Economic crises and independent banks
3:33 pm - September 10th 2008
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Oliver Kamm has an interesting take on Bryan Gould’s argument against independence for the Bank of England.
Living in Brazil gives me quite a different perspective on a number of issues facing the British left. Inflation here hit 45% a month in 1994 and our first directly elected President, Fernando Collor, froze everyone’s bank accounts in an attempt to tackle the problem five years before that. He was subsequently indicted for corruption and one of the reasons why most Brazilians support an independent central bank is that we simply don’t trust our politicians with responsibility for such an important decision.
When I first arrived in Brazil interest rates were close to 30%, because investors were in panic after the election of our first left wing President. Lula’s government has not touched the issue of central bank independence because Brazil needs to retain investor confidence. Economic stablity is a pre-requisite for social reform, but I sometimes think that the British left cannot imagine what it would be like to live in a country where there is a genuine risk of total collapse.
Giving independence to the Bank of England was long seen as Gordon Brown’s economic masterstroke, signalling that New Labour could also be “trusted” to run the economy. A long period of low inflation and steady growth followed, punctuated by a few periods of turbulence, such as the Asian Financial Crisis of 1997, the burst of the dot-com bubble in 2000 and the serious shock to the system after 9/11. The response of both the Bank of England and the US Federal Reserve was to cut interest rates on each occasion, which is probably what they would have done if they had been under government control. In the current crisis both have cut rates again – although the Bank of England has moved slower and more cautiously than many would like.
The reason for this has been concern about inflation and the reason for the rise in inflation has been the worldwide increase in commodity prices caused by rising demand in China, India and Brazil. For most of the last 10 years the growth of these economies has been keeping inflation down because they are producing manufactured goods more cheaply than can be done in the west. This has held down wages for western workers and brought huge profits to multinational companies who can source their products where it is cheapest. It has also brought growth to these countries and it is their increase in consumption that has brought inflation back into the equation.
This is the double-whammy that is now hitting the UK economy. The simple fact is that the British do not produce much any more. It is a service economy with a large financial sector, which obviously means that a financial crisis is going to hurt. If Britain was still a net exporter of oil then it would have benefited from the recent hike in these prices. Some energy companies have increased their profits as a result, which has led many on the left to call for a windfall tax. But increasing taxes on a good that has become more expensive makes as much economic sense as cutting taxes on a good that is becoming cheaper – which is coincidentally what those who argue for cutting stamp duty on houses also support.
The point is really who do you trust to take such decisions and, on the issue of central bank independence, I think I will go with Oliver Kamm rather than Bryan Gould. An independent central bank is the logic of a policy of inflation targeting, and this is a legitimate democratic policy aim. Gould’s argument that “the productive sector” of the British economy has borne the burden of the Bank’s counter-inflationary measures while “the primary cause of inflation” has been “the huge rise in bank lending” is simply not borne out by the facts.
Maybe the Bank of England’s monetary policy committee should be moving faster on lowering interest rates, I really don’t know. But unless Gould is suggesting a radically different economic policy, I cannot see what difference bringing the Bank back under political control would achieve apart from giving a bit more power to people who tell lies for a living.
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Conor Foley is a regular contributor and humanitarian aid worker who has worked for a variety of organisations including Liberty, Amnesty International and the UN High Commissioner for Refugees. He currently lives and works in Brazil and is a research fellow at the Human Rights Law Centre at the University of Nottingham. His books include Combating Torture: a manual for judges and prosecutors and A Guide to Property Law in Afghanistan. Also at: Guardian CIF
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Reader comments
Firstly the Bank of England does not have functional independence over monetary policy because the membership of the MPC is by direct appointment and the term of membership is shorter than the term of parliament. This results in an artificial appearance of independence, but the reality is one where it depends on continued patronage.
Secondly the tripartite regulatory system has created functional anarchy in our beloved market economy where authority is routinely bypassed and ‘trust’ has become a term of irrelevance.
All of which means that the BoE is effectively powerless to respond decisively to alter conditions, therefore ‘no change’ in interest rates has been the norm, except where political pressure has been exerted out of electoral expediency.
I wholeheartedly disagree with Bryan Gould for similar reason as outlined in this article, but I at least respect his theoretical consistency.
But those “people who tell lies for a living” are at least accountable to voters for their decisions. As I see it the cause of our current inflation is that goods are more expensive because the underlying cost of producing them has increased (mainly due to the price of oil) rather than any increase in the money supply due to increased bank lending or otherwise, so in that respect you are right and Gould is wrong. Therefore it should be possible for the Bank of England to reduce interest rates whilst still being mindful of meeting its infation target. However, they clearly still see an inflationary risk in cutting interest rates and so are reluctant to do so at present.
