Sep 10 2007
City doubts about the Bank of England
It has been a shared mantra of government and the City that Bank of England independence is a fine thing. Both sides have joined in this misrepresentation of what happened 10 years ago when Gordon Brown took over at the Treasury. Both sides have liked the fairly low interest rates and the fairly low inflation that characterised the period up to 2006.
Today the City is fed up with the higher interest rates, the higher inflation and the credit crunch that is grabbing the headlines. At last City commentators are prepared to ask a few questions about the fabled independence of the Bank, and to show some disappointment at what is now unfolding. I heard one this morning saying that the Monetary Policy Committee should take account of things other than just inflation when setting interest rates.
10 years ago Mr Brown did not make the Bank of England independent. He mainly reduced its power. He took debt issuance away from it and gave it to the Debt Management Office controlled by the Treasury. He took individual bank supervision away from it and gave that to the FSA. He overrode its advice on the management of the foreign exchange reserves, insisting on gold sales at low prices.
What people have in mind when they say he made the Bank independent is the changes he made to the power to set interest rates. He apparently strengthened the independence of the Monetary Policy Committee of the Bank to settle overnight interest rates by meeting once a month and declaring a rate for the following month.
Even this "independence" has been limited by Treasury interference. The Chancellor decided to change the target the Bank had to hit for inflation at a crucial point. Prior to the 2005 election he switched from 2.5% on the RPI to 2% on the CPI. As the CPI goes up less quickly than the RPI this was a relaxation of monetary policy, requiring the Bank to keep interest rates down when they should have been raised. This was an inflationary move. The Chancellor also made sure he had considerable control over who sits on the Monetary Policy Committee.
The Chancellor made the task of controlling inflation far more difficult in the run up to the 2005 election by large and inflationary increases in public spending, much of which went into higher public sector pay rates, allied to big increases in government borrowing, both on and off balance sheet. It is fashionable today to blame private sector market participants for being too inventive in the over borrowed debt vehicles they designed in the easy money years. Maybe we should blame the UK government too, for their elaborate Public Private Partnerships and Private Finance Initiatives to buy public services on the never never.
What should be done? To put things right there are several courses of action the new Chancellor needs to take:
1. Return to an RPI target for inflation - RPI is the figure used for indexed savings products and for wage settlements linked to prices, so it should be the one used for inflation targets for the economy as a whole
2. Get public spending and public sector wage increases under control - as the government is at last trying to do. Brown’s best period as Chancellor was when he followed Conservative spending plans at the beginning. That kept inflation and public borrowing down.
3. Only allow PPPs and PFIs when genuine risk is transferred to the private sector, and account for them on the government’s own balance sheet. Stop fudging the figures in the UK’s two macro economic rules about borrowing.
4. Allow Parliament to confirm or reject Monetary Policy Committee members
5. Cut out some of the waste from public spending.
There is a fuller critique of the so called independent Bank of England policy and Gordon Brown’s role in the inflationary bubble in the Conservative’s Economic Policy Review, "Freeing Britain to compete" which can be downloaded from this site. Chapter 2 of the Report attracted scarcely a word of attention in the publicity which followed its launch, yet it is in many ways the most important Chapter with recommendations that go to the heart of how you create conditions for economic stability and growth.
John Redwood has been the Member of Parliament for Wokingham since 1987. First attending Kent College, Canterbury, he graduated from Magdalen College...
That’s more like it! Now please attempt to get Cameron and Osborne to follow your lead and put their heads above the parapet and show that they aren’t afraid of this dreadful Brown but will highlight day after day the damage this man has inflicted on this country and, as you have done, illustrate the solutions to the problems he has created.
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As usual, an interesting and insightful post. May I suggest that you make this into an article for a newspaper. Most journalists don’t look beyond the spin.
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I hope that you will permit me a second post.
When Gordon Brown was in Oppostion and the Conservatives began to use PFI in a modest way he described it as “a cynical distortion of the public finances”. I wonder what he would call it now?!
Reply: I wonder. I would like to turn this into a newspaper article, but the newspapers are not very willing to rpint this kind of piece.
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Excellent article John. I have always been opposed to the ‘independence’ of the Bank of England on the grounds of accountability. Gordon Brown already has an opt-out clause written into the BOE’s remit, which he is sure to enact if ever the decisions of the BOE run counter Gordon Brown’s political plans. We certainly need to get a more accurate reading on inflation. Labour have clearly moved the goalposts. I read recently that some financial experts believe UK inflation to be a high as 7% and about to climb. More must be done to expose Gordon Brown’s ersatz-economy.
Reply: Thank you. Yes, inflation has been running well above Brown’s CPI measurement, which disguised it from some of the pundits but not from the public going shopping. I think now inflation is going to come down on both sides of the Atlantic.
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[...] admin wrote an interesting post today onHere’s a quick excerptIt is fashionable today to blame private sector market participants for being too inventive in the over borrowed debt vehicles they designed in the easy money years. Maybe we should blame the UK government too, for their elaborate … [...]
Up to now, Conservatives have been foursquare in saying that Britain’s apparent prosperity came principally from reforms made by previous Conservative governments. Now that there is a sniff of trouble it’s clearly all Brown’s fault and this prosperity is apparently an illusion. How opportune! Brown will no doubt now follow the well-worn Conservative line in blaming a worldwide recession for the coming UK bust. How easy life becomes when you can take credit for a boom and avoid blame for the inevitable following bust.
Some of us actually understand that a boom based purely on debt has to end in a bust, however some others seem only to have this wisdom in hindsight. This latter group seems to include every mainstream economist, the city of London and the entire world banking industry. Are you in the first or the second group?
Brown’s main mistake was in believing those who continually try to convince us that wealth can actually be created just from moving money or selling debt and not from actually adding value to raw materials. Thus he, Blair and the rest of the clowns indeed did follow the Conservative doctrine in allowing the erosion of manufacturing industry, heralding the service industry economy and even applauding the transfer of jobs from UK to China. Where will this end up leaving the Western economy pray tell us?
Also, if we are about clearing up the falsity of economic indicators shall we also get back to a proper accounting of unemployed?
Reply: We agree about the failure to include many out of work in the unemployment figures. I have highlighted that on this blog many times, and my colleagues have highlighted it elsewhere. I do not agree that all wealth comes from adding value to physical commodities, although that is import.It can also come from services.
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