Should we abolish the Monetary Policy Committee?

Mr Blanchflower resigned from the Monetary Policy Committee. He now thinks it should be abolished because it did not agree with him whilst he was on it, and may soon disagree with him again.

Readers of this blog will know that I too have been constantly critical of the various calls the MPC have made, in the run up to the Crunch, during the Crunch and in the aftermath of the Crunch. The MPC was told to keep inflation around 2%. They allowed it to soar well above target, they forced it to slump well below target,.and now they are letting it surge well above target. It is not a good record.

The MPC are given the task of regulating the economic clock so it always gives steady and reliable time. Instead they speed it up too much when it is already running fast, and slow it down too much when it is already in danger of stopping. Mr Blanchflower is someone who favours speeeding the clock up. He recommends lower interest rates and loser money. He is trying to fight unemployment and recession, and thinks you can do that by printing money – if only. Inflation well over the target rate does not seem to worry him.

The MPC remit is to control inflation. They have failed to do this. They need to think again about why they have got it so wrong, and try to do better in the future. Who are they kidding with their current 0.5% interest rate? Have they not noticed that everyone else has to use much higher rates than their recommended rate, and even the government now has to pay a lot more for most of its money.

This entry was posted in Blog. Bookmark the permalink. Both comments and trackbacks are currently closed.

32 Comments

  1. Stuart Fairney
    Posted January 20, 2010 at 9:06 am | Permalink

    A welcome first step indeed. We would not tolerate a committee of experts telling us how much bread should cost, yet we tolerate it for money. Why?

    Perhaps then we could do away with the Bank of England and Fiat money altogether ?

    • Lola
      Posted January 20, 2010 at 11:50 am | Permalink

      Quite. They are trying all the time to 'buck the market'. And because cannot ever 'know' enough (an information deficit to the 'market') all the decisions they make are wrong.

      Removing interest rate decisions from politicians was a good first step – even if done for the wrong reasons and in practice not done at all. Now somehow we have to remove interest rate decisons from 'experts'.

      In theory you could privatise money. Return the freedom to banks to issue their own money. This would prompt banks to market themselves on security rather than rates and charges. This must be good for the stability of money and inflation. The role of the bank of England as lender of last resort could be easily maintained even though it did not mange a single UK currency. It conceivably use Gold to lend to banks in short term need of extra funds. And charge a price for that service.

      In effect banks already issue money by the credit creation process. But that's not actual cash. But if that cannot be countenaced then bank supervision needs to be specific and thorough, especially as regards capital and reserves.

      Certainly a first step, assuming we keep the State monopoly of money, is to make sure that the State and its central bank supplies us with consistent sound money. Next the State must control its own spending and reduce its borrowing to as near zero as possible. State borrowing and spending on the epic scale is a major cause of boom and bust and inflation – in my opinion.

      There is a lot more to say on this subject, but no space here. But, this discussion needs to be had in the wider circles of politics and the electorate. The lack of understanding of these essentially simple issues among the wider population is tragic, and an indictment of our education 'system' and especially the leftist, statist monopolistic thought control education polices we have been pursuing for decades. I suppose that might be deliberate.

      Of course this an anathema to lefty statist and their attendant bureaucracies. Good.

      • Stuart Fairney
        Posted January 21, 2010 at 6:53 am | Permalink

        I never thought I would say this, but I have come around to the Ron Paul/Austrian position on money i.e. that fiat money is by definition inflationary and leads to boom/bust cycles. Further, we simply cannot trust politicians of any stripe or central banks with a fiat currency because they will use the power to fund deficit spending, (QE for example) and the deficit is then eroded by inflating out of it rather than actually paying it off.

        Ergo, to avoid boom/bust in reality as oposed to the PM's rhetoric, we should revert to a commodity based monetary system, which would not be inflationary, it would encourage saving (as inflation would not erode the value) and interest rate decisions would be a matter for the lender-borrower relationship not some bureaucrat ~ (however much they might fancy themselves as 'experts').

    • Nick
      Posted January 21, 2010 at 12:26 am | Permalink

      The committee doesn't set prices. The market does. (Unless you're a forced buyer of things like government 'services')

      The target for the MPC is inflation. They haven't been very good, but they haven't been awful. Currently the problem is that they have been told what to do by Gordon. Namely print me lots of money to spend.

