The last 24 hours or so has seen several suggestions appear in response to the request by the Shadow Chancellor of the Exchequer John McDonnell for a review of the Bank of England’s remit on the 18th of October last year. So our first impression is that it is not only monetary policy which operates with a lag! Perhaps it is economists too.
However the mandate of the Bank of England is very important and mostly unknown to the public it has been shifting in recent times as the primacy of the inflation target where the Consumer Price Index is supposed to rise at 2% per annum has been reduced. Successive changes have brought in a sentence which poses its own problems.
Subject to that, to support the economic policy of Her Majesty’s Government, including its objectives for growth and employment.
I have two issues with this. The first is that it is rather wishy-washy and the second is that I am in the camp who believe that most of the post credit crunch Bank of England policy has been to deliver the second objective and not the first.
My suggestions are different
The two suggestions I have seen over the past 24 hours from Tony Yates and Gabriel Sterne both come from people who worked at the Bank of England and can be classified as insiders to both the Bank and its way of thinking and to the UK establishment.I note that two members of the review team ( David Blanchflower and Adam Posen) are what I would describe as Bank of England insiders too. With respect to them and their views what is needed is some outsider thinking as most people reading this will recognise that if things were going so well we would not be where we are.
Also there has been debate on this issue – as so often in the modern era on Twitter with advantages of timing but of course only 140 characters – which has headed in the direction of a rise in the inflation target. For example Tony Yates suggested this.
Inflation target: a rise in the inflation target, to something like 4%, the level to be reviewed by some third party body, i.e. not BoE, not HMT, and to take effect 2-3 years after getting inflation back to the old target. This being the surest way to minimise future trips to the zero bound. Level to be reviewed every 5 years.
The online debate saw Dame Kate Barker ( ex Bank of England ) suggest that she would in time prefer a 3% inflation target. So the insider view is for a higher target whereas I would change it but my changes would be in the direction of (mostly) tightening it as I will explain below. Let us not be like the Bank of Canada which after pointing out there are grounds for a lower inflation target seems set to ignore them and head the other way.
The Inflation Target
If we look back in time we see that the inflation target of 2% per annum actually arrived by fluke as it “seemed right” rather than being the result of a fundamental econometric study. Also my contention is that the UK inflation infrastructure saw a loosening back in the period 2002/03 when the Consumer Price Index replaced the Retail Price Index. This was for two reasons of which the first is that the gap these days between CPI and RPI is now of the order of 1% whereas the target changed only by 0.5%.
Also secondly I would argue that what we saw pre credit crunch was an asset bubble and the change from CPI to RPI took out the asset measure (house prices) some five years or so earlier. It was supposed to be put back in but that got “forgotten”. Actually Europe is on the road to putting it back in (although their methodology is flawed) and we should do the same. Our perspective of consumer inflation would change if we properly measured it via introducing a house price influence.
In general the influence here would be to raise the level of measured inflation and would for example change the view right now of where we are. Of course the action would be in reverse on the rarer occasions when UK house prices fall.
Just to be clear I have spent quite some time at the Royal Statistical Society (RSS) debating these issues and am aware that there is a theoretical inconsistency in including house prices in a consumer inflation measure. However the debate there pretty much accepts this now as the theoretically consistent approach has again failed with the shambles that trying to use rents as a measure of house/asset prices has been. To this end I would direct people towards the Household Inflation Index developed by Jill Leyland and John Austin at the RSS which is an improvement on what we currently have in my view. No inflation measure is perfect but some are more equal than others to coin a phrase.
This is a something I have been advancing for over five years now so let me state my proposal from September 2010.
Also I have a further thought and it does indicate quite a change. As the role of the Monetary Policy Committee has changed and expanded more than could have been forecast when it was introduced in 1997 there need to be new checks and balances on its power. My suggestion for a change is that MPC members should stand for election as they are currently much more powerful than many of our elected representatives.
Let me add to this that such a case is in my view even stronger should you decide to follow the suggestions you have already received. A further increase in the power of the Bank of England requires more democratic accountability or we will make the same mistake as the Euro area did when it appointed technocrats. Democracy has to be complete or it fails.
One area where I agree with the proposals you have received is that the number of external members needs to be increased from the current 4. If it was raised to 5 as Gabriel Sterne suggests then they would be in a theoretical majority albeit a tenuous one in practice and if they were elected they would also have a mandate. This gets ever more necessary as the power of the Bank of England increases and is especially important were you decided to give it (more) fiscal power as Tony Yates suggests. I say more because QE (Quantitative Easing) has already influenced fiscal policy.
This move would also return some independence to the Bank of England. As it stands it is subject to the critique that it is not independent at all and I have argued this and believe it. Giving the external members a majority and subjecting them to election would change this for the better.
As the issue of nominal GDP (Gross Domestic Product) targets has been raised elsewhere I agree with the proposals I have seen that it would be a mistake. The revisions to GDP growth make that case rather eloquently. One would often be chasing a mirage.
This has become one of the worst four-letter words which can be applied to monetary policy which is that it has become a joke. So let us put it out of its misery and end it.
Foreign Exchange Reserves
The position here needs clarifying as I have read in the past that both the Bank of England and the government could use the reserves and now note this from the UK Government website.
Specific prior authority from Treasury Ministers is required for intervention designed to influence sterling exchange rates using the EEA, or for EEA participation in concerted intervention in support of any other currency
This needs clarity as in a crisis situation the idea of the Bank of England raising interest-rates in response in the way we have seen in Africa,Russia and Ukraine but not controlling foreign exchange reserves use seems to be a case for “order, counter-order, disorder” to me.
This is in essence my case and your will find on this website a lot more detail and information on the issues discussed. Also I wish to make it clear that these suggestions are for all political parties as I run a non-partisan operation. I have contacted the Chancellor of the Exchequer in the past on economic issues but for no other reason than he was and indeed is the Chancellor. In the same way I contacted the Portuguese government as the Euro crisis built up. Should either of them give me the courtesy of a reply I will let you know. I would also be more than happy to discuss my views on this issue with any of the other political parties.
We also have a situation where economic policy across the world is run more and more by central bankers as elected politicians retreat from it. This has clearly been evident in the Euro area where the European Central Bank has at times dictated to governments. So we are on a more dangerous road than many might think in my opinion and adding some democracy to the Bank of England would be a way of reversing the trend away from accountability.
Also my thoughts are open to reply and comment on here as you will find that readers come up with some good ideas which returns me to my point that we need to move on from what can look like a cosy insiders club. If that was going so well we would not be where we are.