One of the myths that needs to be cast aside in any review of the role of the Bank of England in recent years is the myth that the Bank is and can be independent. In a democracy voters take great interest in economic progress as it affects their jobs, their incomes and their living standards. They hold the two senior elected officials, Prime Minister and Chancellor, to account for economic progress, along with the government generally. A government may choose to entrust part of its economic management to the Bank, but will be blamed for its failure and claim credit for its success.
Far from making the Bank independent, the last Labour government demonstrated just how much of a creature of the government it is. At the beginnning of their tenure they stripped the Bank of its powers to monitor and control the day to day workings of the commercial banks. They passed this important work over to a new body, the FSA.
They claimed to give the Bank more independence to fix interest rates. However, all the MPC members were government appointments directly or indirectly. They never explained why some were renewed and others were not. They changed the requirements from RPI to CPI at a crucial point, in a way which moved the Bank to an easier money policy as the bubble was growing. They rightly overrode the Bank , cutting interest rates in international Finance Minister crisis meetings. They asked the Bank on one crucial occasion to endorse such action in a special meeting of the MPC, which they duly did.
The Coalition has changed the Bank’s powers and remit again on taking over government. They say this is to create a stronger independent Central Bank. However, the government itself still signs off decisions to print more money, and often expresses views on bank regulation and credit easing.
In reviewing the Bank’s conduct in recent years it is important to be fair and to understand that there were high levels of political intervention at crucial times. When it came to cutting interest rates in the middle of the crisis the politicians were wiser than the Bank and correct to force their hand. When it came to choosing MPC members, to changing targets and removing powers to control banks, the politicians made the Bank’s task more difficult. Governors traditionally work closely with the government of the day to avoid public conflicts of view.
The famously “independent” German Central Bank of the post war period was instructed how to handle ostmark/DM union when it gave wise independent advice the politicians did not like. It was also told to surrender the DM altogether, the very currency its ” independence” was meant to protect!
May 26, 2012
Of course ultimate power will always rest with politicians: they control the police and the armed services. Politicians can break down the central bank’s front door and impose their will any time. And frequently they do.
However, it’s an extremely good idea to have a central bank with SOME SORT OF independence, because we all know what politicians tend to do given access to the printing press. I.e. a second and moderately independent opinion on whether stimulus is required is desirable.
Moreover, the decision as to how much stimulus is needed is a very TECHNICAL ONE. If the decision is taken by a finance minister / treasury, it’s far better to have the decision taken by well qualified economists and other technicians WITHIN THE TREASURY, not populist rabble rousing politicians.
So if the above decision is best taken by technicians, let’s just recognise and formalise the fact. Whether that committee of technicians is actually located in the Treasury or the central bank is relatively unimportant.
May 26, 2012
How do state bureaucrats know what the price of money should be?
If they know these prices why not fix all prices?
May 26, 2012
I recall Peter Lilley spoke in Parliament as Shadow Chancellor when the Bill was introduced and set out many of the pitfalls which duly came to pass. The BBC of course never reported this.
May 26, 2012
Precisely why we need competing currencies so that if a government destroys it’s currency people can simply choose to use another one. Those competing currencies can be foreign or privately issued and include precious metals. No more being robbed by central bank inflation and no more profligate spending by governments- which is why so many politicians hate the idea.
May 26, 2012
As a general rule any organisation that feels the need to claim it is “independent” is not in reality. Otherwise it would not need to claim it “the Independent Police Complaints Commission” perhaps as an example.
The BBC claim to be independent yet Blair’s men were able to make Director General Greg Dyke go because a reporter spoke the truth on a sensitive issue for him.
There is however the usual problem of the 5 year electoral time scale and the need for a longer term view for monetary policy. So that political manipulation does not take place just for short term electoral advantage as it so often has.
Surely a mechanism can be found to achieve this somehow?
May 26, 2012
So if we accept the BOE is simply a function of government why does the govt “borrow” money and pay interest on national debt from BOE? Also isn’t it time that we honoured our market economy and let bankrupt banks go the way of British Leyland, British Steel etc.? These zombie banks are extending the recession and dragging on any potential recovery whilst continuing to feather their own nests at taxpayers expense. The strategy of debt default via inflation and devaluation is likely to engender more extremist politics aka Greece. Have you looked at Prof Steve Keen’s work? He is recommendimg debt forgiveness to clear the system. When one considers how indebted the UK is, and how public sector spending is still increasing he may have a point. The current system is broken and we now need innovative solutions for the future. E.g. we prob. need to get over this obsession with growth. All economies cannot all grow at same time, there is always balance of surpluses and deficits. We should be looking to find a new approach, perhaps 30hr week wi lower STD living, and more job shares…enough!
May 26, 2012
It’s all Mary Poppins….I can’t help thinking about Mr Dawes…..’If the Banks of England fall, England falls’……’Now little boy give me your tuppence…’…..’No!’….Out of the mouths of babes……
But seriously Jed, we can’t let the banks fail, think how much they invest in the political system to get their politicians to push through legislation they can run rings round. We need to bail them out with all our tax money so that they can pay bonuses to each other. The poor little dears must not suffer for their ineptitude. As Bazman might say, ram it!