      Blanchflower is wrong. His remit was inflation. His remit was not the 'economy'. That's someone elses responsbility, and that's Brown and Darling and they have managed a big balls up

      Nick

      • Stuart Fairney
        Posted January 21, 2010 at 12:43 pm | Permalink

        At the risk of being a pedant, a great many financial products take their lead, and are tied to base rates

        • Mark
          Posted January 21, 2010 at 5:04 pm | Permalink

          Look more closely and you'll see that isn't really the case. For example, the margin on "base rate tracker" mortgages is highly variable over time for a similar security risk. The reason is that the forward swaps market sets the real price for the duration of the deal. It used to be the case that a typical mortgage was set at base rate +2% for its entire 20-25 year life, even though they weren't contractually base rate trackers. The discount to base rate deals that were briefly available a couple of years back could only be achieved through swaps hedging. New base rate tied mortgages are now offered at a huge premium.

          Most existing trackers only guarantee the margin for a relatively short period before they revert to SVR. This is partly because there is limited liquidity in longer duration swaps, which are much riskier and therefore more expensive. The other reason is that a high SVR encourages you to re-finance, and pay another round of application fees, adding to the bank's margin.

      • Lola
        Posted January 21, 2010 at 1:11 pm | Permalink

        Yes, you're right 'the economy is Darling Brown Balls responsibility. But that means them 'running' it. As in, they are the only three people who know what to do and we, all 60 million less three of us, should do exactly as they say. They need to work out that they cannot 'run the economy'. All they can do is get in its way. Me and you run the economy and we do it very nicely thank you without any help at all from Darling Brown Balls.

  2. Brian Tomkinson
    Posted January 20, 2010 at 10:54 am | Permalink

    I question the true independence from government of the MPC particularly when the four external members are appointed by the Chancellor. As an interested outsider, it seems to me that far from being an independent body that takes away political control from the setting of interest rates it is a Trojan horse doing the government's bidding.

    • alan jutson
      Posted January 21, 2010 at 10:38 am | Permalink

      Brian

      Agreed

  3. Irene
    Posted January 20, 2010 at 12:49 pm | Permalink

    Blanchflower is just a mouthpiece for Labour

  4. Javelin
    Posted January 20, 2010 at 12:52 pm | Permalink

    The MPC needs to reflect reality – but reality is more complex than keeping interest unde control.

    With regard to the economic cycle, my view is that there are two related cycles in the economic cycle. One cycle is the investment cycle the other is the asset cycle. In 1987 and
    2000 the investment cycle took down turns (i.e. privatisation and the dot-dom). In 1991 and 2008 the asset cycle too down turns (i.e. housing and house prices).

    Investment cycles generally effect business, asset cycles effect consumers. But there is cross contagion in investment cycles, when consumers buy investments (e.g. shares). There is also
    contagion in asset cycles, when investors provide funds for consumers (e.g. mortgage backed bonds).

    The relationship between the two cycles is that they are well spaced apart – not necessarily diametically opposed. The reason for this is partially because the benefits of investment
    takes time to work through the system and the benefits of investment are used to stoke asset prices.

    When economists try to fix the problems in one cycle, with say the dot-com boom they end up setting up the following asset price crash. It’s not economic problems don’t repeat themselves, they do – but economic problems alternate between investment and asset down turns. Fixing one problem doesn’t fix the next problem because the next problem is different.

    The trigger points for the crashes are similar, but different. The trigger point for investment crashes is the realisation that interest rates bear better returns than investment assets. When interest rates are high the crash is sudden (i.e. 1987), when interest rates are low the crash is slow (i.e. 2000). Interest rates also trigger the asset crashes – but this time because of rising inflation/interest rates they make assets unaffordable – (i.e. ERM 1991/2, oil prices 2007).

    The credit crunch is interesting because it was effectively an asset crash, which usually only effects the consumer sector, but there was contagion in the investment banks because they supplied credit to the consumer sector and took on a lot of the consumer risk. If retail banks hadn’t taken on this risk and passed it to their investment arms, then investment banks would not have suffered so much.

    There has also been contagion from investors to consumers, for example with misselling of endowment mortgages where investments did not yield the returns promised.

