What should be the mandate of the Bank of England?

This issue was raised yesterday by the Shadow Chancellor John McDonnell in his speech to the Labour party conference. Already there have been a lot of misconceptions so it is time to take a look again at the mandate of the Bank of England. First let us consider his speech.

I will also be setting up a review of the Bank of England.

That seems perfectly reasonable as it has in my opinion been shown up as flawed by the credit crunch era. However we hit choppy water early.

Let me be clear that we will guarantee the independence of the Bank of England.

There are two major problems here. The first is demonstrated by the £375 billion of Quantitative Easing or QE and its remit letter. You see it required the Chancellor Alistair Darling to not only authorise the concept but also the amount (£150 billion back then). How independent is that? We may also have a reason why the present Bank of England Governor seems not to be keen on QE.

Also there is the issue of the institution being taken over by the UK establishment. Last night at the Royal Statistical Society the presentation on the Bean Review on UK Economic Statistics was given by a Vice Chairman of the BBC Trust and a former member of the Government’s Statistical Service. Oh and the Review is led by a former Deputy Governor of the Bank of England Charlie Bean. Every now and then the meeting heard the word “independence” almost chanted whilst I mulled independence from what?

The major plank of the new plan came here.

It is time though to open a debate on the Bank’s mandate that was set by Parliament 18 years ago. The mandate focuses on inflation, and even there the Bank regularly fails to meet its target. We will launch a debate on expanding that mandate to include new objectives for its Monetary Policy Committee including growth, employment and earnings.

The first sentence will come as a surprise to the Governor of the Bank of England as he thought the mandate was changed in March 2013!

Thank you for your letter setting out the new remit for the MPC. It is, in my view, a sensible change to previous remits and contains useful improvements to the framework.

The second sentence I completely agree with and will discuss it later. The last sentence seems as though it is unclear about the current mandate which does include this.

to support the economic policy of Her Majesty’s Government, including its objectives for growth and employment.

So the addition is earnings and let’s face it as I wrote on Friday the Bank of England did do its best for earnings in 2014 by raising the pay of the Financial Policy Committee by 17% and for the board of the Prudential Regulation Authority by 32%. Apart from that what could it do?

What alternatives could come in?

The McDonnell speech looked as though it was affirming the supremacy of inflation targeting so Robert Peston of the BBC has suggested this.

For those critics of Bank inaction, an increase in the inflation target to 3% or so would be a possible solution.

In the past Robert Peston has been well-connected with the Labour party ( he wrote a biography of Gordon Brown) so he may well be an “insider” still but of course the Labour party has changed so we cannot be sure. One interesting facet of the situation is the choice of 3% as a target which to be the best of my recollection is unique. Usually those who want to ease policy choose 4% as those setting inflation targets seem to have a bias against odd numbers! Perhaps they thought that choosing 3% would be the equivalent of scaring the horses and decided on a halfway house compromise.

One of the new economic advisers Simon Wren Lewis has suggested policies along that line.

We should use the monetary and fiscal tools we have at our disposal (and invent some new ones if need be) to do so. There is no magic to raising demand – we have various tried and tested means of doing so. The basic barrier to raising demand has been and always will be inflation, so when that barrier is nowhere in sight (in fact appears to be moving further away) it is a criminal waste not to expand demand.

Is it rude to wonder if the Ivory Tower occupied by Professor Wren-Lewis is next to the one occupied by the Riksbank of Sweden with its -0.35% interest-rates and a fast growing economy. Both seem unable to look down from their towers and see that overheating housing markets are a sure sign of inflation.

Oh and he may well move towards the Nominal GDP targeting that I analysed yesterday.

Nevertheless, what my view implies is that – all other things equal – the case for a nominal GDP target relative to the current regime is rather stronger in the UK than it is in the US right now.

What does he prefer about the US framework. In essence it is considered to have moved towards a dual mandate as described below by the St.Louis Fed.

The FOMC mentioned “maximum employment,” the second part of its dual mandate required by HH, for the first time in its December 2008 policy statement……., the FOMC began stating its objectives in terms of “maximum employment and price stability”

What about Joseph Stiglitz? Well we get a clue from his views on the US.

But, in the current circumstances, higher inflation would be good for the economy. There is essentially no risk that the economy would overheat so quickly that the Fed could not intervene in time to prevent excessive inflation.

So higher inflation is good and central banks can easily control it. If we look at British economic history then neither of those have proven to be true.

