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.