.

  6. Tom Fletcher
    Posted July 9, 2008 at 2:48 pm | Permalink

    Making our central bank independant would not necessarily promote growth and minimise inflation. It would simply allow them to make decisions which may be favourable in the short-term, but abusive in the long-term. It's important to keep a very close eye on the people who control the issuance of money in our economy.

    The rate of inflation should be calculated taking into account the rising price of other things too. Why set an inflation limit when you are simply going to change the way inflation is calculated to avoid having to openly exceed it. Inflation surely cannot be as low as it's made out to be?

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    John Redwood won a free place at Kent College, Canterbury, He graduated from Magdalen College Oxford, has a DPhil and is a fellow of All Souls College. A businessman by background, he has been a director of NM Rothschild merchant bank and chairman of a quoted industrial PLC.

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