The Bank of England can get it wrong

          After the failure of the Exchange Rate Mechanism we had an interlude of successful economic policy. From 1992 onwards the economy recovered well. Labour continued the fiscal  policy of the outgoing Conservative government for the first couple of years. By 2000 the UK economy was in good shape and the public finances were recovering strongly from the ERM disaster. There were still many in the Establishment who cast envious glances to Germany. If we could not import German discipline by hitching  our currency to theirs, they reasoned, why not adopt a German style independent Bank to enforce our own teutonic controls?

            Labour doubted it could command respect for an independent monetary and economic policy, so it was vulnerable to these siren  voices. It offered two reassurances. It would follow Conservative spending plans for a bit, and would not raise Income  Tax rates. Once in office it added the decision to “make the Bank of England independent”. As always in an age of spin  it was important to look at what they did rather than what they said. They stripped the Bank of its bank regulating powers, and took away its job of raising money for the government in the money markets. Far from making the Bank overall more independent they all but demolished it, making it less in tune with how money and debt markets were moving. They created a so called independent Monetary Policy Committee. Their task was to set interest rates with a view to keeping price inflation close to a stated low target for RPI increases.

                    Every person on the MPC was a direct appointment chosen by the Chancellor, or was chosen by someone chosen by the Chancellor in the case of Bank employees. Some found their tenures renewed, others served just one term. There was no transparency over how you got selected or re selected. Treasury Ministers sometimes seemed alert to  likely future interest rate changes.  During the second Labour Parliament the Chancellor changed the target from RPI to CPI in  a way likely to result in looser monetary policy, as he did not fully allow for the lower historic  rate of increase in CPI compared to RPI. In more recent times  Chancellors have become intimately involved again in monetary policy, as their  consent is required for quantitative easing.

               A body with a single aim should be judged by their results. For  most  of the last 60 months inflation has been higher than the permitted level. In their most recent report the Bank and the MPC have stated they do not have much idea of what will happen next in the economy. They stand ready to fight deflation and to fight inflation. They have had once again to revise  their forecast for the inflation rate upwards. This has all happened against the background of depressed western world demand and very low price inflation in the US, Euroland, Japan  and the other main advanced countries.

               The apologists for the Bank claim that it was not the Bank’s fauilt that the UK economy lurched from a credit soaked boom in 2007 to the deepest recession since the 1930s in 2008-9. They argue that international factors were to blame. Alternatively they say it was the fault of  the banking crisis where the FSA was the prime regulator. They still have to explain why it should be that against such a background the MPC was not even able to control price increases when practically everywhere else in the advanced world inflation had ceased to be a problem. They also need to explain why the Bank of England did not take its duty to avoid systemic collapses in the banking market more seriously at an earleir stage of the crisis.

                 The truth is the Bank of England lurched from money which was too easy and interest rates which were too low, to money which was too tight and rates which were too high in 2007-8. Their policy allowed or fuelled the bubble, and their policy helped burst it. They did an extreme version of what the ERM had done to the UK economy a couple of decades earlier. Many people and two Opposition parties warned that credit and mortgages were too easily available  prior to 2007. We called for tighter policy. A few of us urged the Bank and government to loosen in the summer of 2007 to avoid the run on the Rock, but our well intentioned advice fell on deaf ears. There were even fewer of us offering an alternative to bank nationalisation, once the monetary tightening threatened to overwhelm bigger banks in 2008.

                   The Bank now accept that current inflation in the UK is partly the result of a major devaluation of the pound which the Bank allowed and facilitated during  the crisis. If they wish to uphold the value of the currency they need to take actions designed to retain its external value as well as its internal value, as the two do have an intimate relationship. The combination of money printing and low interest rates  has undermined the external value of sterling. In an open economy like ours where we import so much it has directly slashed our living standards. This site has been warning against excessive devaluation and inflation for many months, but the Bank seemed unable to see it when it mattered. As a result we have ended up with a stunningly high 5% RPI inflation at worst , and a 25% devaluation.

