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| The public in most western democracies have decreasing faith in the national institutions that make decisions in their name. From Warsaw to Washington, from Moscow to Madrid ordinary people are sceptical of those in authority – and that includes central bankers. |
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| As a politician scrutinising UK monetary policy on the House of Commons Treasury Select Committee I believe weaknesses are emerging in the way the Bank of England is made accountable for its decisions. Some of these weaknesses are replicated in other Western countries. |
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| Before Bank of England independence in 1997 interest rates were set by the Chancellor of the Exchequer. This gave rise to the suspicion that those decisions were sometimes influenced by political considerations, not purely economic ones. Put simply, Chancellors tried not to put up interest rates near a general election if they could possibly avoid it. The creation of the Monetary Policy Committee (MPC) has remedied that. As Mervyn King said in his Mansion House speech in June: “The essence of monetary policy is to reduce uncertainty by anchoring inflation expectations” and that “communication with financial markets and the public is a key part of the responsibilities of the Monetary Policy Committee.” In this, he is obviously correct. If the official interest rate changes the rates set by commercial banks, buildings societies, credit card companies and other financial institutions change for savers and borrowers. House prices, share prices and the level of spending in the retail sector are affected. An explicit target for inflation makes it easier for businesses and households to form their expectations of inflation. The UK’s inflation track record since 1997 when the inflation target was 2.5% has been good – RPIX inflation averaged 2.4% (CHECK FIGURES) – and the man in the street, if asked, would probably say Bank of England independence has been a success. |
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| But that does not mean that the current regime is without flaws. They have not seemed so important during a period when the UK has enjoyed an historic run of uninterrupted GDP growth. If economic times start to get tough the flaws will be exposed – and something will have to be done about them. |
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| There is a wide consensus that the manner of decision-making by the MPC is transparent. There are nine members, five are from the internal permanent Bank staff and four are external members appointed by the Chancellor of the Exchequer. They meet at the monthly monetary meeting and minutes are duly published, including a record of each vote cast, on the Wednesday of the second week after the meeting. Each quarter, the Bank publishes its inflation report, providing a detailed analysis of economic conditions and the prospects for economic growth and inflation. The Bank also publishes other material to increase awareness of the monetary policy function. And MPC members also speak to audiences outside London to explain the MPC’s work. These regional visits give MPC members not only a good PR opportunity but a genuine chance to gather economic intelligence. |
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| Yet doubts now arise as to whether the right people are being chosen to sit on the MPC as external members. Gus O’Donnell, one of the architects of this policy has said that: “The role of the Chancellor in appointing the four outsiders was part of the delicate constitutional balance that was struck in a move towards a legitimate model of central independence consistent with British-style ministerial accountability to Parliament.” It is true that Gordon Brown has avoided the partisan temptation to pack the MPC with political sympathisers, a possibility which at the outset concerned some in the Opposition parties. He ruled out choosing new members from regions or geographical areas. Nor did he set a quota of appointments from specific sectors such as financial services or retail or manufacturing, or from vested interests like employers or the trades unions. |
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| Doubts remain, though, as to whether his appointments have been made on the basis of those best qualified to carry out the task. That is why the Select Committee on Economic Affairs in the House of Lords said in November 2004 that: “The recent appointments as external members of the MPC do not appear to have expertise in monetary economics that earlier external members had and do not contribute through lectures and articles nearly as much to the public debate about monetary policy.” Previous members of the Committee, including Sushil Wadhwani and Alan Budd, were renowned for their lectures and reports that contributed greatly to public understanding of the MPC. This has resulted in an increased reliance on the views of the internal members of the MPC, in particular the Governor and the Chief Economist. So the Lords’ Committee recommended that: “The Chancellor restore his former practice of choosing external members of the MPC with acknowledged expertise in monetary economics, ensuring an appropriate balance in the committee.” It has been suggested that the Chancellor heeded this tart advice in the recent appointment of Mr David Walton. |
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| In my view, however, the Chancellor’s discretion to appoint members needs more formal and rigorous policing. The time has come for the House of Commons Select Committee to have a statutory veto on any of his appointments, akin to that which operates in the United States of America, where the Senate can veto a Presidential nominee. This idea was first put forward by the Treasury Select Committee (TSC) in its first report on the subject: “In our view the independence of the appointment process would be enhanced by giving the Treasury Committee power under the new Bank of England Act to confirm nominations”. |