Now there is clearly a question which needs to be asked, which is whether the slowdown in the economy so serious that it is worth running the risk of higher inflation in order to boost the economy by a (possibly sharp) reduction in interest rates. That is a political as much as an economic decision and it has to be made by the government, it is outside the current remit of the Bank of England. It is right that politicians should be able to make this kind of decision and be accountable to the voters for the outcome. Central Bank independence is fine up to a point but it should be elected politicians who set the parameters within which the work.
An independent central bank is the logic of a policy of inflation targeting, and this is a legitimate democratic policy aim.
There was a discussion on Newsnight a few days ago where Paxman asks why the BoE doesn’t look more broadly at economic conditions rather than simply the inflation target. Keeping inflation under control can no doubt keep the economy more stable but I think the current financial crises has thrown things out of the window. This, not only because it deeply affects the financial industries, but because the high price of oil ensures that inflation cannot remain so traditionally low.
So I’d also ask the same question – why is the Bank focusing only on inflation rather than our economy more broadly, as the US Federal Bank does?
Thomas: I will defer to you on how independently minded the members of the MPC have actually been since I have been out of Britain for most of the last eight years. It seems like the broad trend in rates has been the same as it would have been if the Chancellor had been making them directly. Given that Britain has just enjoyed a decade of steady growth and low inflation their “independence” has not really been tested until now. In Brazil we had a couple of years where our minister of finance regularly called on the Bank to cut interest rates and they ignored him (he might have just been doing it for political effect). Now there is a (mini) crisis in Britain and so the independence could be tested.
What struck me about Gould’s article was his claim that the BoE was keeping rates too high out of some kind of anti-industry bias and that “excessive lending” was the primary cause of Britain’s inflation. This is about as convincing as Neal Lawson’s claim that the “unearned and undeserved profits” of the energy companies is keeping the cost of mortgages high. These are politicians spinning the truth because that is what politicians do.
Andrew: a fair enough point, but politicians do set the parameters by giving the BoE an inflation target. Presumably they could raise this. Alternatively, the next time the Bank send a letter to the Chancellor he could reply telling them “go ahead and cut them even more I don’t care about inflation”.
Sunny: because that is what the government told them to do.
Conor, yes exactly. My point is that if we had a truly independent central bank he would not be able to do this, but this is right and proper because you cannot always separate economic decisions from political ones and soemtimes it is right that our elected representatives make these calls and are accountable for them.
The increase in oil and other commodity prices has one simple impact – we as a net importer of these things (only just in oil, so we shouldn’t really be that badly off) – are worse off. There’s nothing really that can be done about this except take it on the chin. Also remember that inflation is a change in prices, once the high price of oil stops rising it doesn’t affect inflation.
True, its what the UK govt told them to look out for. But what are the reasons that cannot be changed?
Conor, I’m sorry you distrust politicians so much, but consider that members of the MPC are not scrutinized to anywhere near the level of our politicians and don’t have the same pressures to live with. Making an “up a bit, down a bit” decision is never going to be as controversial as a decision over war, for example.
The problem with an independent Bank of England. First, is the idea of independence, the bank has a narrow remit (controlling inflation) determined by the Chancellor, it could be expanded but but that would then make it a political decision. Second I think the bank’s limited remit has been a problem because it has been unable to take in factors such as the housing market into consideration. I think that the bank should have considered a broader set of needs for the economy beyond inflation, but expanding the remit would make it increasingly politicised.
Given that view, I think it’s best that the decisions be made by those who are democratically accountable, with the recommendations drawn up by the MPC.
I agree to your comment andreas.
Interesting article.
Maybe I will link to this on one of my pages.
Surely, if Drug pushers are sentenced to long prison sentences and their private property confiscated, Bankers who also have created misery through their desire to obtain quick bonuses, high salaries etc. by false accounting practices, promoting poor loans and credit, off balance sheet manipulations etc. are just as deserving. Until these people are held to account for the misery they have caused, are causing and will cause, they will continue to repeat history. What is there to prevent these people from taking their profits, golden parachutes, bonuses etc. and then running to their hideaways off shore (France; Spain; USA) leaving behind misery for many.
I dont know how they could be prosecuted. The government is so in bed with them that they would be turkeys voting for Christmas, but something should be done. I suspect that many civil servants and MPs will end up in senior banking positions, through the back door opened by nationalisation and thus even a bigger mess in the future. Professional malpractice, lack of duty of care, incompetence especially on the part of the Boards and Auditors must somehow constitute grounds for recovery of what they have in effect stolen.
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