               Meanwhile, what became of the bold German model for these two schemes?  Germany gave up on the Exchange Rate Mechanism and moved rapidly into the Euro so other countries could no longer  devalue against her. Her Central Bank remains, but no longer has a currency or an interest rate structure to operate. In the dying years of German monetary independence even Germany showed that her Central Bank was not and could not be truly independent in a democracy. On the two main questions of the day the politicians overruled the Bank. They ordered a badly chosen  swap of ostmarks for DM on the reunification of Germany against Bank advice. Their chosen rate of one ostmark to one DM was boudn to cause economic problems.  They ordered the abolition of the DM, the currency the German Central Bank had to maintain and defend as its main purpose in life.

               Tomorrow we will look at what would be a better system for curbing wanton politicians and for curing Central Banks with bad judgement. Meanwhile both major parties, Conservative and Labour, should reflect sorrowfully on how their experiments with auto pilot monetary policy  resulted in boom and bust, leading in both cases to bad election defeats. The  autopilot  model, whether exercised through exchange rate linkage or through an independent Central Bank, has both times done damage to the Uk economy and to the political parties in office at the time.

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43 Comments

  1. Mike Stallard
    Posted November 15, 2010 at 6:56 am | Permalink

    This article is you at your very best. It is what keeps me and many others like me coming back. So, thank you!
    If anyone out there thinks that this is the rantings of a right winger, I would very much advise them to read “End the Fed” by Ron Paul, an American Politician.
    I am currently on holiday in Australia and we are truly feeling the drop in the value of the pound. This used, once, to be a really cheap country to visit. No more.

    • Posted November 15, 2010 at 1:36 pm | Permalink

      Mike – John Redwood is indeed a clever man, but he is not Ron Paul. We don’t have a Ron Paul here, more is the pity.

  2. lifelogic
    Posted November 15, 2010 at 7:38 am | Permalink

    It is not really a difficult job to set a sensible monetary policy they just need a sensible chancellor or some one else sensible to do it. Anyone with a good track record of predicting the ERM fiasco and all the mistakes of the past few years.

    I am sure you could do it in an afternoon twice a month. Even I would have done better than Major, Blair and Brown, avoiding the ERM the recent boom and bust and providing proper regulation of deposit takers. The problem seems to be that anyone sensible is not allowed near the levers of power – hence the recent further cave in to the EU, the mad rigged “green” energy policy and the own goal of over high tax rates.

    • lifelogic
      Posted November 15, 2010 at 9:29 am | Permalink

      Perhaps I am being unreasonable in expecting someone sensible to run things. Government is so often like fashion and marketing just about what nonsense we can get people to swallow (or to fear) this year or what nonsense the BBC will happily push into people brains.

      One year its the Gold standard, then perhaps, the new Ice Age, the Millennium computer bug, the “free trade” common market, avian flu, too much salt and butter, the EMU, swine flu, Trans-Fats, the great global warming exaggeration, sustainability, the big society –

      This year darling perhaps we can get the fashionable set to wear silly windmills and pointless P.V. panels on their houses or even on their hats at Ascot what do you think? I am sure Cameron would love it.

      • lola
        Posted November 15, 2010 at 4:16 pm | Permalink

        “Perhaps I am being unreasonable in expecting someone sensible to run things.” That’d be you then. And me. And everyone else who comments on here, and all those that don’t. Thing is central planning does not work, ever. The more we stop politicians, central bankers and bureaucrats doing that the better things always get.

      • Kenneth
        Posted November 15, 2010 at 7:53 pm | Permalink

        nonsense the BBC will happily push into people brains

        …and the BBC left wing propoganda is still in full swing

    • waramess
      Posted November 15, 2010 at 9:37 am | Permalink

      Anyone sensible has a real job.

  3. Brian Tomkinson
    Posted November 15, 2010 at 9:26 am | Permalink

    I hope tomorrow’s blog will also include your analysis of the current Irish debt crisis.

  4. Stuart Fairney
    Posted November 15, 2010 at 9:29 am | Permalink

    Off topic, but please….

    http://uk.news.yahoo.com/18/20101115/tpl-govt-to-introduce-happiness-index-re-5b839a9.html

    You want to measure if we are happy? This is NOT your responsibility, please sack the staff engaged on this and borrow a bit less money!