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| Whilst this proposed enhancement to the accountability regime was rejected by the Chancellor, the TSC nevertheless decided to go ahead and hold hearings on a non-statutory basis assessing an “individual’s personal independence and professional competence.” |
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| Of the first thirteen confirmation hearings and one reconfirmation hearing on all but two occasions the nominations were confirmed unanimously. In the case of Christopher Allsopp the TSC asked the Chancellor to reconsider his nomination. My own view, having sat on the TSC for over four years, is that because we know the Chancellor can override our recommendations on his nominees the sharpness of our scrutiny is blunted. A statutory veto, which the Chancellor could not override, would give the confirmation process teeth and make the members of the TSC focus with more laser-like intensity on the kind of expertise the nominee would bring to the MPC. I do not accept Mr Edward George’s (Governor of the Bank’s) view that hearings may lead to a situation where “you would find that there were quite a lot of people who said ‘frankly I am not prepared to go through this process’”. |
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| Any candidate worth a place on the MPC should have the ability to withstand questioning from the TSC or indeed any other scrutiny committee. If a confirmation hearing puts the candidate off from applying then he or she is probably not suitable for the post in the first place. |
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| Scrutiny of central bankers was highlighted in an international context at Central Banking’s conference at Christ’s College, Cambridge this September. Two powerful criticisms were made by Western central bank officials about the politicians who scrutinised them in public hearings in their parliaments or assemblies. The first was that the politicians just wanted to have a public row with a central banker in order to get column inches in the newspapers and a few minutes of television exposure. Often, this was accompanied by the politicians telling the newspapers before the hearing that the central banker was going to get kicked very hard for alleged shortcomings and deficiencies in the conduct of monetary policy. In my view, if this happens, central bankers should be much more robust and should say before the public hearing starts something like: “I regret that your committee of scrutiny saw fit to give an account of what was going to happen to me today, without having had the benefit of hearing my answers first at this hearing. I believe this to be a discourtesy and I hope that in the interests of a free, open and mature debate we can have a dialogue about why we changed interest rates last month.” |
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| The second complaint about politicians was that, frankly, many were technically ignorant of the matters they were asking questions about. Again, the central banker in front of a committee of scrutiny is often too polite. He will hardly ever tell the politician that he does not know what he is talking about. A central banker, faced with blustering questioning that is vague or misconceived, should quietly say to the politician something like: “I am afraid I do not understand the technical basis of your question. The technical issues are set out in the main article in the Bank of England bulletin last May, which no doubt you will have had the opportunity to read.” If the politician is not familiar with that reference it will instinctively put him on the back foot and make him do his homework and ask better questions next time. This aids transparency and accountability in monetary policy because the better the quality of the questions that politicians ask, the better the scrutiny of central bankers and so ultimately the conduct of monetary policy. It is up to central bankers to raise the game of politicians. The Bank of England could certainly do more to inform and educate members of Parliamentary Select Committees by having more informal teach-ins and discussions about those technical areas of monetary policy that are contentious or difficult for non-central bankers to understand. |
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| One case in point, currently relevant, is the CPI inflation measure that has replaced the old retail prices index excluding mortgage interest payments (RPIX). In the last Inflation Report and minutes from the August meeting there seems comparatively little attention given to the fact that the CPI is at variance with other inflationary measures (primarily because it excludes housing) and there is little advertence to measures of core inflation that exclude energy prices (which are given a higher weighting under the CPI than RPIX). We see the CPI showing inflation to be well above the official 2% target. Yet according to the previous RPIX measure, inflation is slightly below target. The suspicion among some politicians is that the Bank may be slightly more tunnel-visioned in its adherence to a 2% CPI target which might not be the appropriate inflation target measure. If the UK economy weakens then this may become a very contentious issue. |
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| And, of course, if the economy gets in to serious difficulty of a kind not experienced since independence there could well be pressure for the first time on the Bank to accept more responsibility for demand management, as the US Federal Reserve has done. |
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| Now a debate about that really would make the Bank think about accountability. |
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