Sunday, May 22, 2022
The Bank's problem is not being independent enough
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission.

The last time inflation, measured by the consumer prices index, was higher than last month’s rate of 9 per cent, revealed a few days ago, was in March 1982, more than 40 years ago. Things were different back then, when inflation was 9.1 per cent. The unemployment rate was more than 10 per cent and its level was on the way to more than three million. Inflation, though, was on its way down from more than 20 per cent.

Perhaps that is why consumer confidence, as recorded by the long-running GfK survey, was higher than now. On Friday GfK announced that its consumer confidence index has fallen to a record low of -40 as this inflation squeeze bites. In March 1982, despite the uncertainty and rising unemployment, the reading was -18.

There are other differences. These days the unemployment rate is just 3.7 per cent, although that low rate is partly due to the shrinkage of the workforce, and employment is lower than before the pandemic. Most strikingly, while an official interest rate of more than 13 per cent was regarded as necessary to fight inflation in March 1982, these days Bank Rate is just 1 per cent.

One big similarity, though, concerns the Bank of England. In 1982, under the governorship of Gordon Richardson, later Lord Richardson, the Bank was at loggerheads with the government. It never bought into the Thatcher government’s monetarist experiment and relations were not good. The Bank only needed to bide its time. Even then the writing was on the wall for the experiment. But the writing was also on the wall for Richardson, who the following year was replaced by Robin Leigh-Pemberton, former chairman of NatWest Bank and Tory leader of Kent County Council.

These days the Bank is again at loggerheads, if not with the government as a whole, certainly with many Tory MPs and some unnamed cabinet ministers. The jump in inflation to 9 per cent and the current governor’s admission a few days ago the Bank feels “helpless” in the face of the current inflation surge and that “apocalyptic” food price rises are in store, has focused attention on the Bank, and not in a good way.

The 25th anniversary of Bank independence was not supposed to be marked by mutterings from the governing party that it might be no bad thing to take back control, so to speak, of interest rate decisions. They are only mutterings, but we should remember that, under the Bank of England Act, the Treasury has reserve powers to direct the Bank on monetary policy in “extreme economic circumstances” if that is deemed to be in the public interest.

The Bank, as is clear, should not be immune from criticism. It has got some things seriously wrong, including its inflation forecasting. But we should be very wary of moving beyond criticism into a change that would be seriously economically damaging. There is another example of this happening, though I can’t quite put my finger on it.

The Bank’s defence is that even it had acted earlier last year in raising interest rates and halting quantitative easing (QE), as many, including me, urged, it would have made no significant difference to the current inflation surge.
We cannot know whether that is the case, although it is reasonable for the Bank to point to the lags in monetary policy, and the difficulty of tightening it when we were still in the depths of the pandemic, in the second half of 2020 or early 2021.

A more telling criticism is that the Bank, along with other central banks, were prey to “groupthink”. No two crises are the same, but the playbook adopted by the Bank and other central banks was straight out of the one adopted for the global financial crisis in 2008-9. That playbook, slash interest rates and launch large amounts of quantitative easing (QE), was right when the economy faced a demand shock and a damaged banking and financial system more than a decade ago. But when the problem was a supply shock, which would be exacerbated as the world economy recovered from the pandemic, it was much more questionable. Lord (Mervyn) King, the former governor, is among those who have made this criticism recently.

Had central banks not done this, it is likely that we would still have had a post-pandemic inflationary shock, exacerbated by the Russian invasion of Ukraine. But the inflation peak would probably have been closer to the 5 per cent that we saw in 2008 and 2011, than the 9 per cent now. It is only fair to say that this is with the benefit of hindsight. It seemed to be the right thing to do at the time.

That is water under the bridge and if it is of any comfort, so incidentally is the big surge in inflation, which has seen the rate jump from 1.5 per cent to 9 per cent over 12 months. Inflation will be helped in coming months by so-called base effects (prices were already rising strongly a year earlier) and by some of the oddities returning to normal. Second-hand car prices, for example, are now falling. And, while inflation may go a little higher later this year, it will not be much above current levels, if at all, and is still on course for a fall next year.

If we look at the Bank, it seems to me that the problem is not that it is independent, but that it is not independent enough. The decision to launch an aggressive QE programme in March 2020 was, at least in part, to improve the functioning of the gilt market, and to make it easier for the government, which had an unprecedented deficit to fund, to do so. The Bank has found it hard to kill the criticism that its pandemic QE programme was for the convenience of the Treasury. There is a question about whether its softly-softly approach on interests was driven in part by concerns over the government’s debt interest bill.

Bank of America’s London office, in a critical note on the Bank, warned of its “growing concerns” about its approach. Markets struggle to work out its “reaction function” – when it will raise rates and why - together with “a building impression we have that monetary policy may appear more politicised”. To avoid upsetting the government, the Bank has been “reluctant to talk recently about one of the key supply shocks hitting the UK, Brexit.”

These things can be improved. The convention that the Bank cannot make any assumptions about changes in government policy, as other forecasters do, should be dumped. Its forecast of inflation topping 10 per cent later this year assumed there would be no further government action in response to the cost-of-living crisis.

In the meantime, we should forget any talk of reversing the Bank’s independence. That would be the surest way of adding a sterling crisis to the cost-of-living crisis and generating a “buyers’ strike” for the bonds (gilts) the government has to sell to fund the budget deficit. It would, in other words, make a difficult situation much worse.