26 July 2022

Is it time to look again at the Bank of England’s independence?


Twenty-five years ago, Gordon Brown shocked the political world (and Tony Blair) by announcing he was giving the Bank of England back its independence. 

In doing so, Brown was attempting to win for New Labour the economic credibility that every previous Labour government had squandered. It meant reversing the status quo following the Bank’s nationalisation in 1946 and letting the Bank set interest rates, instead of the Treasury. No more would people’s mortgages and savings be a plaything for Chancellor’s eager to drop rates to create a boom or raise them to curb the ensuing inflation. There would be no repeat of the ERM debacle for the Iron Chancellor. 

It was also of a piece with the contemporary economic orthodoxy. Following the rampant inflation of the 1970s and 1980s and the victory of Friedmanite thinking in its wake, governments across the world took steps to enshrine their central banks’ independence. The management of rates and inflation by sensible technocrats became a pillar of emergent globalisation. 

Now that question seems up for grabs once more. One of the more interesting aspects of the battle between Trussonomics and Sunakonomics has been the debate over the Monetary Policy Committee’s efforts to control inflation. Truss, for example, has said she would tighten the Bank’s mandate for its target level of inflation – encouraging interest rate hikes. 

Supporters of her economic approach, such as Patrick Minford and Julian Jessop, have also suggested that higher interest rates might be no bad thing. That is not only for the capacity of recessions to clear out some deadwood, but also because it will reduce the inflationary impact of the £30bn in tax cuts that Truss has slated.

This would certainly represent the biggest Treasury interference in the Bank’s monetary policy since independence was granted. Many have suggested that as Chancellor Sunak was at fault for not pressing the Bank for more action sooner.

Since 2007, on the over 30 occasions when the Bank has breached its 2% inflation target, the Governor has written an open letter to the Chancellor to inform him, and the Chancellor has written one back. These formal missives have done nothing to change policy or to stop inflation from hurtling past 11%. Clearly, something has to give.

My personal view is that our current inflation is partially the product of the global post-Covid economic hangover, and partially the consequence of the record expansion of the money supply that the lockdown response of our government brought. As such, I am rather keen for interest rates to rise substantially from only 1.25% as soon as possible.

Historically, interest rates have been far higher than they are today. Across the 19th century, for example, they ranged between 4% and 10%. The dropping of rates from 5.5% in 2008 to 0.5% by late 2016 and then 0.25% during Covid represents a historic low. 

That it has remained so low for so long demonstrates a flaw in practice with an independent central bank. Whereas interest rates were previously subject to the whims of Chancellors keen on cooking up a boom, they are now stifled by Bank orthodoxy and the unwillingness of members of the MPC to break with the rest of the group. 

A camel is a horse made by committee; an interest rate made by committee will not have a hump, but it will be overly cautious. There is no Geoffrey Howe to boldly whack up rates to 17%. Instead, inflation must reach its highest levels since Duran Duran were in the charts for the Bank to even begin raising rates. 

Supporters of the Bank’s continuing independence might argue that it has been broadly successful. In the UK and across the Western world, the pre-2008 norm was steady growth and low inflation. But one could easily argue that that was not the product of prudent financial management – goodbye, Lehman Brothers – but a one-off shock from China’s entry into the world economy.

In a post-Covid, post-Trump world of international decoupling, growing tariffs, and a Chinese economic slowdown, that deflationary windfall increasingly looks to have passed. We could simply wait it out, hoping for technological breakthroughs that will replicate that fall in prices and costs, but it looks more likely that inflation is here to stay.

So how we deal with inflation is now, once again, an ongoing and central issue in our politics. Leaving it to a central bank won’t do. The pain that the European Central Bank inflicted on various European states in the 2010s to make them more like Germany is evidence enough of the problems cause by a disconnected, monomaniacal institution. 

Nor has the Bank of England covered itself in glory. It has been persistently slow to acknowledge inflation’s arrival, its persistence, or growth – to say nothing of continuing the disastrous policy of quantitative easing long after it had ceased to be necessary. 

Even Larry Summers and Ed Balls – two figures crucial to Labour’s decision to give the Bank its independence – have now suggested the relationship between Threadneedle Street and the Treasury should be reconsidered. That might not involve revoking independence wholesale, but the Chancellor should be given a stronger role in setting rates, and the power of the MPC should be weakened.

Britain’s post-war history is littered with examples of where politicians got it wrong, from John Major’s ERM debacle to the disastrous Barber boom. But the point of those failures is that we can at least hold politicians to account for them. The Bank of England should not be beyond criticism – and it deserves a healthy dose of it as soon as possible. 

So whether it is Trussonomics or Sunakonomics (and their respective standard-bearers) who triumph after this leadership election, the next Prime Minister and Chancellor must be as bold as Brown was, and launch a fundamental change in how our politicians and central bankers make their most important decisions. 

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William Atkinson is Assistant Editor of ConservativeHome.