Comment

Let me welcome the idea of a debate around inflation targeting. In its current form it has plainly failed as it otherwise we would not be where we are. However simply raising the target has a multitude of problems. Firstly how does making everybody worse off in real terms improve things? Secondly currently unless you drive your currency lower there appears to be no way of driving consumer inflation higher with Japan for example making enormous efforts to end up at 0%. Oh well! As Fleetwood Mac put it. Driving your currency lower just makes everybody worse off in another way and if it ignites inflation will for example make them doubly worse off. So there is an element of misleading people by confusing nominal with real changes.

In response I would argue as I did last night at the Royal Statistical Society that our measure of targeted consumer inflation should include asset prices which in the UK would mean house prices. An entirely different inflation picture would be provided right now as we would correctly be looking at falling good prices but rising prices for assets and the service-sector. Rather than 0% we would be looking at more like 1%. So with a nod to the stunning view it provided from Chelsea Bridge last night we need to consider the whole picture and sing along with The Waterboys.

You saw the whole of the moon
The whole of the moon!

Oh and in the section on the UK establishment I  have been unfair on Diane Coyle who has published some interesting and good ideas but my point is that such thoughts are collectively rare in the UK establishment.

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18 thoughts on “What should be the mandate of the Bank of England?

  1. what a load of codswallop

    “The basic barrier to raising demand has been and always will be inflation, so when that barrier is nowhere in sight (in fact appears to be moving further away) it is a criminal waste not to expand demand.”

    beggars belief this guy gets paid for this

    inflation is there ! – its been “hidden” by false accounting , along with bogus GDP figures

    2% GDP is standing still and we must run twice as fast to get anywhere …..

    ( oh, did he mean RPI or CPI or majick unicorn inflation ? ie imputed )

    and

    “There is no magic to raising demand – we have various tried and tested means of doing so”

    and all these atempts have utterly failed !

    Good job nobody notices , eh ?

    Forbin

    • Hi Forbin

      It is a common theme amongst those who argue for inflationary policies that they claim that a central bank can easily control any inflationary upsurge. Nobody seems to point out the UK’s economic history or as recently as 2010/11 when it “overlooked it”. Also they claim that demand is easy to push higher when in fact a 25% reduction in the value of the UK Pound £, a cut in Bank Rate to 0.5% and the advent of QE did not to any great degree.

      Oh and the combination of the two which reduced real wages and depressed demand is locked away in a cupboard. We are back to “Reality was once a friend of mine”…

      If you tell people want they want to hear then their brains will mostly be set to neutral.

  2. Hi Shaun. BoE?
    1) Do as the chancellor bloody says.
    Which is precisely what happens now, but banksters get peerages for taking the flak that politicos should get, which allows said politicoes them to avoid accountability for their foul-ups.
    BoE independence is as fundamentally wrong as allowing the Chief of the Defence Staff to decide when we go to war.

    • Hi therrawbuzzin

      I agree that you describe the current situation as the supine acceptance of CPI in 2002/03 proved. You have reminded my that I failed to point out today that I advocate MPC members standing for election which would add some direct democratic accountability to the process and allow for some dissent. Yes for newer readers i would stand.

  3. Hi Shaun

    It seems to me that if you include employment, earnings and growth in the mandate for the BOE you have to ask the question: what is the role of government?

    As the PSBR would continue to be set by government it seems that expanding the mandate puts the BOE in the position of having to square the circle and achieving balance in the context of an assessment of aggregate demand (if the PSBR is “too high” then the private sector would have to be reined back in the context of an aggregate demand total consistent with a given inflationary target). Can this be done by the main tools of monetary policy and would any “reining back” be acceptable to the politicians? somehow I doubt it. As you have said the BOE has an exemplary record of non achievement with its current mandate which hardly gives one confidence about expanding it. It seems to me we’re in danger of outsourcing responsibility for government to the BOE.

    As to inflation targeting I find it amusing that people light on a particular figure; why 3%? why not 4 or 5 or even 2.675%. I think we need some inflation simply because it is a peaceful means of reconciling the claims of debtors and creditors by stealth; one of the dangers of the current situation is that we have very little inflation and so debts cannot be inflated away, one of the reasons I think the current situation we’re in will not end well.

    • Hi Bob J

      It used to be considered that a central bank needed to have at least one policy instrument for everything it tried to do in economic policy terms. So for inflation targeting it had the interest-rate and at times the exchange-rate. Now we seem to be getting a proliferation of targets when the effective number of policy instruments has shrunk or is “maxxed-out”.

      Your point about government is well made. What responsibility will they have for economic matters when they have pushed it all on the central bank? A bit like the Euro area crisis which was made worse by such actions.

