The expected death of the “independent” Monetary Policy Committee

Yesterday at a little after noon the Prime Minister announced a 50 basis point cut in UK interest rates to the Commons. He told us the Governor of the Bank had decided it. The decision came a day before the Monetary Policy Committee had completed its usual monthly processes to settle their view of interest rates. The statement did not say rates were being cut in order to hit the inflation target, but to take part in concerted action around the world to help with the banking crisis. I agreed with the need to take urgent action to cut rates, and am glad the authorities did it.

I have long argued there can be no such thing as a truly independent Bank or Monetary Policy Committee in a democracy. Parliament – or Congress and President – can leave an “independent” body free to do these things as long as they like. However, this freedom will only be extended for as long as the “independent” body does it job well and the system still pleases the people and elected politicians. Once there are worries, concerns or doubts, it is likely the elected officials will reassert their direct power, or change the system. The US system has always required the Fed to support the economic policy of the Administration. Mr Darling has reminded us that the Bank of England too has another duty as well as curbing inflaiton.

You could argue that the lack of independence of the MPC was obvious as long ago as December 2003, when the government changed the inflation target from RPI to CPI and from 2.5% to 2%. This in effect encouraged the MPC to set lower interest rates, as the CPI was going up much less quickly than the RPI. You can argue that the lack of transparency over who gets reappointed to the MPC and who does not was another weakness in its structure. Surely no sensible person after yesterday can say the MPC is independent?

I do not mourn the passing of the “independent” phase of the MPC. This is the body which kept rates too low in 2003-6. Its main aim was to keep inflation down to 2%. It has shot up to two and a half times that. It failed in the good years to be tough enough. It failed to control prices as advertised.

Now we are on the threshold of bad years it has been too tough. Its actions in keeping rates high as we peer towards recession will increase the number of people who lose their jobs and their businesses during the downswing. Once again the MPC seemed to be driving by looking into the rear view mirror, to capture the inflation it has already allowed, rather than looking through the windscreen to see the crunch ahead.

Let us hope we now can have a more intelligent debate about how to control money in a democracy. It is a great pity that the “independent” MPC did not succeed in curbing excess money and credit growth in the good years. We need new people or a stronger system that will control inflation next time round, when the extent of public debt will lead some to hanker for more inflation to reduce the liabilities. In the meantime we need an MPC and Bank fully committed to countering deflation.

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17 Comments

  1. Posted October 9, 2008 at 1:46 pm | Permalink

    "Mr Darling has reminded us that the Bank of England too has another duty as well as curbing inflaiton."

    The Bank of England has whatever duties the government chooses to give it, surely? First it was given one inflation target, then another, and now its duty seems to involve taking risks with the currency in exchange for growth.

    If we try to inflate our way out of the crisis, we will make prudent savers pay for the mistakes of the profligate. Mervyn King worried about moral hazard applied to banks, but this would be a mistake many times worse: it would extend moral hazard to everyone in the country. "Spend your money today, for tomorrow it will be gone."

  2. Posted October 9, 2008 at 1:49 pm | Permalink

    The politicians and now the independent experts have tried and failed to control inflation. So why not leave it to the market to set the base rate? Or there is always the gold standard…

    • Posted October 9, 2008 at 4:47 pm | Permalink

      I have been asking the question "why not return to the gold standard" for some years now, and have never had a convincing reply from the economics experts. Apart from the fact that the genius that is G Brown has sold half our gold reserves at knock-down prices, what are the arguments against this, John, anyone?

      • Posted October 10, 2008 at 8:51 am | Permalink

        An obvious one is an insufficient supply of gold for monetary purposes. If you can't back enough money with gold then you induce a howling deflation as less money and liquidity is available for the purchase of goods (so prices drop). This would be very bad indeed.

        • Posted October 10, 2008 at 4:02 pm | Permalink

          Thank you for this. But since a howling inflation in asset prices, caused by a huge and unjustified credit bubble got us into the mess in the first place, what is wrong with some deflation and lower prices?

  3. Posted October 9, 2008 at 2:12 pm | Permalink

    Gordon Brown was quite open in his letter to the governor in May 1997 that he reserved the right to usurp MPC policy if he felt it was in the national interest. Of course this has created an atmosphere in which the MPC has been afraid to step outside of government policy, for fear of humiliation and has done the Labour governments bidding. Any idea that the MPC is some autonomous body is farcical. The question is what will a Conservative government do to de-politicize the MPC, to roll back the state in this crucial area?