    • lifelogic
      Posted November 15, 2010 at 1:53 pm | Permalink

      I would certainly be a lot happier if Cameron scrapped this socialist happiness index before its birth and sacked anyone involved. It would however be very out of Character for him to do so.

      • alan jutson
        Posted November 15, 2010 at 7:02 pm | Permalink

        lifelogic

        Me too, what an absolute waste of money.

        Typical thinking of a PR man.

  5. alan jutson
    Posted November 15, 2010 at 9:30 am | Permalink

    Many thanks for your explanation, never been explained as simply by anyone before.

    As usual it would seem that the problem is politicians playing the micromanaged power game. Why is it that people who have never managed anything in their life before, think they can manage an economy of a Country.

    I see the Irish are in trouble again this weekend, looks like another EU bail out, but this time (according to the Telegraph this morning) we may be in the loop to contribute. It would seem Mr Darling signed an EU Financial Agreement when he went there AFTER the election, but before the Coalition was up and running.

    About time it was published that these financial problems were not all about greedy Bankers (although they did not help) but by Political dogma.

    What a shame that your talents and experience SEEM to be ignored by all concerned. I only hope that you are being consulted in some way behind the scenes.

  6. waramess
    Posted November 15, 2010 at 9:36 am | Permalink

    What to do? Cut down on the cream cakes? Cut down on the fries? Cut down on the sugary drinks? Frankly if you are to slim it must be with far greater vigour.
    What’s wrong with cutting the state down to twenty percent? The fat man will protest that you don’t understand the problem if you want to cut his diet by more than the cream cakes and likewise the politicians will make similar protests.
    It is not difficult, just that a lot of silly political objections get in the way.
    As for the Central bank, just abolish it.
    With tax taking 53 percent of our income this is no time to pussy-foot around picking over the entrails.

    • Jan
      Posted November 15, 2010 at 2:08 pm | Permalink

      I agree we should stop pussy-footing around. How about a flat 10% income tax rate for incomes above say £15K? Get rid of most of HMRC because that should simplify things no end. I wonder what that would do to the tax take but of course if we applied similar simplifications to the benefits system, corporate laws and regulations etc you wouldn’t need all the tax to pay for the armies of beaurocrats currently employed to administer it all.

      • waramess
        Posted November 16, 2010 at 10:28 am | Permalink

        How about privatising health and schooling for a start. No reason why the politicians should be so good at running education and health, better they privatise them and, if they feel there is then not enough to do they could set up in competition making tractors and washing machines, or just find another job

  7. lola
    Posted November 15, 2010 at 10:07 am | Permalink

    Many people and two Opposition parties warned that credit and mortgages were too easily available prior to 2007 I am a ‘many people’. My business is in retail financial advice. Since the day Brown taxed pensions, and then by his creation of the ludicrous tripartite regulatory ‘system’, and the creation of the ‘indendent bank of england’ we have been warning clients about all this. The FSA having been part of this failure, and in a large part its cause, are now setting about destroying the independent mortgage advice sector my the introduction of the Mortgage Market Review. This MMr is based on an utterly flawed analysis. They need to listen to Mr R (or us), because the end game of their meddling will be anothre crisis – or totalitarianism.

    Trouble is Mr R, your colleague Mr Hoban has ‘gone native’.

  8. Iain Gill
    Posted November 15, 2010 at 10:58 am | Permalink

    I’d love to see a similar critique of the borders agency, the migration advisory committee, and the home affairs select committee

    Would make similarly bad reading

  9. GJ Wyatt
    Posted November 15, 2010 at 11:03 am | Permalink

    The Bank is supposed to be equally concerned about inflation deviations in both directions away from its target. But in practice has been more concerned to avoid deviations below the target than above. As you point out, its “operational independence” under Brown was a sham with MPC members appointed for their political views as much as their insight into inflation. Nobody carries the can for missing the target. The Governor has simply honed his letter-writing skills. The Bank’s “independence” was cobbled together as a political fig leaf, not from the blueprint of a modern independent central bank.

