First, Gordon Brown smashed the Bank of England’s ability to understand the money markets by removing their duty to regulate the day to day activities of the commercial banks, and by removing their task of raising the public debt.
Second, he set up a so called independent Monetary Policy Committee. Every member of it was either appointed by the Chancellor, or by someone appointed by him. We have not been told how they were selected, and why some were renewed and some were not. The Committee was given an easier target to hit in December 2003 at a time when they should have been putting interest rates up. They were effectively told to cut rates recently as part of a concerted international move, one day before they had undertaken their normal review of the economy to make a decision. Yesterday the Chancellor effectively instructed them to cut rates again, whilst intoning that they were still independent!
What he should do instead is write a new letter to the Governor. It should say:
I realise the conduct of money and banking policy has gone badly wrong in recent years. On reflection, I think the Bank does need to regulate the commercial banks and to handle government debt issue, so it is hands on in the money markets as it used to be. I therefore intend to restore these powers as soon as possible. I believe Parliament will welcome this move. It was clear that in the good days the Bank did not see enough of the business to realise that the commercial banks were too liquid, and from August 2007 the Bank did not appreciate how starved of money markets had become. We need a strong Bank which is close to the needs and misdeeds of commercial banks, so that it can correct and adjust more rapidly.
I would like to continue with a more independent Monetary Policy Committee. This will require a more independent approach to appointments and renewals. I am considering giving the Treasury Select Committee of the Commons a role in this process. However, recent events have also shown that there is merit in the US system where the Fed has a clear duty to consider output levels as well as inflation, and where it is required to work in a way which is compatible with the Administration’s policy. Clearly it is not desirable if the government is using fiscal policy to expand the economy if the Bank is using interest rate policy to do the opposite. On the other hand if any government is seeking to pursue too reckless a fiscal policy then the Bank should be able to signal its concern. I will be consulting interested parties on how we can get this balance right. I have no wish to stifle the views of a genuinely independent MPC, but there may be occasions as when we agreed emergency rate cuts with other countries where the government does have to override. This should always be done in a transparent way, with reasons being given for the use of the reserve power.
It is perhaps too early to go into who is to blame for the sharp move from excess credit to credit crunch, as we need to manage the situation day by day at the moment. However, I do hope the MPC is asking itself how it came to set rates that were too low for too long, leading to inflation rising to 150% above the target rate. I also hope it will ask itself urgently whether rates are now too high for the deflationary situation we find ourselves in.
For my part I do accept the public sector cannot spend our way out of this recession given the state of the national finances. I fully understand that if we seek to borrow too much the strain will be taken on sterling and the longer term rate of interest. These market pressures will constrain me in my judgements about spending.