Oh I almost forgot we can’t let Greece get away with defaulting or debt forgiveness because the French and German banks are up to their necks…It’s not as if Germany has ever effectively defaulted or been granted debt forgiveness…..Oh wait…WWII.
I am still waiting for Greece to play this Joker card….
zorro
May 26, 2012
Claims that the central bank is “independent” is a convenient fiction for the politicians in charge as you so clearly demonstrate. I have the same feeling about the OBR, paid for by the Treasury, based in the Treasury (?) and mostly staffed by the Treasury. The so-called climate change legislation, intended to cut global temperature by cutting man-made CO2, is another convenient fiction and on more than one level. They all fall into the category of “fooling the people”. But people do notice and it does nothing for the reputations of the politicians concerned.
May 26, 2012
The Bank of England is wholly owned by the Treasury – I hope nobody is going to waste time disputing that legal reality – and its “independence” is based on the 1998 Bank of England Act, through which it was granted a limited and conditional operational independence with respect to monetary policy.
http://www.legislation.gov.uk/ukpga/1998/11/contents
“10 Operational responsibility.
In section 4(1) of the Bank of England Act 1946 (power of the Treasury to give directions to the Bank), at the end there is inserted ” , except in relation to monetary policy “.”
“11 Objectives.
In relation to monetary policy, the objectives of the Bank of England shall be –
(a) to maintain price stability, and
(b) subject to that, to support the economic policy of Her Majesty’s Government, including its objectives for growth and employment.
12 Specification of matters relevant to objectives.
(1) The Treasury may by notice in writing to the Bank specify for the purposes of section 11 –
(a) what price stability is to be taken to consist of, or
(b) what the economic policy of Her Majesty’s Government is to be taken to be … ”
Not only can Parliament amend that Act, but under Section 19 there is also the possibility of the Treasury invoking reserve powers to temporarily suspend its independence through an order:
“The Treasury, after consultation with the Governor of the Bank, may by order give the Bank directions with respect to monetary policy if they are satisfied that the directions are required in the public interest and by extreme economic circumstances.”
“A statutory instrument containing an order under this section shall be laid before Parliament after being made … Unless an order under this section is approved by resolution of each House of Parliament before the end of the period of 28 days beginning with the day on which it is made, it shall cease to have effect at the end of that period.”
“While an order under this section has effect, section 11 shall not have effect.”
As far as I know neither Darling nor Osborne have used Section 19, which in theory at least would have given MPs the chance to question what they were doing and why.
While Brown could pretend that he was going along with the EU model of “independent” central banks, even copying some of the language in Section 11 from the EU treaties – “the primary objective of both of which shall be to maintain price stability and, without prejudice to this objective, to support the general economic policies in the Union” – the ECB has a much higher level of independence with much stronger legal protection.
There being no equivalent of Section 11, so that the ECB decides its own inflation target and makes its own interpretations of the correct economic policies, and far from there being an equivalent of Section 19 to allow EU political leaders to exercise reserve powers they are expressly prohibited from attempting to influence the ECB in any way; while any change to its stated mandate would require a change to the EU treaties to be agreed and approved by the national governments and parliaments.
Yesterday the German representative on its Governing Council said that the ECB is now at the limit of that mandate:
http://www.forexlive.com/blog/2012/05/25/weidmann-ecb-has-reached-the-limit-of-its-mandate-press/
And:
“Weidmann also reiterated his opposition to the idea of granting a banking license to the European Stability Mechanism so that it could obtain funding directly from the ECB. He opposes such a move, he said, because it would amount to “subjugating monetary policy to budget policy, which greatly harm the credibility of the ECB. And also because monetary financing of states, for good reasons, is strictly prohibited by the [EU] treaties.””
Some would say that the ECB has already gone beyond its mandate, and suspect that rather than changing the treaties it will be found easier to carry on breaking them.
May 26, 2012
We never do Dennis…we just wonder why they have the convoluted arrangement of the government borrowing money from the B of E and paying interest on the national debt….?
zorro
May 27, 2012
Well, some do …
I think the answer to your question is the same as before, that it’s simpler to just carry on paying the coupons on the gilts to all their holders, including the Bank, knowing that the money can be recycled to the Treasury as part of the Bank’s profits.
Another side to the arrangement is that the Treasury has indemnified the Bank against any losses it may make on the gilts it has bought.
May 26, 2012
I believe that the Bank and all the other organisations such as the FSA should be fully under government control as part of the Civil Service.
All the government “agencies” and “authorities” are attempts to persuade the electorate that they are independent organisations which, as you say, is an illusion since the government appoints all those within the organisation who have the real power.
This, of course has the advantage for ministers when something goes wrong of being able to give the “It wasn’t me guv” excuse, and then firing the person at the head of the agency concerned. It also hides the true number of Civil Servants. The recent (and ongoing) debacle of our Border Controls, is a typical example of how a minister manages to evade her responsibilities by firing the Head of the agency concerned, but the public aren’t all fools and are capable of recognising where the real responsibility lies.