  10. A.Sedgwick
    Posted November 15, 2010 at 11:14 am | Permalink

    Good piece, just one comment – very few of us believe or have believed the inflation figures for years – they are managed and another example of opaque government. Why the need for two rates? When you go to buy a bunch of bananas you don’t have the option of two prices – oh I’ll pay the higher price!

  11. Acorn
    Posted November 15, 2010 at 2:01 pm | Permalink

    The fascinating bit about Central Banks is, how do they un-print the money they printed? Pressing the send key on the keyboard is a lot easier than pressing the delete key.

    Presumably, at some stage CBs will have to sell the junk they bought, including government IOUs; get the cash back, and then press the delete key on that printed cash. So who is going to buy all that central bank junk, when there will be new junk coming to market from highly indebted governments. With the market flooded with IOUs, the price is going to come down; hence interest rates will go up.

    Now it is written. If the central bank forces interest rates down for a period with QE, the currency has to fall to bring the capital markets back to equilibrium. That is, the market will want, over that period, a steady appreciation of the currency to compensate for the reduced interest over that period. Now, if I reverse that equation I get … a headache.

    • Mark
      Posted November 15, 2010 at 10:09 pm | Permalink

      I think the calculation is supposed to be that we’ll be alright so long as the US and the EU trash their currencies more than we do. The problem with that is that exp(-x), exp(-2x) and exp(-3x) all tend to zero – being top of that pile is no recipe for success. Still leaves your headache.

    • Denis Cooper
      Posted November 16, 2010 at 5:51 pm | Permalink

      The Bank of England now owns gilts worth around £200 billion, and while I don’t know the average maturity of the gilts it holds I believe the average for all gilts is about 14 years.

      So if the Bank just hung on to those gilts the Treasury would pay the Bank interest on them every six months, and after some time – maybe 14 years on average, maybe not – it would redeem a tranche and pay the capital sum to the Bank.

      Presumably that means that the Bank could gradually cancel the money it originally created to buy the gilts, and more besides, and as the Treasury would be paying the Bank with money taken in taxes it would be withdrawn from the economy.

      Does that make sense?

  12. lola
    Posted November 15, 2010 at 2:16 pm | Permalink

    Essentially this is a real world example of the impossibility of economic calculation under any form of central planning. The ‘economic impossibility of socialism’ discovered by Mises / Hayek.

    The ongoing conceit of central bankers and other ‘mandarins, and politicians, that they continue to believe that they can successfully ‘central plan’ anything much is arrogant and wrong. Arrogance and ignorance are a toxic combination.

  13. Mike Delaney
    Posted November 15, 2010 at 4:15 pm | Permalink

    I saw this in today’s Telegraph and thought, “wonder what JR thinks” – looks like you are very much in tune with the issues that still haunt us.

    http://www.telegraph.co.uk/finance/economics/8134134/Banks-Weale-Economy-may-need-more-stimulus.html

    Why can Mr Weale make such comments which seem to be influential and predictive. In corporate speak, he would be fired.
    I’m dismayed by the easy manner our currency gets manipulated and devalued. Why bother to save?

    • Sally C.
      Posted November 15, 2010 at 7:12 pm | Permalink

      It seems to me that the MPC is full of Weasels… all trying to devalue the pound and force savers to spend, spend, spend. We desperately need an overhaul of the current committee.

  14. David Hearnshaw
    Posted November 15, 2010 at 4:32 pm | Permalink

    Prudent savers are amongst the victims of this profligacy, being screwed twice, once by derisory interest rates and then again, by high inflation thanks to devaluation and printing money. It makes us very angry indeed!
    Cameron’s insistance on pouring more money into the black holes of the EU and foreign aid whilst cutting defence and spending on law ‘n order only adds insult to injury.
    One wonders why we bothered to vote Tory.

    • Stuart Fairney
      Posted November 16, 2010 at 7:47 pm | Permalink

      Thrice in fact as you are likely taxed on the notional cash gain, but actual loss you make on the interest.

