Last autumn, roughly a quarter of a century after the Bank of England was granted operational independence, inflation hit a forty-year high. Public confidence in the Bank fell dramatically. So it seemed a good time for the House of Lords Economic Affairs Committee to ask a simple question of the Bank: “How is independence working?”
Looking at the last 25 years as a whole, although debate rages as to how great a role globalisation played in keeping prices down, it is clear that taking monetary policy out of politicians’ hands has made a positive contribution to price stability and has underpinned confidence in the UK economy. So independence should be preserved. But – and it is a big “but” – that does not mean all is well in terms of the performance of the Bank, or the framework in which it operates. There is room for improvement.
First, and most obviously, the Bank needs to learn lessons from errors made in controlling inflation in recent years. It was not the only central bank that failed to anticipate high and persistent inflation: many years of low inflation (up until 2021) gave rise to a sense of complacency among all major central banks. We received evidence that the mistaken belief that above-target inflation was “transitory” in 2020 and 2021 reflected a lack of diversity of views not just at the Bank of England but also in the wider central bank community. When inflation rose, central bankers focused on supply-side shocks as the cause. Some of our witnesses therefore considered that the inflationary potential of elevated rates of money supply growth were given insufficient attention by the Bank. Furthermore, the Bank – and all central banks for that matter – may have also become over-reliant on inadequate forecasting models that seldom predict anything other than a return to the inflation target.
To address this, the Bank must do more to foster a diversity of views and strengthen a culture that encourages challenge. The Review into the Bank’s forecasting and related processes, led by Dr Ben Bernanke, is welcome. But other areas need attention: governance, hiring practices and appointments, especially to the Monetary Policy Committee.
Alongside this is the need to ensure that the Bank is focused on its primary objectives of controlling inflation and maintaining financial stability. Over the years, the Government has expanded the Bank’s remit. This concerned a number of our witnesses, who pointed to the growing number of policy areas the Bank is expected to “have regard to” or “consider” —climate change being the most cited example—to support the Government’s economic policy. This widening of the Bank’s remit risks jeopardising the Bank’s ability to prioritise its primary objectives; risks drawing the Bank into the Government’s wider policy agenda; and increases the potential for conflict between its objectives. The Treasury should therefore prune the Bank’s remit. Meanwhile, the Bank’s management structure, which has expanded in line with its growing remit, should also be reviewed with a focus on whether it could be made more streamlined.
The next area that needs attention is the relationship between the Treasury and the Bank. Years of ultra low rates and quantitative easing, which has led to the Bank’s balance sheet ballooning, have raised questions about this relationship, and the Bank’s independence. This needs addressing. The interaction between fiscal and monetary policy requires clear lines of responsibility and effective communication between the Bank and Treasury, so as to safeguard economic and financial stability. We recommend that the Bank and the Debt Management Office should publish a memorandum of understanding which clarifies how the interaction between monetary policy and debt management should operate. We also want published the Deed of Indemnity – the contractual document between the Treasury and the Bank, which commits the taxpayer to paying any financial losses suffered by the Bank which might result from the quantitative easing programme.
Finally, the Bank is one of the most powerful institutions in the country: its unelected officials exercise significant powers which affect us all. Given that the Government is unable to challenge the Bank’s decisions without compromising its independence, it is imperative that the Bank and its remit are effectively scrutinised by, and its officials are held accountable to, Parliament. There is a number of means by which Parliamentarians can – and do – hold the Bank’s leadership and Ministers to account. However, as the Bank’s remit has grown, there has not been a commensurate increase in its scrutiny: a democratic deficit has emerged. To address this, Parliament should conduct a review of the Bank’s remit and operations every five years, enhancing Parliament’s ability to hold the Bank to account and express its view on its performance and leadership. Accountability and independence must go together, hand in hand.
Greater challenge within the Bank; more focus in terms of the Bank’s remit; more clarity of the relationship between the Bank and the Treasury; and, above all, more accountability to Parliament: this will all help make an independent Bank of England work better.
Lord Bridges is Senior Adviser to Ana BotĂn, Group Executive Chairman of Banco Santander. He was Parliamentary Under Secretary of State at the Department for Exiting the European Union (DExEU) until he resigned in June 2017, having been a Minister in the Cabinet Office since May 2015.
