This week, the Bank of England took leave of its senses again. It generated blood-curdling headlines that the state of inflation and the economy was now such that interest rates could not be lowered again, this year or next. Newspapers wrote that we are to look forward to letters from the Governor to the Chancellor explaining why inflation is well over target. They even gave the press the opportunity to ramp the story up, by using colourful language, telling us the â€œNice decadeâ€ was over, and inviting us to expect a nasty time ahead.
What do they think they are doing? No sensible analyst would dream of saying interest rates cannot fall for that length of time, given the slowdown and the uncertainties. Why on earth, when sentiment is collapsing, would the Bank wish to strengthen the forces of gloom and doom? Donâ€™t they understand that we need to be fighting slowdown as well as dealing with the inherited inflation from the Bankâ€™s excesses of previous years leaving interest rates too low and debt too high? Have they seen what the Fed is doing? Why do they take unacceptably high levels of government borrowing for granted and never speak out against them?
The truth is the Bank of England was badly broken by Gordon Brownâ€™s attack on it in 1997-8, and it has not recovered. In the age of spin, it has gone along with the fatuous nonsense that it has a valued â€œindependenceâ€, when it has lost its power to regulate and understand the day-to-day activities of the many powerful commercial banks in London, and been stripped of its control of government debt issue by a power-hungry Treasury which nationalised it. In place of these crucial powers and duties in the Money markets, it was given a monthly academic tea party to set indicative interest rates, rates which the markets have scorned and ignored in the last few months of turbulence.
If the Bank had been an institution of substance it would have fought against the stripping of its powers in 1997-8. The Governor then should have resigned if he could not keep his Bank in good shape. Subsequent Governors should have made an issue of the Bankâ€™s loss of influence and power in the money markets, and the Bankâ€™s loss of understanding of the actions of the commercial banks in those markets, to wrestle back those necessary duties. The Bank should have fought for proper independence in the appointments to its Monetary Policy Committee. When I asked why some members were renewed and others were not, no good reason was given. When I asked what process of review and decision was in place to ensure that good and truly independent members were renewed, there was no proper reply to my question. The MPC became the Treasuryâ€™s plaything, appointing who it wished, when it wished, with no independent control on the appointments. The fact that some members were very good is no substitute for having a robust process to reassure us all. The whole system was deeply compromised by Gordon Brownâ€™s decision to switch inflation target at a crucial time, diluting monetary discipline by opting for the soft target of the CPI instead of the RPI. There was no loud voice of complaint from the so-called independent Bank.
The change to the RPI helped undermine inflation control and public confidence in the system. No-one I know believes 3% is the current rate of inflation, yet this is what the CPI tells us. Even the RPI at 4.2% does not reflect the full pain of the very high increases in the prices of the basics we have to meet day by day, because of the weightings of cheaper and lower inflation goods in the RPI. When Gordon Brown switched targets he cut the target by just 0.5% to â€œallowâ€ for the relative softness of the CPI. Today, the true differential with RPI is 140% more than 0.5% at 1.2%. Government further complicates it all with RPI-X as well as RPI. Fortunately for people with inflation links in their savings or their pay deal, they use the RPI and not the meaningless CPI. In that sense, this is an economy facing full RPI inflation, not CPI.
The Bank has to accept its junior role to the Chancellorâ€™s in creating the current mess. It is now widely accepted that the UK is in the worst position of the major economies to tackle the Credit Crunch because, uniquely, it has spent and borrowed far too much in both the government and private sectors. It has compounded its fiscal laxity uniquely with the botched nationalisation of a leading mortgage bank at great cash cost and financial risk to taxpayers. Even Will Hutton now agrees that the government overdid the spending and the borrowing! He and I donâ€™t often agree on these things. How did it get into such a state?
The main blame must rest with a government which has spent and wasted too much money, and now seems to think its capacity to borrow is unlimited. Â£2.7 billion to see it through a by-election to give people the promise of a tax cut? No problem. Â£13 billion a year for centralising computer schemes in the public sector, some of which wonâ€™t work as intended? Yes, letâ€™s have them. Thousands more civil servants? Yes, letâ€™s not leave the others lonely. Â£90 billion of swaps for commercial banks? Is that enough? Â£100 billion of new liabilities for the state by nationalising a bank? Bring it on. More spin doctors to explain how wonderful everything is? You canâ€™t have enough of them these days.
But the Bank is not blameless. Here are the questions the Bank should at least be asking itself about how it all went so wrong:
1. Why did it not complain about the loss of powers and explain the need to keep them in the late 1990s?
2. Why did it not oppose the new target based on CPI when it was announced, or at least set out clearly why it was a weakening of discipline at a crucial time?
3. Why did it never warn of the inflationary dangers inherent in the huge build-up of public sector debt and spending during the upswing?
4. Why did it fail to supply sufficient liquidity to the money markets in August 2007, when it was obvious banks were starting to struggle?
5. Why did the Bank famously state there would be no banking bail-outs shortly before helping bail out Northern Rock?
6. Why did the Bank make available large funds this year, when it had said â€œNoâ€ to such measures for banks last summer?
7. Why did the Bank keep interest rates low in the run-up to the 2005 election, when there were inflationary signs?
8. Why is the Bank now keeping rates high, when credit is well and truly squeezed, and the inflationary burst we have to live through cannot be stopped by high interest rates today?
9. Why is it now saying interest rates cannot be cut for a long time in the future, narrowing its future room for manoeuvre or, in due course, forcing it into another U-turn?
10. Why is it still not telling the government it needs to cut its borrowings to get the UK economy into better shape?
The danger for us is that the Bank is trying now to follow a tight policy, at a time when the government is still borrowing as if there were no tomorrow, as it adds huge banking and money-market liabilities to its creaking balance sheet. The Bank and the Treasury need to sit down together and settle their differences. We need a proper plan for getting out slowdown, which needs a government plan to cut its borrowing sensibly, and the Bank to show greater flexibility and understanding of the needs of the money market. This government could easily cut borrowing and spending without touching schools, hospitals, police and other core services.