    • Posted October 9, 2008 at 3:10 pm | Permalink

      This decision, plus the timing, was made in the interests of one Gordon Brown, rather than "national interest". He is lapping this whole crisis up, sadly with the BBC towing the "not invented here" line unless the Tories stop getting caught in the headlights we (incredibly given his 10 year hand in this crisis) could even up with Labour given 5 more years to complete their destruction of our once great nation. A clear case as ever there was of frying pan and fire.

  4. Posted October 9, 2008 at 3:36 pm | Permalink

    What expertise do politicians have to control money in a democracy? Very little in my opinion. Therefore, I am not filled with joy at the thought of the Bank of England's role, limited as it was by Brown's changes in 1997, being usurped by such people. I thought the Conservative Party wanted a bigger role for an independent Bank of England? Did I dream that or was it just a throwaway line when it was thought to be politically expedient to speak of such things?

  5. Posted October 9, 2008 at 4:22 pm | Permalink

    Brown only made The Bank of England so called independent to stop it looking over his shoulder. I would suggest if Brown had not done all these things, it would not be as bad as it is now.

    He has been the worst long term Chancellor and PM we have ever had.

  6. Posted October 9, 2008 at 4:54 pm | Permalink

    John – I agree about the MPC. This is an example of the Government agency myth – all blame can be attributed to said agency/quango (see Ed Balls and exam marking for details) but any credit accrues to the relevant Government Minister. The great thing about the Government running things and taking responsibility is that if they don't like it the electorate can throw them out every so often. They can't do this to unelected agencies/quangoes, which are therefore profoundly anti-democratic as well as being inefficient. Also, as we note from various agencies/quangoes, they tend to be headed by Government toadies/aparatchicks/office politicians on the make. It is simply an unwelcome extension of Government patronage,and belongs more to the 18th rather than 21st century.

  7. Posted October 9, 2008 at 5:31 pm | Permalink

    A friend of mine sent me this. I hope it explains why government should keep out of banking:
    In September 2010, (leading UK banks -ed) joined together to form the National Bank, whose deposits are guaranteed by the Government. We aim, together, to provide excellence in banking in the 21st century.
    This means that, by November 2010, you must transfer your account to the National Bank.
    Here are the things you have to do. IF YOU DO NOT YOU MAY LOSE YOUR ACCOUNT.
    Go to any bank counter of the National Bank. All National Banks are clearly labeled for your convenience. You may have to wait. Try to be patient.
    Ask for Form RIBE54/3. (This may vary in some areas as forms are in short supply). You can get this Form in your own language (Just ask at the counter for Form RIBE 93/7c.) You may ask for Form RIBE 54/3 to be sent to your home address. (This does not apply to Form RIBE 54/7 which is available only in Tower Hamlets and Towcester). Please allow a week for delivery.
    Fill in ALL of Form RIBE 54/3. Don’t forget to put in your marital status and sexual orientation (you can find this on page 25). We also ask for you to complete the racial identity survey (you can find this on page 34) so that we can make sure that everyone is treated fairly, regardless of ethnicity or sexual orientation. Remember the Medical Section (Pages 13-24) must be countersigned by a Doctor. IF YOU DO NOT SEND US THE COMPLETE FORM YOUR ACCOUNT MAY NOT BE VALIDATED.
    If you would like to speak in your own language, please ask for an interpreter. (This service is provided free of charge.)
    The National Bank does not accept accounts from any member of the British National Party or from members of the UKIP.
    Are you working for any government department? If you are, please ask for an appointment with one of our equal opportunities advisors. This will save us time in completing your transfer by fast tracking your application.
    We give special consideration to single mothers and those on disability benefits.
    Special consideration is also given to Core Workers. If you are a party activist you may be a Core Worker. (You can see a list of people entitled to this benefit on Appendix V/RIBE 54/3, or Appendix III/RIBE 54/17 in Wales)
    The National Bank aims to provide excellence into the 21st century. We want to hear what you think of our delivery. Don’t forget to fill in the Appreciation Survey which you will find at the end of Form RIBE 54/3. There is a Freepost envelope provided for your convenience.
    We aim to reply to your completed application within three calendar months of receipt. If you do not hear from us within that time, please assume that your application has not been successful.