    What would I do to reduce the problems in the system. First recognise there are two cycles and a process of contagion between them. It’s a simple model.

    To reduce problems in the investment cycle means companies being more transparent about their risks and returns from investments. To reduce contagion in the investment cycle from investors to consumers it means investment funds being more transparent about the risks and returns to consumers. To reduce problems in the asset cycle (i.e house prices) it means consumers being more transparent about their ability to pay. To reduce contagion in the asset cycle means banks being more transparent about how they are funding their loans. Then on top of all this transparency there needs to be rules to restrict how companies report their future profits, restrict how investment funds report their growth, restrict how much money people can borrow and restrict how much banks can borrow to fund their loans. I’ll leave the implementation details up to you.

    Setting levels of interest rates – means splitting business interest rates and consumer interest rates. When consumers need higher interest rates then investors don’t. The cycles are
    different. Again there are lots of ways of implementing this (e.g. caps, tax etc) but the important thing is that the policy stems from the understanding that there are two cycles.

    I think this model provides a good framework for Regulatory, Monetary and Fiscal Policy.

    So in reply I think the MPC needs overhauling but I think there needs to be a recognition that consumer asset prices and commerical investment bubbles are not the same thing and that regulation needs to be brought into the equation as well.

    I guess what I’m saying is that setting interest rates needs to take the whole picture into account. Having the MPC do that would make the Chancellor largely redundant. So I think a report (containing voted recommendations) should be given publically to the Chancellor and he should respond publically saying what he is doing and why.

    • Nick
      Posted January 21, 2010 at 12:27 am | Permalink

      The MPC needs to reflect reality – but reality is more complex than keeping interest unde control.

      ===============

      They have no remit to keep interest rates under control, just inflation

    • Lola
      Posted January 21, 2010 at 1:27 pm | Permalink

      Is all this complexity you propose designed to produce a steady state economy? If so its doomed.

      Or is it designed to produce the 'correct' interest rates? If so, it's doomed.

      Or yet again is it desinged to stop asset price bubbles. It might work, but only at the expense of strangling wealth creation.

      Would not a simpler idea be to return to markets the setting of interest rates? I'll leave the techinicalities of how to achieve that up to you!

  5. BillyB
    Posted January 20, 2010 at 12:58 pm | Permalink

    Why was setting up the MPC seen as a sound/smart move in the first place?

  6. JohnRS
    Posted January 20, 2010 at 1:00 pm | Permalink

    If the MPC were truly independent then it would be an effective force for good in the economy. But it’s loaded with New Labour appointees so it’s really just a paper tiger.

    West Germany would seem to be a good example of an independent central bank keeping politician’s bad habits under control during the post-war boom decades.

    Might be worth looking at how Germany kept the Bundesbank honest?

    • Nick
      Posted January 21, 2010 at 12:29 am | Permalink

      Quite. The inflation target was wrong and fiddled (RPI – CPI)

      The inflation target didn't include House prices.

      The real issue is the 7-8 trillion of real liabilities of the government.

      Combine that with rampant spending, and it's going to go bust.

      Factoid of the day.

      The House of Lords costs 2,000 pounds a minute to run

  7. Sally C.
    Posted January 20, 2010 at 1:31 pm | Permalink

    Austrian economists would argue for the B of E and the MPC to be abolished. My feeling is that we have to take a pragmatic position. We have a fiat currency and we are not going back to the gold standard any time soon. Therefore, the B of E should continue to exist but the MPC should have a majority of Austrian economists on the panel. Personally, I would nominate Paul Volker (who although not an Austrian economist, thinks the same way), Steven Roach (but I don’t think he would take the pay cut), Vaclav Klaus (when he decides to step down as President of the Czech Republic), Frank Shostak and George Reisman, (two well known Austrian economists) to the MPC. We could then be sure that the currency would not be debased any further.

