The political classes in the UK have for most of my active life in politics been gripped by a destructive wish to find an “independent” discipline to run the economy to take it out of the hands of politicians. Some will say this shows a great wisdom and a certain humility about their own skills in this area. I wish to make an alternative case.
In a democracy the ultimate power rests with the people. They can pressurise and lobby their elected government, or they can remove it if it fails to deliver what enough people want. Mortgage and savings rates, the number of jobs and the advance or retreat of prosperity are often the dominant preoccupations. Whether economic policy has been subcontracted or not the voters will hold the elected government responsible for the outturn. The buck rests with the PM and Chancellor, whatever the details may say about who controls banks, money and interest rates.
In the last 30 years there have been two experiments with delegating the crucial powers. The first was the Establishment decision to join the Exchange Rate Mechanism. A Conservative government did it and carried the can for it, but all major political parties and the principal lobby groups all wanted it. The second was the Labour idea of a so called “independent” Bank of England. This was also widely welcomed by the other political parties and by the main interest groups. Both these approaches resulted in wild swings from boom to bust. We need to ask why.
Both policy approaches have been heavily influenced by Germany. The UK establishment was impressed by the long period of post war low inflation and growth achieved in Germany in the period from 1950 to 1980. The decision to tie the UK’s fortunes to the DM by putting the pound into the Exchange Rate Mechanism was designed to import Germany’s excellence at controlling inflation. If the DM was a low inflation currency, surely they argued we could hitch a ride to low inflation by linking our fortunes to it?
I remember how lonely it was opposing this view in the later 1980s. A handful of us did so. I even took the large company I was chairing out of CBI membership partly in protest at their support for joining the ERM. I published a pamphlet in April 1989, before we entered the ERM, explaining how it would be destabilising. I argued that in the short term, because the markets wanted to push the pound up, it would be inflationary. The Bank of England would create more pounds to sell across the exchanges to try to keep the rate down. This would become high powered money in the banking system leading to a surge of credit.
The Uk joined and this was exactly what happened. A credit boom was unleashed by the bizarre monetary policy forced on the Bank by the need to keep the pound down. This in turn drove up prices. In due course the reverse happened. Foreigners wanted to sell sterling. The Bank had to buy up pounds to try to keep the rate up. The credit bubble was burst by the monetary contraction and by the need for much higher interest rates to try to keep the hot money in the UK. The UK lurched from a bad inflationary bubble created by excess money and credit, to an even worse recession, caused by too little money and credit. Both were the direct result of the independent system which all its supporters had said would lead to greater price stability and underpin smooth growth.
Few now would defend the ERM or are even prepared to remember their misplaced enthusiasm for it. The British Establishment has moved on, and has told itself the Conservatives lost in 1997 for other reasons. In truth the Conservatives lost in 1997 because the public were sore at the ultra high interest rates and the plunging activity levels created by ERM membership. A domestic policy could have been smoother and better for the UK.
Tomorrow I will look at the experiment with a so called independent Bank of England.