  15. Kenneth
    Posted November 15, 2010 at 5:44 pm | Permalink

    I am pretty dumb at monetary economics but even I can see that printing more money will lead to devaluation and inflation. It seems to me that the only thing that is keeping things from being much worse is the dire state of both the Dollar and the Euro.

    BTW Only dimly related, I know, but how can the banks get away with agreeing on bonuses? Surely this is illegal? Surely we should get away from this fixed banking market with just a few players?

    • Conrad Jones (Cheam)
      Posted November 15, 2010 at 8:59 pm | Permalink

      Kenneth,

      I think you – as a Tax payer; are absolutely right to criticise the Bankers on their bonuses. But I think the main problem is that our Government allows the Bank of England to fund the losses of the Private Banks, through inflating our money supply and stealing money from prudent savers – many of whom have spent a lifetime accumulating their wealth through hard work and require it to live on in their old age.

      Both RBS and Northern Rock have announced this year that they are awarding their staff millions of pounds in bonuses while many of us are having to make do with wage freezes and NO bonuses.

      Banks and Building Societies such as Barclays, Nationwide BS, Yorkshire BS and HSBC do have a right to pay bonuses but I think it is an insult for bailed out Banks to pay bonuses when they should be happy at simply still being in employment.

      If we didn’t bail them out – no one would care what the Banks paid as bonuses. In fact, if the British taxpayer wasn’t bailing them out; they wouldn’t be able to afford to pay themselves large bonuses unless they truely had made profits. Unfortunately, the profits which they are now recording are the profits they have made from Government handouts.

      Be prepared for the MPC (BoE) to ammounce more Quantitative Easing (Bank’s Gravy Train) next year.

  16. lola
    Posted November 15, 2010 at 8:49 pm | Permalink

    Your headline would read more accurately as follows:-

    “The Bank of England canwill get it wrong”

  17. electro-kevin
    Posted November 15, 2010 at 8:59 pm | Permalink

    Never mind the Bank of England getting it wrong. So is the BBC – and so are many doctors if Panorama is to be believed.

    That a ‘fat tax’ should be imposed on everyone because ‘we’ are all getting obese. I’m sorry ? I’m of similar build to you, Mr Redwood. ‘We’ says the super-skinny
    Jeremy Vine – because he’s too gutless to point out that we’re not all to blame.

    When is your pathetic party going to start standing up for people who do things right ? Because until you do you can forget economic recover.

    • electro-kevin
      Posted November 15, 2010 at 8:59 pm | Permalink

      …y

  18. Andrew Gately
    Posted November 15, 2010 at 9:19 pm | Permalink

    I am in agreement with this article and glad that someone has the guts to shine a light on the useless academics who claim to be economic geniuses.

    In June 2007 the world changed overnight, that it took the Bank of England 16 months to respond is a disgrace. During that time we lost Northern Rock, Bradford and Bingley, Alliance and Leicester and almost lost the massive HBOS and RBS because the Bank of England refused to keep the markets liquid.

    The next question is what are the government going to do about it? So far I have seen nothing to suggest they want to change the role of the Bank of England or to remove it’s failed academic leader Mervyn King.

    They also seem happy to continue with the policy of selling Northern Rock without providing any compensation to NR shareholders. At the time of nationalisation Northern Rock had shareholder funds of £1.7 billion for which the government has no intention of paying for, this in my opinion is theft.

  19. Gary
    Posted November 15, 2010 at 10:23 pm | Permalink

    Your premise is competely wrong. You are arguing for the form the central bank should take when the argument should be when the Central Bank should be abolished. Let the market set the rates, let people freely transact in the currency of their choice, and if banks make insane bets let them die with their folly. You don’t need a central bank for anything except malfeance and graft.

    • lola
      Posted November 16, 2010 at 10:22 am | Permalink

      Seconded. Lender of ast resort? Pah! That’s me and you then. Not the politicians tho’. They are ‘tax consumers’ – not all of them. Mr R has a ‘proper job’ with real a business that presumably pays him a wage.

  20. Mark
    Posted November 16, 2010 at 12:04 am | Permalink

    People need to be judged not by what they say, but by what they do. As you succinctly analyse, Brown dissected and dismembered the BoE and then packed the Court with lackeys while preserving a veneer of apparent respectability. He entered into a Faustian pact with the City, offering them untold riches so long as they supported his project. He cared not who made the laws in Brussels or Holyrood or Westminster because he controlled the money supply.