  8. Mark
    Posted January 20, 2010 at 1:32 pm | Permalink

    The MPC was to some extent modelled on the Council of the Bundesbank, which had a particularly successful record of maintaining the value of the DM during its run in charge between 1948 and the ERM in 1990 in a country which had suffered two hyperinflations in less than 30 years. There is some interesting history in this BoE paper:
    http://www.bankofengland.co.uk/publications/other

    It is clear that the switch from money supply growth rate to RPI inflation targetting that followed the UK exit from the ERM in 1992 was successful, and equally that the move to CPI has helped let the cat out of the bag. The paper (which dates from 2005) makes an amusing read for the informed, with some magnificent ignoring of the elephants in the room:

    "the recent rapid growth in the money supply has been concentrated in the holdings of… entities which in effect intermediate funds between different banks, and
    financial vehicles whose object is to shift risk off banks’ balance sheets. The implications of the
    activities of each of these for asset prices and future movements in nominal demand are not easy
    to gauge."

    "While an increase in house prices does not directly make most households better off – a homeowner can
    only unlock the capital gain if (s)he is willing to move to a cheaper house – it does increase the
    collateral against which cash-constrained households can borrow and may thus boost consumer
    spending through that route. So house prices are one factor influencing consumer spending."

    Perhaps if the BoE had had a proper regulatory role they would have been better informed.

    I agree with Brian Tomkinson. The concept of an independent MPC was essential to Brown gaining credibility with the markets in 1997. His cover now is completely blown, as is the independence of the MPC, with placemen such as Blanchflower, Kate Barker (of the famed housing review that claimed house prices could only ever increase), and Nickell all playing ostrich.

    Sheikh Oteiba, the then UAE Oil Minister commented as oil prices became dominated by free markets in the late 1980s "OPEC benchmark prices are like churches: beautiful to look at, but no longer relevant." Much the same seems to have happened with the Bank Rate. Its only relevance is to set the floor at which banks can borrow from small customers or the state. There is no competition in banking markets to ensure that borrowers can obtain funds at a competitive margin over bank rate: indeed, such competition has been suspended until the banks are re-capitalised. The setting of Bank Rate is no longer to act as a benchmark for borrowers, and thus influence the economy.

    The policy instruments that are or were potentially available to the Bank are a) short term interest rates; b) shape of yield curve through selecting maturity of government debt offered and retired and the repo market; c) money supply, and d) exchange rate. Of these, the exchange rate has been shown to require deeper pockets than the Bank possesses by the ERM debacle, and is therefore no longer considered; control of the money supply has been completely abandoned, debasing the coinage of the realm to finance the treasury; yield curve manipulation is rife – even though some of the mechanism has been surrendered to the DMO and is thus outside Bank control – but will almost certainly fail when the manipulation mechanism of QE is ended, and short term interest rates are set to benefit the banking sector rather than control the economy.

    Should we abolish the MPC? In the end, my answer is no – we should ensure the members are more uniformly of higher calibre and independence of thought; we should restore to the BoE the regulatory oversight that is essential to having a sufficiently deep understanding to set policy more accurately; we should concentrate on sorting out the banking sector with fresh capital and better regulation; and we should get government borrowing back under control. Then perhaps we can achieve some of the stability that the Bundesbank provided for Germany, or even that the BoE managed before Brown wrecked the whole structure.

    In the mean time we will have to recognise that the BoE and the government is once again about to appear extremely impotent as the market asserts itself.

    • Lola
      Posted January 21, 2010 at 1:15 pm | Permalink

      Seconded in spades.

  9. Ian Jones
    Posted January 20, 2010 at 1:58 pm | Permalink

    Whilst not the greatest fan of the MPC, in comparison to that idiot Blanchflower I would keep the MPC. Blanchflower wanted to slash rates even before we got to 5% inflation, imagine what it would have ended up at! The guy gets too much press and demonstrates a serious weakness of the MPC, its populated by people picked by Gordon Brown.

    Inflation targetting is dependent on being forward looking and having only interest rates means asset bubbles form simply because the structure of the economy moves over time. In this case, we imported deflation and therefore had domestic inflation. In the case of some services and housing, massive inflation. The economy is now skewed and in trouble as the imported deflation turns to inflation.

  10. Michael Lewis
    Posted January 20, 2010 at 2:27 pm | Permalink

    “Mr Blanchflower resigned from the Monetary Policy Committee. ”

    That is the one thing I think he was right about.