  4. Yes independence of the BOE is a myth as is the independence of MSM, BBC etc. They might as well admit as much.

    I agree the inflation figures are also bogus without including housing which is not only the biggest cost of all for most people but is also the one rising the fastest! Associated “services” such as conveyancing/moving/solicitors costs and letting/estate agents’ fees are also sky high. I’m glad you were able to point this out Shaun.

    We are crying out for some honesty from “the establishment”. That would do for a start instead of them playing an elaborate game at our (taxpayers) expense whilst feathering their own nests.

    • Hi Jan

      I was intrigued last night by the fact that former Bank of England Deputy Governor Bean appears to have a new full-time job. Apparently even a pension fund valued at just under £4 million back in the 2013 accounts is not what it used to be! Surely it has not be affected by inflation?

  5. I find all this very amusing.

    The bank can be given a hundred targets, btu the continue to ONLY have one lever they can automatically pull: Base Interest rate.

    Everything else (including QE) they do surely requires some sign off /endorsement from HMG.

    Either you give them true independence along with a defined mandate. Or you leave them to tinker with Base rate and keep the control for other stuff with HMG. Cant have your cake and eat it.

    IMO their mandate should be this:

    Inflation
    House Prices
    Currency Stability
    Nominal GRP Targeting

    But they need to be given tools and paramaters to operate within and then be told to get on with the job.

    Abject failure over an 18 month period (within an agreed range) should lead to automatic dismissal.

    • Hi Anand

      You make some good points especially on the subject of the Bank of England being given enough tools to do the job. Also you are too kind to it as the credit crunch record is one of failure following on from the failures pre credit crunch.

      So get ready for all terms to be only 18 months!

  6. Too many targets dilute effectiveness but I should say the Fed has it right. A queston Shaun – you sperak of including asset prices in inflation which would be housing but are increases equities/bonds included in CPI/RPI too? If not do yopu think they should be included in inflation numbers as well as house prices?

    • Hi Noo 2

      in theory yes they should but in practice there is no way of doing this. Actually I have often mulled the situation regarding equities and retreat from including them on the grounds that at times there will be genuine growth and how do you measure it? Perhaps the post QE boom is an example but it is almost unmeasurable. You are right about bonds but that is even harder.

      So in my opinion when you move from theory to practice they get rejected because there is no decent measure or benchmark.

    • Hi Zummerzetman

      Have you been reading tonight’s speech from Mark Carney.

      “There is a growing international consensus that climate change is unequivocal.

      Many of the changes in our world since the 1950s are without precedent: not merely over decades but over millennia.

      Research tells us with a high degree of confidence that:

      In the Northern Hemisphere the last 30 years have been the warmest since Anglo-Saxon times; indeed, eight of the ten warmest years on record in the UK have occurred since 2002;
      Atmospheric concentrations of greenhouse gases are at levels not seen in 800,000 years; and
      The rate of sea level rise is quicker now than at any time over the last 2 millennia.

      Evidence is mounting of man’s role in climate change.”

      http://www.bankofengland.co.uk/publications/Pages/speeches/2015/844.aspx

      I presume that you had seen it….

      • Hi Shaun,

        That’s where my comment was coming from. I recall this being a really big issue until the economic crisis hit and since then it’s been pushed into the background. I read recently many USA car buyers been tempted back to large gas-guzzlers as their gasoline prices have fallen. Like so many things we blindly store up problems for the future.

        • Hi Zummerzetman

          Yet we find ourselves in a situation like in economics where we now do not know what we can trust. I doubt that VW was alone in fiddling the emissions figures and what else was fiddled? My last 2 cars were diesels ( Astras) partly on the basis that the technology was better, I am not sure I believe that now and doubt I was told the truth.

          I am not sure that the scandal ridden Bank of England is the template that we need! Especially as we wonder about the influence of Goldman Sachs on this.

      • Climate change has been unequivocal throughout the existence of the planet.
        Anthropogenic climate change is a faith based on computer games.

        As for the consensus, well what would you expect from politicians for whom this is a justification to tax, and scientists whose funding would immediately halt, were the negative provable.

        • It’s been known for a while there’s a lot of gamesmanship when it comes to emissions testing. It has been reported the vehicles tested sometimes had their alternators removed to put less load on the engine, and there have been other ‘cheats’ to improve rolling resistance of tyres, improve aerodynamics etc that are not part of the vehicle that is in the showroom. I thought it strange the Government are going to tax all vehicles the same with the exception of the few zero emissions models in future. However, the tax take must have dropped as everyone switched to ‘lower emission’ vehicles to take advantage of the cheaper tax bands, which I assume must be the driver for the decision.

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