  8. Posted October 9, 2008 at 7:09 pm | Permalink

    "I have long argued there can be no such thing as a truly independent Bank or Monetary Policy Committee in a democracy. Parliament – or Congress and President – can leave an “independent” body free to do these things as long as they like. However, this freedom will only be extended for as long as the “independent” body does it job well and the system still pleases the people and elected politicians".

    This says it all.

    I also heard Bush saying "Ask your finance ministers to have a chat with our boys at the Federal reserve", and I also heard the IMF boss saying "There's a recession on the way if you all don't come up with a coherent policy to deal with the crisis".

    I also seen Mervyn King walking into No10 instead of No11, and I heard the Prime Minister telling everyone how he had solved the problem his Chancellor was just about to tell the hosue about.

    Indeed, the Bank of England is far from being independent and nor should it be, but we still don't hear much about democracy or what the people need.

    More to the point, Europe has not followed suit and yet there's still no argument from the shadow benches.

    Don't you think there's something a little fishy about it all yet ?

  9. Posted October 10, 2008 at 12:48 am | Permalink

    Agreed with puncheoon and others – from outset I reckon that the MPC was a poisoned chalice. Its purose was to provide another external force Gordon could blame and to take the eyes of the public away from his own failings. Plus if it 'failed' (or could be made to fail) he could recover control and be seen as the Great Saviour. Politically the MPC was an extremely astute move. Economically and fiscally it was useless, along with its companion legislation the FSMA 2000.

  10. Posted October 10, 2008 at 3:46 am | Permalink

    I wonder if Mr Redwood would have a line on thoughts expressed by Professor Buiter on the FT's website ("Maverecon'").

    He is commenting in his latest post on the collapse of Iceland's banking system. He reveals he told Iceland's government in March this year – in a private paper which he now produces – that its banking model was vulnerable to a banking run. He is surprisingly prescient about what took place this week in that paper.

    More ominously, Prof Buiter believes the UK banking system is vulnerable too to a banking run. Which might mean the UK's banking system could be safer in the eurozone with the protection of Europe's central banking system. Oh dear.

    Over to you, Mr Redwood.

    • Posted October 10, 2008 at 12:04 pm | Permalink

      I had a problem finding that article, but I think this is it:
      http://blogs.ft.com/maverecon/2008/10/icelands-ba

      Presumably in practice the banks would deposit sterling assets with the Bank of England, and obtain cash in exchange. They would then convert that money to another currency in order to meet their non-sterling obligations. This would cause pressure on the value of sterling.

      Since July, sterling has held steady against the euro, but fallen against the dollar. Does that mean that our banks are having a problem meeting dollar-denominated obligations, but are doing better in the eurozone?

  11. Posted October 10, 2008 at 11:17 am | Permalink

    If the MPC/BoE were given the charter to preserve the value of Sterling, instead of chasing price inflation, then we might have had a different outcome.

  12. Posted October 10, 2008 at 11:40 am | Permalink

    I have never approved of the MPC. Only the market should set interest rates. Money is not cheap or dear, it is money. People will lend money if they get an adequate return they cannot get elsewhere.

    High interest rates are a tax on the productive areas of the economy in favour of the unproductive. They increase the value of the pound and this uncompetitive rate is one reason why we have lost so much of our manufacturing sector.

    The MPC has not followed its brief but during 2004/6 kept interest rates high because of house price inflation even though house prices were specifically excluded from CPI.

    The situation at the moment is pure panic, irrational fear. The government should suspend trading in bank shares for 6 months until the true losses from debt instruments have been worked out.

    We do not need more banking regulation but we need to restructure the industry so that retail banking is run by different banks to investment banking and the collapse of the casino element of the latter does not affect the former. In the current crisis we should be even bolder and say that banking deposits are the property of the depositor and not of the bank so that if a bank goes bankrupt it is the purchasers of the fancy instruments who lose money and not the depositors. Then it is unnecessary for taxpayers to send yet more money into the already fat purses of Russia, China and the middle east.

  • About John Redwood


    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

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