    It was only when Mephistopheles returned to claim his soul that he sought a way out. “Stand still, you ever mounting piles of debt That time may cease and deflation never come.” So the Adders and Serpents let him breathe a while by hiding it with QE. Cut is the branch of Northern Rock that might have grown full straight. Like Faust, his wish for no deflation was granted in an inferno – of inflation.

    The role of the BoE has become to cause inflation while denying it in a bid to devalue our debts. As we have discussed here several times, the resulting currency fall reduces our ability to take advantage, because it increases our import costs, while our decimated export industries are too few to benefit and nominal wages are held in check by high unemployment, leaving us less able to service the debt while running the risk that the market will demand compensation for the fall in sterling should we seek to borrow abroad. An epitaph for Brown’s BoE:

    “Whose fiendful fortune may exhort the wise,
    Onely to wonder at unlawful things,
    Whose deepness doth entice such forward wits,
    To practise more than heavenly power permits.”

  21. Lindsay McDougall
    Posted November 16, 2010 at 4:04 am | Permalink

    There are two problems with the Bank of England and the MPC. The first is that they haven’t stck to the knitting. Their job is to hit an inflation target. At some point, possibly in response to Gordon Brown, they decided that was also their job to “prevent a recession”. That is none of their business, even assuming that they had the first clue how to go about it. It is for the Chancellor of the Exchequer to relax the inflation target, and make a public declaration, should he wish to do so.

    The second is their economic model seems to be neo-Keynesian and useless. If you overestimate future GDP growth, you will underestimate inflation.

    If the current procedures are to survive, the Bank of England mst be given better instructions. They must be made to target an inflation measure that includes house prices and other asset prices, and the target should be much closer to 0% than it is now. That is what honest money means.

    • Denis Cooper
      Posted November 16, 2010 at 5:28 pm | Permalink

      The system actually worked quite well for some years. However among other things Chancellor Brown didn’t respond to the increase in cheap imports from countries in China by adjusting the RPI-X inflation target downwards, as he could have done, and instead he changed the target from one expressed in terms of RPI-X to one expressed in terms of the EU’s CPI, which took even less account of rising house prices. Meryvn King did sound a note of warning about the latter at the time the change came into effect.

  22. Gary
    Posted November 16, 2010 at 8:14 am | Permalink

    jan

    how about a flat tax of 10% ?

    it won’t work in this debt based fiat system. the dirty secret is that a large chunk of taxes go towards the debt on the money. At 10% you would have precious little left over.

    • Jan
      Posted November 16, 2010 at 1:31 pm | Permalink

      Yes, the ridiculous borrowing we have taken on over the years is the real cause of our problems. Why we didn’t save at least some of our windfall North Sea oil income as Norway did or even try to live wihin our means as a country is insane. Why we allowed ourselves to be seduced by the “have it now, pay for it later” debt culture is also madness.

    • Mervyn Rosenberg
      Posted November 16, 2010 at 5:23 pm | Permalink

      How about a flat15% until we have paid our debts and then revert to 10%?

      • Stuart Fairney
        Posted November 16, 2010 at 8:17 pm | Permalink

        Er, the national debt according to Channel 4 is £4.6 Trillion or £77,000 per person, ie not taxpayer, per man, woman and child in the UK. Also Osborne continues to rack up debt.

        We will never repay the debt. Never. There is a word for that.

        Also can you imagine Cameron or any of ’em saying “Sorry taxes have to be increased a lot and services need to be cut seriously, because the non-voting Chinese need their money back”

        Me neither.

  23. Roger Thornhill
    Posted November 16, 2010 at 8:42 am | Permalink

    It is not that we need the Cttee to be overhauled or other such tinkering, but we need Free Banking with an end to the monopoly over currencies.

    The market and competing currencies can then decide what to do about an errant currency operator be they a private bank or The Bank of England, who will find Sterling has to compete.

  • About John Redwood


    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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