I was asked these questions on the blog yesterday:
- What would be the short-term effects of the BoE losing its independence?
- Would the pound drop?
- Would our credit rating change?
- Would that in itself drive inflation or deflation?
As the commentator said:
- Undoubtedly long term it would be better but I'm curious how such a change would affect money markets.
Those are fair questions, and I think the comments from Clive Parry echo the same sentiments, so let me address them.
In my opinion, by far the biggest adverse reactions to our ending Bank of England independence would come from other central banks, and the European Union.
Dealing with the second of these first, it is currently a requirement of EU membership that a country have an independent central bank. As a consequence, ending the Bank of England's control of monetary policy would prevent our return to the EU, and I obviously see some problems in that. However, given that I suspect that once the UK had reversed its policy on this issue, many other countries would either do the same or wish to do so, I think that by the time any potential return to the EU might arise the possibility of not having an independent central bank might be embraced within the EU construct. And, if it hadn't, we might need to ask whether restoring Bank of England independence was a price worth paying to return to the EU, or whether a compromise around membership of the Customs Union and Single Market might be a better deal in any event. Given that all these things would take many years, if not decades, to work through, I do not place much weight on this objection.
I am quite sure that other central bankers would raise considerable objections to this proposal. However, the fact that the idea of central bank independence, with the very clear implication within it that politicians cannot be trusted to manage an economy, is a central plank of an anti-democratic neoliberal form of thinking to which all central bankers subscribe cannot be ignored. Of course, they would rally in defence of their colleagues, who they would perceive to be under attack in the UK, simply for the reason of defending their own positions, which would then be seen to be market more vulnerable. The likelihood that once one central bank falls back under democratic control, others might do so is, very obviously, quite high. In that case, of course significant objections will be raised. But my point is a simple one. If the dispute is over the right of a democratically elected government to pursue an economic policy of its own choosing to fulfil its mandate, on what can basis central bankers claim their entitlement to object? Are they, in fact, declaring their opposition to democratic government by doing so? How will that go down? And, will our politicians ultimately give in to their unelected appointees? I suspect not, so I think that in the end, this objection would also fall aside.
The short-term money market reactions are, therefore, more interesting, but I doubt that they would be significantly adverse.
This would most especially be true if inflation was low at the time that the change was made, as is very likely to be the case.
This would also be true if the conflict between the government and the central bank was over growth policy when almost all money markets would support growth. That is because, in their opinion, growth supports the value of a currency. For once, they are likely to be right. If growth increases either the value of trade from a jurisdiction or productivity within it, then the value of its currency invariably increases. If support of this policy was seen to be the reason for ending central bank independence, I would be very surprised if money markets acted adversely to any such change. Explanation would, therefore, be required to support such a change and after, at most, a brief period of uncertainty, I think markets would quickly accept the change, in contrast to what happened after Brexit, for example.
Would our credit rating change as a result? Given the wholly irrational nature of those few agencies who issue credit ratings, whose role in any economy should have been terminated following their disastrous performance during the 2008 global financial crisis, I am tempted to ask why this matters. Saying that, I am, of course, aware that some banking regulation is based upon these rankings, but candidly, anybody who thinks that the risk of default on UK debt would be impacted by such a change when the ability of the UK government to make repayment of sums that it owes would not be altered as a consequence clearly does not understand the way in which government finances operate, and they should have no influence on economic policy as a result. In other words, I think that any consequence will, in effect, be inconsequential.
So, would such a change drive inflation or deflation? On this I can be quite confident. The answer is very clearly that it would not. Large as financial flows are, the disruption caused by this event would last a day or two, at most, and have no long-term bearing of any sort. Inflation is now very largely caused by the rigging of prices in international commodities markets and not much else. The price of money would change little, if at all, as a result of this policy suggestion and as a result, I cannot see an inflation impact rising because I think the likelihood that the exchange rate would alter much, if at all, is very low.
I am, of course, speculating when making these comments. Anyone proposing a change has to do so. But what are the serious arguments to the contrary? I will take note of the comments, below
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Firstly: Wouldn’t taking control of monetary policy away from the BoE allow for a reverse of high Base Rate and QT, which would exert significant downward pressure on inflation? Aren’t high interest rates are as much a driver of inflation as international price rigging?
