16 September 2022

Time the bloated Bank of England faced some accountability


The recent sacking of the permanent secretary at the Treasury, as well as recent comments by the new Prime Minister and Chancellor on the Bank of England’s remit have raised eyebrows. But whatever your political views, it’s now abundantly clear that our macroeconomic policymakers need new ideas, and financial markets are heading for choppy waters if they do not come soon.

The first issue is with the way the Government’s debt is managed. The Debt Management Office (DMO) is responsible for selling new bonds to raise money for the Government. However, the Bank has been taking these bonds back out of the market through its quantitative easing programme to lower interest rates in financial markets. The Bank now owns half of all gilts and has superseded the DMO as debt manager; the Bank, not the DMO, now controls the amount of Government debt held by investors. 

Not only is this inefficient, but it could spell bad news for financial markets over the coming months. In a panic over inflation, the Bank has decided to reverse its bond buying. In April, the DMO planned to issue £125bn of gilts over the coming year, of which £40bn would have gone to the Bank as it replaced maturing bonds, leaving £85bn that needed to be sold to investors. The Bank is planning to halt renewals and add a further £40bn in sales, taking total bond sales by government institutions to £165bn, which, give or take a few months, is almost double the £85bn that would have gone to market originally. This is before factoring in extra borrowing for the energy price cap. Without a coordinated approach to debt management, bond markets are set for trouble.

The source of this problem is New Labour’s 1997 reforms, which gave the Bank independence over its policy tools. Not wanting to give an independent institution too much power, the Treasury stripped the Bank of its historic roles of financial regulator and debt manager. After the 2007-8 financial crisis, it was agreed that removing its regulator role was a mistake. The current situation is showing that stripping out its role as debt manager was also misguided. 

The Bank has ended up assuming all its prior roles, but in a muddled way, and kept its independence. The best way to ensure orderly bond markets is to formally move debt management back into the Bank. Because this would return it to its pre-1997 state where it had greater powers, it is right that its operational independence be looked at. 

The problems do not stop at the framework; decision-making at the top of the Bank has long been questionable. With the national debt so high and with the country going through a worsening cost of living crisis, interest rate rises are going to have a greater impact on people’s lives than at any time since independence. Odd then, that the Bank is hiking rates aggressively.

It says it is doing so because it fears inflation will start being factored into wage negotiations and price setting by companies, giving inflation its own upward momentum. Given the Bank has spent the last two years getting inflation wrong, it shows some level of hubris to raise rates sharply based on an argument with no precedent in economic history. Every major episode of post-war inflation in Britain has been accompanied by rapid growth in credit and money. The post-pandemic inflation was no different, but these indicators have since returned to normal growth rates. 

A related problem is the Bank’s lack of intellectual diversity. During the inflationary 1970s, the Bank was home to two of Britain’s great economists: Charles Goodhart, who thought the money supply was important, and Christopher Dow, who thought the money supply was irrelevant and that fiscal was more important than monetary policy. They viewed the economy very differently, but a governor could be sure of hearing a range of opinions. The debate on show in the Bank’s current minutes and speeches are sterile by comparison, and part of the reason it has been behind the curve on inflation. 

With the Bank failing on its core remit, some of its extra-curricular activities must come under scrutiny. It has been conducting a huge amount of research into an official crypto currency, which no one has asked for and which other central banks like the Bank of Japan and Bank of Canada have dismissed as not solving any problems. It produces too much academic work, luring postgraduates with high salaries to produce university-style papers that contribute little to policy. It has a climate unit, but unless it can dish out grants for insulation or build new rail lines, it is hard to see what good it can do. 

Much of what happens at the Bank, from the appointment of its senior staff and its policy priorities, is influenced, or even controlled, by the Treasury. It is high time for some accountability.

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Chris Papadopoullos is an economist and writer.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.