My suggestions for the McDonnell Review of Bank of England policy and mandate

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.

Accountability

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.

Alternative Targets

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.

Forward Guidance

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.

Conclusion

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.

Advertisements

21 thoughts on “My suggestions for the McDonnell Review of Bank of England policy and mandate

  1. Wonderful column, Shaun. What a shame that you are not a member of the MPC!
    Just to be clear about your remark that Europe is on the path to putting housing prices back into the inflation measure, but with a thawed methodology, you do endorse Eurostat’s net acquisitions approach to owner-occupied housing (OOH) do you not? I believe you have reservations about some of the details of their methodology, as do I.
    By the way, if you saw my posting on the RPI CPI User Group website, Statistics South Africa continues with its own pilot project to calculate an OOH series based on net acquisitions described in a November 2011 paper. It seems Stats SA’s main problem has been the small number of quotes in their house price sample, but it is taking measures to resolve it.

    • Hi Andrew and thank you

      “thawed methodology” not quite as it has got very cold over here as North America has sent its cold burst this way! More seriously yes I endorse the idea of a type of net acquisitions approach using house prices as being better than the other choices proposed a few years ago but as we have both discovered on checking into the detail then the breakdown and practice of the way it has been applied has neutered it somewhat and soured the milk. For readers unaware of the topic it may well be that it is only Andrew and I who follow the net acquisitions numbers in detail.

      As to South Africa I will take a look as I did notice your post as I posted myself yesterday. An interesting time to do that with all the issues provided for inflation measurement by the ongoing Rand fall…..

  2. One problem including housing costs in some form into a new CPI, it would result in an greater increase in the cost of index linked benefits and payments.
    Having a more democratic and accountable Bank of England would reduce Government influence.
    As these two issues are not what politicians want, don’t expect any change, any time soon!

    • Hi Foxy

      One of the reasons I have written this post and have sent it to Danny Blanchflower who is leading the McDonnell Review is to challenge these issues. There is enormous pressure in the other direction I completely agree.

      Also returning to the Household Inflation Index developed at the RSS its purpose is as an uprating index so it would be completely appropriate for that. Along the way it would open more than one can of worms for the thoughtful.

  3. Hi Shaun
    I can understand you long-held view that there should be accountability in the BoE. However we do already elect MPs. If elected MPs were on the committees there would be accountability, yes? But of course that would reverese the idea of independance from politics. But how do you elect without political interference. Just look at the labour party leadership example. Open up elections to the public and the only ones that will be bothered to vote in any numbers will be those with a vested interest or representing a power block of some kind.
    I have sympathy with your aims but I don’t have any solution to how in practice it would work in the way you clearly want it to.

    • But there never really is “independence” because the appointees wish to be appointed and then stay there, so will wish to influence the appointors.
      Far better that the whole process is open to public view.

      • But how many of the ‘public’ will view? Its a very limited audience. Don’t you think its very easily ‘captured’ by one group or other? Do we have interest policy determined by ‘crowd sourcing’?

      • So called ‘independence’ has proved to be exactly that,so called.

        I have little faith in mnay of our MP’s and even less in the central bankers.At least with the MP’s there is the vague possibility that they could get kicked out.

        On that latter point we have a pretty unaccountable electoral system and an even more unaccountable central banking system.Pot,kettle etc

    • Hi JW

      There are issues that have come along the way for example the Police Commissioners elections which were disappointing at best. But we badly need reform and it was interesting that the initial replies were “I don’t consider myself an insider…” Er HELLO (with apologies to Adele). Also it would challenge the Carneys Cronies issue amongst others.

  4. hello shaun

    well if we could vote , I’d vote for you !

    but we live in a Mockracy so no chance of the people having a choice

    even if the BoE head could be voted for , do you think we’d get any better choice than the muppets we already have?

    As for the “economics” that TPTB follow, well its the Humpty Dumpty version – its what ever they want it to be – all depends on who is the master , does it not?

    MSM , sad old bu@@ers , just follow the emperor’s new clothes

    I see what’s mine and take it (Finders keepers, losers weepers) – PANIC! AT THE DISCO

    Still gotta laff

    Forbin

    • Hi Forbin and thank you

      Late last night I was putting some songs for falling stock markets on Twitter after some requests – a list regular readers will mostly be familiar with- and I will try to remember the group Panic at the disco for next time.

      As to the Governor I would not elect him but give him quite a few to deal with (a majority on the MPC ) who are. Would it work? Well you either believe in democracy or you don’t in my view.

      Meanwhile the oil price continues to slip slide away with Brent Crude Oil dropping below US $29 yesterday. The disinflationary pressure continues…

  5. My suggestion for the MPC is that they wear high heels…so they can be extracted from the sphincter of the Chancellor.

    • Hi therrawbuzzin

      Since the MPC began the contention has been that the Governor controls it mostly, although Mervyn King did eventually lose a policy vote. In my opinion Carney has got what he wanted with new appointees which is/are cronies. As to them being dictated to by the Chancellor that isn’t necessary as the Sir Humphrey Appleby critique applies which is that they pick the man or woman who will not need influencing!

  6. Democracy at the BOE – how should it be set up ?

    American vote for local sheriffs (so theoretically you can appoint the head of the local police) The FBI are able to investigate problems – with it’s head appointed by politicians. Americans also have recall elections – where you can undo an appointment.

    The Swiss offer meaningful & binding referendums. This seems to work well and seems fair.

    The UK electoral system FPTP is demonstratably unfair, 35% of the popular vote can give a majority in the commons. But it is still better than the Brussels setup.

    For an example of bad practice – look at countries where politicians are granted immunity from prosecution.

    • Hi ExpatInBG

      I would also support a move towards referenda on big issues. The driving force behind my suggestions is to open things up and provide the oxygen of publicity to what is a cosy club for as it stands Carney’s Cronies. The UK taxpayer is paying for him to have enormous patronage – I noted yesterday others making my point about all the new Deputy-Governors etc – . Well “No taxation without representation” to coin a phrase.

      • We have “representation” in Brussels in form of MEPs, but little accountability or democracy. an MEP job is a sinecure.

        All politicians decisions should be overruleable by binding referendum. The evidence of this theory’s validity should be shown in Iceland’s bank bailout referendum and various Swiss referendums.

        It is also worth noting that Swiss referendums are determined by voters. For politician driven referendums, like the Irish Euro accession referendum – they should be a combined vote of confidence, so that any govt losing a politically initiated referendum loses their mandate and faces an immediate election. This will deter dishonest politicians from perverting justice by referendum fatigue “you vote until you return the answer we want”

  7. Shaun, if we had an elected MPC, I would vote for you. But what about the more radical alternative I’ve seen suggested; i.e., abolishing the central bank altogether?

    • Hi Ian and thanks

      They have made such a mess of things that such suggestions are not the outliers they once were. But ironically they have entangled themselves in financial systems and economies ( QE and balance sheets) like a spider’s web and we need to wean ourselves off that ( like for example abandoning Operation Twist) step by step rather than another cold turkey hit I think.

    • Ian,

      You’d have my support on both sentiments.I really think we should examine whether the CBs actually create stability or instability.

      If we are to be forced to have a CB then,we the people,should get a say on who goes on there,so that there’s a chance of a sceptical voice being on the inside.

      At the moment,it’s just all too cosy.Endles debates about 3% or 4% etc with virtually noone questioning the validity of the data.

      The whole story of how these loons arrived at 2%=stability is beyond belief.

  8. The problem with informed choice, Is that the facile politicians, on all sides, who want us too ignorant to vote on any but the most superficial issues, and only then in a simplistic way, also control the educational curriculum.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s