Читать книгу The Chancellors - Howard Davies - Страница 13

Bank of England independence in May 1997 changed the role of both the Treasury and the Chancellor in macroeconomic policy. In the dying days of the long Conservative regime which began in 1979, a hybrid monetary policy-making model had been constructed, in which the Bank of England gave its interest rate advice to the Chancellor, and could publish it, but the Chancellor made the ultimate decision. The so-called Ken and Eddie show (Chancellor Ken Clarke and Governor Eddie George) ran monthly from June 1993 to May 1997. No other country has operated such a hybrid model. For two years, I chaired the internal Bank committee which prepared the draft advice, and attended the meetings. They were civilized encounters but sometimes with an element of Whitehall farce. On occasions, faced with a carefully crafted letter, representing thousands of hours of work by the Bank’s economists leading to a considered recommendation of a quarter point rise (sometimes accompanied by internal Treasury advice saying the same thing), Ken Clarke would open the meeting by saying cheerily: ‘Well there’s obviously no chance of a rise this month.’ He then asked for our views, but only on how long we needed to stay before the Bank team drove out of the Treasury courtyard. Too short a stay, and the waiting press would say our advice had been dismissed without discussion. Too long a stay, and the story would be that there had been a row between the two teams.

That vaudeville act was swept away in 1997, to be replaced by a model of central bank independence worked up in opposition by Brown and Balls, with help from some US policymakers, including Alan Greenspan, and a few Bank and Treasury moles. The model, which was implemented almost exactly as they drafted it, differed from both the US Federal Reserve System (the Fed) and the European Central Bank (ECB) and also from the Reserve Bank of New Zealand, which had been the first to implement an inflation target regime eight years earlier. The architects were sensitive to the complex history of the Bank–Treasury relationship. The Treasury was fearful that the Bank would be overzealous in its pursuit of low inflation, that it had a strong, enclosed, internal culture generating powerful ‘groupthink’ and that it was too hierarchical, with all decision-making roads leading to the Governor’s office. These points were made to me forcefully when the Treasury appointed me Deputy Governor in 1995. There was much truth in that assessment, I discovered.

So unlike the Fed and the ECB, which were left to themselves to define what they meant by price stability, the Bank of England was to operate under an inflation target regime, with the target set by the Treasury. That amounted to instrument independence – the Bank had full control over short-term interest rates – but not target independence. Most independent central banks in other developed countries have the latter as well as the former. The Treasury could change the target if it wished, and indeed has once done so.

The new Bank of England model is distinctive in other ways too. Unlike the Fed, which has a parallel objective of maintaining full employment, the Bank’s objectives are hierarchical. Meeting the inflation target is the prime aim, and only subject to that should it contribute to the government’s other economic objectives. In that respect it is similar to the ECB. Brown recalls that his initial thinking favoured a model more closely aligned to the Fed, with an employment objective: ‘The early papers we put to the Treasury had that idea included. But we could not find a legislative way of implementing a dual target. It involved revising Acts going back hundreds of years.’¹ But while the new Bank is similar to the Fed and the ECB in some ways, it departs from both the other main models in having four part-time outsiders appointed to its Monetary Policy Committee (MPC). That was specifically targeted at the groupthink point. Their power is buttressed by a requirement to publish individual votes of MPC members after every meeting. The Fed publishes ‘dissents’, while the ECB does not produce a voting record. The latter argues that to do so would put intolerable pressure on the voting members from national central banks, which would be expected by their governments to vote according to the circumstances of the economy of their country, rather than the Eurozone as a whole.

The UK model has been criticized by other central bankers for its excess of transparency. The publication of individual votes creates pressure on members to justify their views outside the meeting. The number of monetary policy speeches emanating from the Bank has escalated dramatically, as each member of the MPC tries to explain and defend their policy positions. That has generated a lot of ‘noise’ in the system. If monetary policy works through influencing expectations, it is not clear that these conflicting views help. The markets can become confused and on occasion the Governor has found himself in a minority, obliged to defend a position which is not his own.

In spite of these criticisms, the main architecture of monetary policymaking remained intact throughout the period. The original inflation target was set at 2.5% plus or minus 1%. The target was therefore symmetrical, unlike the target the ECB set for itself, of maintaining inflation below but close to 2%. There are strong arguments for a symmetrical target.

