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Regime change at the Bank 10 years on Samuel Brittan Financial Times 09/03/07 Fashions are important in economic policy. The Bank of England became a hate object in political circles for its alleged role in generating interwar unemployment. Winston Churchill felt that he had been taken for a ride by governor Montagu Norman. Later, Sir Stafford Cripps, chancellor of the exchequer in the postwar Labour government, boasted that the by then nationalised Bank was his "creature". Today, however, the pendulum has swung to the opposite extreme. The virtues of independence for central banks are celebrated across the political spectrum and much comment treats them as omniscient and omnipotent. This May will not only be the 10th anniversary of the Blair government but also of what some regard as its major domestic economic achievement: the granting of operational independence to the Bank. The institutional change was accompanied by the elevation of inflation targets to the dominant position in macroeconomic policy. There was a Roman saying: "If you want peace, prepare for war." Today's equivalent might be: "If you want growth, focus on price stability." There will be a full inquest on the present regime by the House of Commons Treasury committee. But much of the material has already been made available in Volume II of written evidence. As befits the bizarre nature of monetary phenomena, Volume II appears before Volume I. The first decade of Bank independence has, indeed, been much more successful than even its most enthusiastic supporters dared to hope. In the nine years for which full figures are available, the average rate of increase of the UK retail prices index was at 2.5 per cent, far lower than the 9.6 per cent achieved in the 1970s and 1980s. So, far from being accompanied by the stagnation that the pessimists had feared, the growth of output and employment accelerated. The quarterly variability of UK growth was also much lower, thus providing substance to the talk of stability. These new trends were already apparent in the transitional regime inaugurated by chancellor Norman Lamont in the mid-1990s, but the new regime hoped to embed them. The Bank in its evidence wisely refrains from gloating. It shrewdly emphasises the element of good fortune in the recent "nice" - non-inflationary, consistently expansionary - period. It cites the emergence of low-cost emerging-market producers that have held down import prices and ensured that much of any demand stimulus leaks abroad or attracts new immigrants instead of bidding up wages. The Bank fears that the next few years will not be so "nice", citing the uncertain behaviour of commodity prices, the possibility of lower immigration and, above all, the supposedly unsustainable pattern of current account imbalances and the low level of world real interest rates. It also warns that a depreciation of the real sterling exchange rate may be necessary to close the balance of payments deficit. Much of this is conventional. The distinguishing feature of the Bank's evidence is the emphasis on expectations and credibility. If employers and workers expect that inflation will be stable, they will not tempt fate by raising wages and prices in the face of inevitable shocks. Thus, the Bank may not need to move very much if the markets will do its work for it. In the US, Ben Bernanke, the new Federal Reserve Board chairman, has taken this approach much further. He has had to tread carefully in his first year, but he expressed his views in a series of speeches a few years before his appointment. He is less shy than either Mervyn King, governor of the Bank of England, or Jean-Claude Trichet, governor of the European Central Bank, in asserting his responsibility for stabilising both inflation and the real economy. His position partly reflects the dual mandate of the Fed, but he goes further. He states that the Fed can only stimulate real demand if there is "an unshakeable confidence in its commitment to price stability". He stresses the need for joined-up policy between government and the central bank and asserts that it would be "useful and even necessary" at times of severe recession for Congress and the president to apply a temporary fiscal stimulus. He is as committed to fiscal discipline in normal times as any conventional hawk, partly because he wants to leave room for a stimulus to combat recession. He thus supports Lord Lamont's remark that the UK inflation targeting regime is not the end of history. In one important way the Bank is the odd man out. Both the ECB and the Fed talk about adding or withdrawing economic stimulus, which implies some idea, however rough and flexible, of a neutral level of real interest rates and perhaps of money supply growth. The Bank's Achilles heel has been its over-reliance on forecasts. Its decision not to raise interest rates during the present turmoil in financial markets may mark a welcome shift of attention to what is now going on; but don't hold your breath.
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