Ruth Sunderland: The Independent Bank of England may have flaws, but it’s better than the alternative
- Debate rages on whether the Bank of England is right to raise interest rates
- This hides deeper questions: Is inflation targeting the right system?
- Inflation targeting was introduced in 1992
- The concept of inflation targeting is closely related to the independence of the Bank
Debate rages on whether the Bank of England is right to raise interest rates.
This hides deeper questions: Is inflation targeting the right system? And has the bank set its sights on the ball, or is it in danger of being distracted by climate change, the controversy over historical links to the slave trade and even the fact that many employees work from home?
The concept of inflation targeting is closely related to the independence of the Bank. Both are now so familiar that they are taken for granted, even though they are actually relatively recent.
Questions: Has the bank set its sights on the ball or is it in danger of getting distracted?
Inflation targeting was introduced in 1992, shortly after the United Kingdom’s exit from the European Exchange Rate Mechanism. Independence came in 1997, as one of Gordon Brown’s first acts of labor.
The thinking was that politicians could not be trusted with monetary policy, because they would be subject to the temptation to inflate the economy and manipulate interest rates for electoral purposes. It is better to leave such important matters to an adult, that is, to the ruler.
The tacit assumption that the big monsters of central banks, including current governor Andrew Bailey, can be trusted to weather crises, is under scrutiny. If the bank fails to stem inflation, those seeds of doubt risk turning into a real danger.
Handing such an enormous amount of power to unelected fiscal officials is extraordinary when one thinks about it. Independence is seen as a good thing because it appears to have worked: the bank appears, so far, to have halted inflation. There is no average achievement, considering it peaked at 27 percent in 1975, and averaged about 6 percent annually in the 1980s.
Since then, we have enjoyed low inflation and low interest rates. But could the bank really take all the credit, or was so much of it just a happy coincidence?
Let’s waive some favourite for Threadneedle Street. But there have also been some major anti-inflationary forces outside the purview of central bankers, including advances in technology, lowering barriers to trade and increased global competition.
And price stability is not everything.
As we now know, the global financial system has become unstable due to the accumulation of toxic debt, which central bankers failed to prevent and which led to the credit crunch.
However, the Bank of England emerged from that disaster more forcefully, gaining control over areas of financial regulation and supervision that had been divided with other authorities. Bailey and the other officials deserve our gratitude that, in the Covid crisis, commercial banks are entering their balance sheets in a much stronger shape than they were twelve years ago.
But there are concerns that the bank is moving away from its primary objective when it needs a laser focus on shielding the economy from the effects of the pandemic.
However, there were side shows. She has been accused of “waking up” after deciding to remove the oil paintings and busts of former officials associated with the slave trade.
Former Governor Mervyn King has criticized her involvement in climate change, after the chancellor changed her mandate to include support for change to net zero.
However worthwhile these reasons may be, the bank cannot be expected to solve every social problem. It must uphold its main function: to advance the interest of the people of the UK by controlling inflation and maintaining the integrity of the financial system.
If you fail to do so, independence will be jeopardized, and that will be dangerous. An independent bank may have its drawbacks, but it is better than the alternative.