It’s conceivable that politicians might want to take back a measure of control over monetary policy from the Bank of England, writes Mark Berrisford-Smith - head of economics at HSBC UK Commercial Banking.
It was on May 6 1997 that Gordon Brown – just four days into his tenure as chancellor – made one of the biggest announcements of Britain’s post-war economic history.
Up until that point, the Bank of England was responsible for implementing monetary policy, but it was the chancellor who decided when the benchmark short-term interest rate should be changed.
At the heart of the new system was the Monetary Policy Committee (MPC), made up of five representatives from the Bank of England, including the governor, who sat alongside four independent members nominated by the government. But there was a lot more to the new architecture, including quarterly inflation reports, the published minutes of the MPC’s deliberations, and a regular flow of speeches by MPC members.
Two decades on and the rhythm of monetary policy decision-making has become ingrained in the fabric of economic and financial life. The MPC has made 237 decisions; raising interest rates 19 times (all by just 25 basis points); cutting them 27 times; and voting to leave them as they are 191 times.
Any system that survives for two decades is bound to have its flaws and its critics, and the UK’s monetary policy framework is no exception. At a practical level there is the charge that it is over-engineered. Given that the MPC has only altered the bank rate once in the past eight years, there was probably relief all round when the government finally passed the legislation which allowed the number of policy meetings to be trimmed from 12 to eight a year.
More serious are the charges that the framework encourages group-think; that for all the brainpower and expertise of the MPC members and the Bank of England staff that support them, they have sometimes been slow on the uptake. In particular, they were accused of being ‘asleep at the wheel’ as the economy lurched into recession early in 2008, while there was the embarrassing episode in 2013 when the committee made a vain attempt to offer forward guidance based on the rate of unemployment.
Yet arguably the biggest problem is the inflation target itself. These days, domestically-generated inflation is notable by its absence. The MPC therefore finds itself looking through the occasional episodes of inflation that blow in from abroad, thanks to surges in commodity prices or bouts of sterling depreciation. If inflation is something that is always being disregarded, then what point is there in using it as a target?
Take back control
So, how might the system be altered? Firstly, it’s not inconceivable that politicians might one day want to take back a measure of control. After all, it is they who have to face the electorate at general elections and account for the country’s economic performance. Independent central banks have become the norm in advanced economies, and many emerging ones as well, so it would be something of a departure to put politicians back in charge. But there is a general realisation that the central bankers have run out of ammunition, and perhaps ideas.
A mandate for change
Even assuming that the Bank of England is left in charge of the process, it could be given a different mandate. With inflation now firmly in retreat it might be time to downplay its role in monetary policy. Rather than worrying about an inflation threat that no longer exists, perhaps the MPC should be charged with giving greater weight to financial stability, in particular the debt burdens being carried by households and businesses, and structural imbalances in the economy, such as the current-account deficit. The inflation target could even be replaced by a different metric: maybe the nominal growth of GDP or the annual increase in average earnings.
A major announcement on monetary policy four days into the new government’s term would therefore come as an even greater shock than Gordon Brown’s bombshell of 20 years ago.