May 26, 2012
Time for a little thinking outside the box. I am having a summer of MMT, it may change to some other economic theory by next winter, who knows. So, with your indulgence JR, can I suggest to Redwoodians a read of the following; “Why Does Uncle Sam Borrow”, read the comments as well please. What say you, the theory does suffer – and definitely will on this site – from appearing to be a left wing construct, please keep personal abuse to a minimum 😉 . http://neweconomicperspectives.org/2012/04/why-does-uncle-sam-borrow.html .
May 26, 2012
I think the thing that most appealed to Gordon Brown in giving the “independent” BoE the responsibility of setting interest rates was that there by he absolved himself of that task.
May 26, 2012
I have never heard a convincing explanation as to why inflation can be controlled by the single means of interest rates.
Anyone fancy trying?
May 26, 2012
By holding economic activity to the level of capacity in the economy, inflationary and deflationary pressures are constrained. Economic activity under our monetary system is initiated by borrowing (or reduction in saving) with the return on investment being constrained by the cost of borrowing (interest).
May 27, 2012
Thank you, forthurst.
OK as far as it goes, but I do not see how UK interest rates have an effect on World commodity price – at least no where near the effect they have on UK costs.
So, for instance, a step change in the price of oil causes a rise in inflation. The BoE have been saying they do not need to act in such circumstances as the increase will fall out of the inflation figures a year later, but that is not controlling inflation, that is ignoring it.
May 28, 2012
“I do not see how UK interest rates have an effect on World commodity price”
If you mean to directly control external costs. No. If you mean how many pounds are required to purchase a quantum of foreign produce. Yes. If interest rates are too low or money has been printed (QE), as to relatively depreciate its value, foreigners will demand more of it, hence leading to inflation in the UK.
May 26, 2012
Ask the right question. Price increases are not inflation, they are a consequence of inflation which is an increase in the currency supply which in turn is inevitable in a politically controlled fiat system.
With a hard, commodity-backed currency inflation overall is unlikely though of course some sectors may see localised price increases.
May 26, 2012
The stability effect an independent bank seeks to achieve was once achieved by having currency backed by gold or cilver. During the late 19thC a major element of US politics was whether they were willing to go back on the gold or silver standards after the inflation of the civil war. They did it, despite decades of austerity, with the approval of the electors. Perhaps our electorates, or our politicians, lack the backbone to do that now but it has certainly been done by a democracy.
May 26, 2012
The independent German central bank was always an oversimplification of the success of the German economy back in the day. Politicians love the idea of one simple lever of control – hence the myth. Germany’s achievements were the result of a complex mix of benign laws for industry and commerce, and the usual German mix of efficiency and industriousness. Of course their central bank helped but it was only a bit player.
May 26, 2012
Sir
I have been taking careful note of what the “Yes” campaign in Scotland is doing to support Scottish independence and I have to say there is a far greater chance of Hades freezing over than Scotland becoming fully independent.
The reason why it cannot succeed has been plastered all over the press for the past few years for all to see and it concerns the Euro and the position Greece finds itself in.
It seems to me there are three options for their currency.
It can stay with the pound.
It can join the Euro
Or it can produce its own currency.
It is beyond belief that they are considering any of the above with the major problems Greece has found itself with.
If it stays with the pound and obtains full independence Scotland will find itself in the same position as it is now. Without fiscal control.
If Scotland joins the Euro it will find itself in the same position as Greece except Germany will be calling the shots with its currency.
If they go for their own currency once again they will find their selves in the same position as Greece if it returns to the Drachma, with a very great possibility that over night the currency will lose a large portion of its value.
True independence for Scotland is a pipedream that will cause a great deal of ill feeling and weaken both England and Scotland.
Gordon McCann
May 26, 2012
The fourth option you don’t mention would be to repeal legal tender laws and allow competing currencies. Possibly a commodity backed currency could emerge.
The emeregence of some kind of hard currency might once again make Scotland a nation of savers and capitalists. Can’t see the SNP going down this route of course.
May 27, 2012
I hope you are right.
Further, I do not think that it should be assumed that an independent Scotland has within its own gift the choice of retaining the pound – at least not in a way of being able to exert influence.
That also should apply to other issues, such as defence. If Scotland kicks out the nuclear submarines why should England/Wales/N.I./etc care overly much about Scotland.
May 26, 2012
Just to emphasise a point that Denis Cooper made above, Brown as chancellor was instructed to make the BoE independent so that the UK could adopt the euro one day. And then, as John Redwood has amply demonstrated in this post, he set about destroying that independence. But congratulations are also in order to Mervyn King, knighted this year for going along with chancellors from Brown onwards. Banks gambled his QE money on food derivatives, triggering the fundamentalist spring when prices spiked accordingly. Add in his inflationary betrayal of our pensioners and I’m surprised he wasn’t given a dukedom.
May 27, 2012
The government has been trumpeting the need for and wisdom of ultra-low interest rates for a long time now. Theoretically, it is not their decision, and the outcome of high inflation is theoretically against official policy. Strange, very strange.