The significance of the range was that if inflation moved outside it, on the upside, or the down, the Governor should write an open letter to the Chancellor explaining why and what would be done to return to the target. For many years, the Governor’s pen remained capped, causing Mervyn King, in office from 2003 to 2013, to quip that the art of letter-writing was dead. After the financial crisis, letter-writing came back into vogue. But in structural terms, the changes since 1997 have been relatively minor. In December 2003 the centre of the target range was moved down to 2%, when the basis of measurement was changed from the Retail Prices Index (RPI) to the Consumer Prices Index (CPI). The Bank has, since 2010, maintained inflation at an average very close to the target, while the ECB has been well below. The symmetrical target may be partly responsible for that difference. In 2021 the ECB acknowledged that criticism by shifting to a symmetrical approach.²

A potentially more significant change, at the end of the period, was the insertion into the Bank’s mandate of a reference to climate change. In March 2021, Chancellor Sunak reaffirmed the 2% target, but said that monetary policy should ‘also reflect the importance of environmental sustainability and the transition to net zero’.³ The Bank responded that it would change its approach to corporate bond-buying ‘to account for the climate impact of the issuers of the bonds we hold’. There will also be implications for banking supervision. Since at least 2017, when the Network for Greening the Financial System was created, a number of European central banks have been seeking to incorporate climate goals into their monetary and supervisory policies. That has been controversial, with some commentators arguing that an activist approach to climate change would put their independence at risk. At an ECB conference in November 2020, John Cochrane of the Hoover Institution at Stanford argued: ‘This will end badly. Not because these policies are wrong, but because they are intensely political, and they make a mockery of the central bank’s limited mandates.’⁴ The Bank of England is less exposed to that risk, but Sunak’s rather vague formulation puts a heavy burden on the Governor’s shoulders. Mervyn King sees risks for the Bank’s independence: ‘Central banks’ increasing focus on climate change is particularly odd … Most important, the central banks’ new and broader ambitions have profound implications for their independence.’⁵

How did Bank independence affect the Treasury? The staffing implications were minor. The Treasury team of officials and economists preparing interest rate advice was small, and already depended heavily on the Bank of England for market intelligence. There is a Treasury observer on the MPC, who needs to be briefed, but he or she is genuinely an observer, except on fiscal policy where the individual may offer a view on the likely fiscal stance. There is certainly no equality of arms on monetary policy between the two institutions, or indeed on macroeconomic policy more generally. As Gus O’Donnell points out, the Bank employs far more economists than the Treasury, and in the Treasury those in the macroeconomic area ‘are typically young and lacking in experience. There is an advantage, though. Younger staff have been trained more recently, and are not slaves to some defunct economist.’⁶

When the change was made, it was widely assumed that Brown would find it hard to restrain himself from commenting on interest rates. That assumption turned out to be incorrect. Brown was scrupulous in avoiding public comment on the Bank’s policy, whether in Parliament or elsewhere, and his successors have adopted the same self-denying ordinance. We cannot be sure that in their regular lunches the Chancellor and the Governor do not discuss upcoming decisions, but there is no evidence of any attempt to exert inappropriate influence, which – given the voting structure – would in any event be unlikely to have a decisive impact. The Treasury also stopped its previous practice of censoring, or as it used to put it, ‘offering helpful drafting suggestions’ on, the Bank’s publications. There are more examples of Governors commenting on fiscal policy, which is equally inconsistent with the 1997 division of responsibilities. That created tension, between Alistair Darling and Mervyn King in particular. But for the most part the new arrangements worked well. The implicit assumption was that were a loose fiscal policy to threaten to generate inflation above the target, the Bank would react with a rise in interest rates. There was no particular need for active coordination of fiscal and monetary policy. In the meantime, the Treasury benefited from lower long-term gilt rates. For a long time, the British government had paid around 150 basis points more than the German government for its long-term borrowing. That spread narrowed rapidly after Bank independence promised tighter control of inflation in the future.

For a decade this new dispensation caused few problems, though stocking and restocking the MPC was sometimes a challenge. The Treasury has found it particularly difficult to maintain an appropriate gender balance, for which it has attracted criticism. There were lively arguments about the resources the independent members had at their disposal. MPC members also thought the committee met too often: the number of meetings was specified in the legislation, and was later reduced from twelve to eight. But in other respects the new system, even though it had been legislated in haste, has proved remarkably robust.