  11. John Moss
    Posted January 20, 2010 at 3:10 pm | Permalink

    Lawson made similar mistakes in the late 80s, trying to shadow the DeutscheMark rather than controlling inflation and the money supply. That caused a huge asset bubble, which burst with similarly messy results.

    The MPC is an OK idea, but it ain’t the Bundesbank and never will be unless it is given a similarly wide remit and power.

  12. Martin
    Posted January 20, 2010 at 4:50 pm | Permalink

    The big problem with dumping the MPC is that Mr Brown would certainly be playing even more games with interest rates that you fear the MPC is. Mr Blanchflower may have had money printing views and is perhaps best gone.

    An example of Mr Brown’s games is the “Fiscal Responsibility Bill”. If passed it will mean that anybody who can afford fancy lawyers can go down the law courts and allege a violation of this act and demand a judicial review and get any future change in economic policy stuck in law courts for months.

    Reply: Oh no it doesn’t! I have been in the Chamber debating the detail today. It very clearly exempts the Treasury from difficult legal actions.

    • Martin
      Posted January 20, 2010 at 11:27 pm | Permalink

      Thanks for the reply.

      No fixed £100 civil penalties for the chancellor if he is late reducing the deficit then.

  13. mikestallard
    Posted January 20, 2010 at 7:23 pm | Permalink

    If the Governor of the Bank of England is to have full control of monetary policy, then, surely, he must have a group of advisers to whom he turns for advice?
    Is this not the MPC.?
    The devil is, of course,that, like everything else it has touched, New Labour has corrupted this organ of state by reducing it to just a tool for its own ghastly politics.
    It is going to take a very long time to unravel this politicisation. It even has infected the Charity Commission for heaven's sake!

  14. Andrew Gately
    Posted January 20, 2010 at 11:24 pm | Permalink

    I don't think you necessarily need to disolve the MPC.

    I do think that we should return to the RPI measure of inflation and look to avoid the excessive swings in the interest rate.

    IMO the interest rate in the UK is neutal at 4% below that monetary policy is loose above that it is too tight.

    I think with interest rate decisions they are eventually made for you and the job of the monetary policy committee is to get to the correct rate as soon as possible. In this respect Mervyn King in particular failed and to do nothing for 16 months after the wholesale markets froze up was unforgivable and undoubtedly made the eventual fall out much worse.

    The first thing that needs to be done is that Mervyn King needs replaced, the problem is that all the other members apart from Blanchflower also got it wrong. Having initially got it right Blanchflower is now wrong over the future which leaves no credible economist available to take over leadership of the MPC.

    • Lola
      Posted January 21, 2010 at 1:30 pm | Permalink

      Quote. "No Forsyte ever accepts less than 4% on his money". john Galsworthy.

      What goes around comes around.

  15. ikh
    Posted January 21, 2010 at 4:52 am | Permalink

    John, whilst I am sympathetic to your views on the economy, I disagree with
    you on much of the detail. It was not the MPC that caused the credit bubble, or
    the consequent credit crunch. As you yourself point out, their remit is
    solely to control inflation and the tool they have to use is the base rate. This
    was a corse tool under Mrs T and inflation is not particularly responsive to
    changes in base rate over the short term.

    IMHO, the cause of the credit bubble was GB allowing the money supply ( M4 )
    to grow by 300% in the 10 years from 1997 to 2007. At the same time, the US
    money supply grew by over 200%. Whilst interest rates could have been used
    to dampen this, this was outside the remit of the MPC. Inflation ( CPI/RPI )
    only started to grow right at the end of the bubble ( reaching nearly 6% after
    the bubble burst in the month after the failure of Lehman's ).

    As a result of a credit bubble forming, a crunch was inevitable. The MPC raising
    interest rates had nothing to do with bursting the bubble, it was just
    coinsidence. It was the failure of Lehman's that finally burst the bubble.

    The near collapse of the banking system was just about guaranteed because we
    had signed up to Basel II. This had allowed the banks to reduce their capital
    reserves from around 15% ( the historic level ) to around 4%. For the life
    of me I can not fathom why anyone would believe that bank reserves one
    quarter of their historic level would suffice in a banking crisis!

    To add insult to injury, we allowed the largest securities market in history,
    the 60 Trillion credit derivatives market, to go completely unregulated as
    an OTC ( Over The Counter ) market. And then we are surprised that it becomes
    so illiquid that it freezes solid when it goes wrong!