Signs of strain began to emerge, however, in the financial crisis of 2008/9. When interest rate reductions failed to provide enough stimulus to economic activity, the adoption of quantitative easing (QE) muddied the monetary and fiscal waters.⁷ The arguments were expressed most forcefully on the other side of the Atlantic. Charles Plosser, former President of the Federal Reserve Bank of Philadelphia, argued that ‘a large Fed balance sheet that is untethered to the conduct of monetary policy creates the opportunity and incentive for political actors to exploit the Fed and use its balance sheet to conduct off-budget fiscal policy and credit allocation’.⁸

In the UK the potential for confusion about the objectives of policy and the transmission mechanisms of new monetary instruments was offset to some extent by a process of formal approval for QE by the Treasury. So Alistair Darling, in January 2009, authorized the Bank of England to create a new fund called the Asset Purchase Facility, which the MPC could use for the purchase of gilts and corporate bonds. The total amount that can be purchased is set by the Chancellor after a request from the Governor. The initial request was for a ceiling of £150 billion, but there have been successive further increases. By March 2021, the Bank held £875 billion of gilt-edged stock alone.

Formally, the Bank cannot buy gilts directly from the government. That would conflict with the ‘no monetary financing’ rule. But as the volume of purchases grew in the Covid crisis, the distinction became much less clear. Market participants were well aware that the central bank would hoover up the debt they had bought at auction. The Bank became the purchaser of first resort rather than the lender of last resort. In 2021 the Bank owned more than half of all gilts in issue. And the government’s overdraft facility at the Bank, known as the Ways and Means account, was extended without limit.⁹

In practice, the government has not so far needed to draw on the Ways and Means account, but the question of how the MPC determines the volume of gilts it needs to buy has become a serious preoccupation. The Bank has been criticized for putting its monetary policy tools at the service of the government, and determining the volume of QE by reference to the size of the deficit, rather than to what is needed to meet the inflation target. ‘The real question’, as one commentator put it, ‘is whether fiscal sustainability will begin to encroach on an independent monetary policy committee that targets inflation’.¹⁰

Andrew Bailey, Governor of the Bank since 2020, took to the columns of the Financial Times in April 2020 to reject a direct link between the size of the government’s deficit and the Bank’s bond-buying programme. He denied that the volume of QE was in any way related to what the government is going to borrow: ‘Using monetary financing would damage credibility on controlling inflation by eroding operational independence.’¹¹ He emphasized that the MPC remains in full control of how and when that expansion is ultimately unwound. Monetary financing of the deficit would be ‘incompatible with the pursuit of an inflation target by an independent central bank’. But as the programme continued, the sceptical voices grew in volume. The FT surveyed the top eighteen buyers of gilts in the London market, and found that ‘the overwhelming majority believe that QE in its current incarnation works by buying enough bonds to mop up the amount the government issues and keep interest rates low’.¹² They noted that the monthly volumes of Bank gilt purchases tracked the government’s deficit very closely through 2020 and into 2021. In essence, they argue that fiscal dominance has taken over monetary policy. What is certain is that, at least in the short run, QE allows the government to run a lax fiscal policy without facing interest rate pressure.

The Bank has tried to dismiss that concern. Andy Haldane, then its Chief Economist, argued in November 2020 that:

in the current environment the situation is in some respects the very opposite of fiscal dominance. In the face of a huge shock, fiscal expansion has played an extremely helpful role in supporting demand and in helping the MPC return inflation to its target. What we have seen is better described as fiscal assistance than fiscal dominance when it comes to meeting the inflation target. The externalities from expansionary fiscal policy have in that sense been positive, rather than negative, from a monetary policy perspective.¹³

He recognizes that ‘these QE actions have been necessary to support the economy and hit the inflation target. But they pose rising challenges to public understanding of the purposes of QE and, ultimately, perceptions of independence.’ If the market believes, as it seems to do, that QE is driven by the government’s financing needs, then not meeting those expectations could cause yields to rise, which in turn will put further pressure on the government’s finances. The OBR calculated at the time of the March 2021 Budget that a 1% rise in rates would add £22 billion to the government’s deficit.

In those circumstances, would the Bank of England feel able to respond to the prospect of higher inflation with a timely rise in rates? Charles Goodhart of the LSE thinks not. He believes that a combination of ‘massive fiscal and monetary expansion’, on the one hand, and ‘a self-imposed supply shock of immense magnitude’, on the other, will result in ‘a surge in inflation, quite likely more than 5%’. Furthermore, he doubts whether central banks will respond: ‘Inflation will rise considerably above the level of nominal interest rates that our political masters can tolerate.’¹⁴ Haldane also sees that risk. In early 2021 he noted:

There is a tangible risk inflation proves more difficult to tame, requiring monetary policymakers to act more assertively than is currently priced into financial markets. People are right to caution about the risks of central banks acting too conservatively by tightening policy prematurely. But, for me, the greater risk at present is of central bank complacency allowing the inflationary (big) cat out of the bag.¹⁵

In September 2021, the CPI index jumped to 3.2%, requiring the Governor to uncap his pen to explain why the MPC did not plan to react quickly.¹⁶

There have been growing concerns, too, about the accountability framework for QE, and the longer-term risks to the public finances. The Economic Affairs Committee of the House of Lords was particularly trenchant, arguing that ‘the scale and persistence of QE – now equivalent to 40% of GDP – requires significant scrutiny and accountability … The Bank must be more transparent, justify the use of QE and show its working … QE is a serious danger to the long-term health of the public finances. A clear plan on how QE will be unwound is necessary, and this plan must be made public.’¹⁷

It is impossible to forecast the future course of inflation with any confidence. But it is clear that the future of central bank independence is in more doubt than it has been for twenty-five years. There are many who argue that, in spite of all the benefits in terms of inflation control and a reduction in growth volatility, it may be that peak central bank independence has been reached.¹⁸ The risk of fiscal dominance, which now looms largest among the threats, is not the only one. The additional burdens loaded on to central banks, especially in the UK, is another. With its responsibility for prudential supervision of banks, and now insurers too, on top of monetary and macroprudential policies, and a leading role in combating climate change, has the Bank of England become too powerful for its own good? Might the Governor fall into the ‘overmighty citizen’ trap, which enveloped Alan Greenspan in the United States? There is a populist tide which is suspicious of technocratic power, and even their more cerebral political representatives say they have had enough of experts.

In the next chapter I will review the conduct of fiscal policy during the period, but there is an alternative critique of the macroeconomic policy framework which has become more prominent since the financial crisis, and particularly in the Covid pandemic.

That critique maintains that the primacy of the inflation target has already led to suboptimal economic performance, and could seriously hinder further recovery. Simon Wren-Lewis of Oxford University, for example, has argued that ‘to continue with inflation as the primary target could jeopardise a macroeconomic policy that focuses on strong growth, and quickly offsets any negative shocks’.¹⁹ He notes that the Fed’s dual mandate allows it to prioritize maximum unemployment and look through temporary increases in inflation. Indeed, the Fed has recently reviewed its approach to the target and declared that in future it will adopt an ‘averaging’ methodology, which allows it to tolerate overshoots to ‘catch up’ with past shortfalls.

Presenting the new policy, Jerome Powell, chair of the Fed since 2018, noted that, in an environment where inflation expectations are very low, interest rates ‘decline in tandem’. As a result, ‘we would have less scope to cut interest rates to boost unemployment during an economic downturn, further diminishing our capacity to stabilize the economy through cutting interest rates. We have seen this adverse dynamic play out in other major economies.’ To prevent such a dynamic establishing itself in the US, the Fed decided that in future ‘employment can run at or above real-time estimates of its maximum level without causing concern’ and ‘following periods when inflation has been running below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time’.²⁰

The Bank of England argues that the UK inflation target regime, with its focus on inflation at a two-year time horizon, allows it the flexibility to look through temporary overshoots, as it did in 2010. It argues furthermore that since 2010 there has been no undershoot of the target, as there has been in the US and the Eurozone. But, as Wren-Lewis points out, interest rates have been at or close to their lower bound for some time, and the policy tool then available, QE, ‘is just too unreliable compared to interest rates or fiscal policy’.

Ed Balls and colleagues at Harvard Business School have argued that in these circumstances a closer nexus between monetary and fiscal policies is required. They recommend that the Governor should be mandated to write to the Chancellor suggesting the scale of fiscal stimulus they think is needed when interest rates are at their lower bound.²¹ Support for that approach came from Olivier Blanchard, the former Chief Economist of the IMF, who argues that if interest rates remain lower than the growth rate, and if monetary policy is constrained by the zero lower bound, it makes sense to run fiscal deficits to sustain demand, even if this leads to a further increase in debt.²²

So far, neither the Bank of England itself nor the Treasury has shown any signs of being interested in amending the policy framework in this way. If the post-Covid recovery is again sluggish, as the post-GFC recovery was, the question of monetary and fiscal policy coordination will rise up the agenda, but the Bank of England will certainly resist any change which puts its monetary policy independence at risk.