    With London having 50% of the credit derivatives market and New York having
    about 40%, and given the above, we can safely say that this world wide recession
    was caused by two men. They are Alan Greenspan and Gordon Brown. It is
    interesting Alan Greenspan has admitted his responsibility however I expect
    Hell will freeze over before Gordon Brown admits his responsibility.

    So what should have been done when the crunch came? Interest rates should have
    gone high to attract money to the credit market and to fairly share out the
    limited credit supply. The bank baleout should have been done all in shares.
    not 10 billion of preference shares at 12% coupon. And the credit derivatives
    market needed to be re-started by using the BoE to write CDSs ( Credit Default
    Swaps ) at commercial rates and forcing the newly created CDOs
    ( Collateralised Debt Obligations ) to be traded on a recognised exchange.

    So, in answer to your question about the MPC, yes, we should abolish it and
    allow interest rates to float. The market is already ignoring the base rate
    to a great extent. Control of the money supply can be done by using bank
    reserves of 15% as the base line and increasing reserves to take money out
    of the economy. This has the advantage that if a particular asset class
    starts to run away ( i.e. house prices ) we could raise reserves just on
    residential property without reducing the supply of money to commerce.

    /ikh

  16. Norman
    Posted January 21, 2010 at 11:29 am | Permalink

    Slightly related, on the interest rate bearing no resemblence to reality. I have an old Capital One credit card lying around, unused for years, that keeps getting renewed automatically and last night I received a letter from them stating that due to the economically harsh environment they were now raising the interest rates on the card to 39.9%. This isn't some loan sharking business, I believe they are quite a large company. Even though I had no balance I cancelled the card to try and make some kind of protest.

    I realise there are a lot of people not as lucky as me and who may be in low paid jobs with a few thousand pounds on a card and unable to pay it off in one go and would like to keep the card active. These are the very people Labour espouse to help and now will be squeezed until they squeak by these new rates.

    The socialist solution to this economically harsh environment: tax banks and bankers! The result of which will be more letters of the like I received yesterday. If you're above middle income, don't worry, the changes won't affect you, if you are on a lower income I'd be very afraid of the proposals floating around to introduce punitive taxes on banks.

  17. Grumpy Optimist
    Posted January 21, 2010 at 11:35 pm | Permalink

    The problem has been a special case of this governments target obsession. By focusing on just one thing – consumer prices – the result was bound to be distortion. The MPC could not be trusted to aim for monetary and asset price stability/equilibrium because it is the target and the spin which this government is obsessed by.
    How could they be allowed to use their initiative. To give Blanchflower his due, he understands that more than a cpi target is at stake. Unfortunately and as is clear from his writings in the New Statesman, his temperament and politics make him completely unsuited to being part of the MPC as he has no empathy or understanding at all for the importance of a stable monetary environment.
    To have him on the MPC is like having a happy and contented alcoholic in charge a teetotal campaign.

  18. Lindsay McDougall
    Posted January 22, 2010 at 2:57 am | Permalink

    We need base rates to move back up to about 3% and an inflation target steadily reduced to zero.

    I am totally indifferent whether it is politicians or an 'independent' MPC that makes the decisions, as long as the decision making institution in a UK one and not a European one.

  19. Adrian Peirson
    Posted January 24, 2010 at 11:51 pm | Permalink

    We should abolish All institutions and policies that do not recognise that the root cause of ALL our problems is who has control over the money supply.
    A video from http://www.Mises.org

    mises video http://www.youtube.com/watch?v=m-LJ3wZjD4I

One Trackback

  • By I am quadruply conflicted « Freethinking Economist on January 20, 2010 at 6:32 pm

    […] you may disagree with him but you can’t deny that he’s bright” mode, when I read this post about abolishing the MPC: The MPC remit is to control inflation. They have failed to do this. They […]

  • 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.

  • John’s Books

  • Email Alerts

    You can sign up to receive John's blog posts by e-mail by entering your e-mail address in the box below.

    Enter your email address:

    Delivered by FeedBurner

    The e-mail service is powered by Google's FeedBurner service. Your information is not shared.

  • Map of Visitors

    Locations of visitors to this page