Second: Wouldn’t a “a compromise around membership of the Customs Union….” ( a Norway arrangement, more or less) be much more pragmatic and sensible, while bolstering the blocking of pressures from some quarters to join the Eurozone? A compromise which could and should have been implemented in 2019, had hotheads and the corrupt not had their way, IMO.
A very fine post. The argument for CB independence rests on the idea that “experts” know better than politicos wrt money & the economy.
But there is zero evidence for this, quite the reverse. The evidence is that when CB’s are independent the (unelected) experts meddle in politics, directly or indirectly.
The events in Germany in the 1960s offer prima facie evidence of this. The current detachement of the ECB from the gathering climate disaster is another.
Making these points in the EU & at gatherings in Bx gets a reaction akin to suggesting that the Pope is a fan of death metal and S&M.
BoE independence is as a number of commentators have shown – a fig-leaf – which needs to be torn away. Reeves won’t do it – but as pressure mounts on Starmer for results – she may find her “sell-by-date” rapidly approaching.
I think the likelihhod Reeves will do 5 years is low
Someone will have to pay the price for a failed growth narrartive when it bcomes apparent it is not delivering
She will go then
In the mean time she can do a lot of damage, and, even after that, will her replacement be any better?
The UK was an EU member before Gordon Brown decided to give the BoE independence.
Maastricht
“… almost all money markets would support growth … If growth increases either the value of trade from a jurisdiction or productivity within it, then the value of its currency invariably increases.”
Unfortunately like Scammer & Co the mindset is government doesn’t create much of any value and creates little in the way of increased productivity. Neoliberal idiocy in other words fuelled by greed!
Thank you and well said, Richard.
I wrote my masters on central bank independence, 1994 – 5 and included a period of study in Germany. I opposed central bank independence then and have always done, seeing no evidence of superior economic performance and governance, but evidence of oligarch and finance capital control.
The Bundesbank’s independence is attributed to the chaos of the Weimar Republic and hyperinflation, but it was Reichsbank policy to inflate Germany’s WW1 debts / reparations away.
After WW2, the newly minted Bundesbank was given autonomy as part of the diffusion of power that included consolidation of laender into larger and more powerful units as countervailing forces to the centre.
With regard to the markets, I have sat on trading floors, as a compliance officer, and known a few traders on and off duty. Richard and readers may be stunned at their poor grasp of economics / political economy and the regulation of markets. Few are economists.
I think ending central bank independence is a price well worth paying.
Thanks
Re traders: the arbitrage available in the moment is all that really matters to them
Thank you, Richard.
That’s correct. They are no different to Trotters Independent Traders and may be related, judging by some.
With regard to central bank independence, only applicants for European monetary union need to have it. In the UK, a simple one liner will suffice to repeal the Bank of England’s operational independence.
But everyone joining the EU has to be a potyential applicant to the Euro
That’s why I think this might be an obstacle. They have the experience of Sweden to know that they can be played around
“Inflation is now very largely caused by the rigging of prices in international commodities markets and not much else.”
It’s the deliberate relative deflationary effect of Chinese currency rigging that’s creating economic problems in the West as relatively well paying factory jobs decline and workers are forced into the lower paying services and agriculture ones.
That’s a persistent trend
Inflation is always a passing trend
First, I am not sure that an independent Central Bank is a requirement for joining the EU but it is certainly a requirement to join the single currency. I think (but I am not certain) that new entrants must aspire to join the Eurozone but none will be Eurozone members when they join. What does “aspire” mean in practice? Well, unlike the UK that got a specific opt-out in Maastricht, Sweden signed up to join the Eurozone when they met the pre-conditions… but all they did was ensure that those pre-conditions were never met – in particular the Riksbank (Swedish Central Bank) does not fully meet the criteria on “independence”. For me, rejoining the EU is an important long term aim and any barrier to that would worry me… but I don’t think BoE independence would stop us in theory or practice.
Second, if I ran the BoE with a few other like minded folk then I would be arguing strongly for independence from an interfering Treasury! I want competence, co-operation with government and a broad balance of opinion (not just bankers/economists) throughout the whole institution. And the government already has strong powers to do this. the BoE is not “independent” it is “operationally independent” – the government gets to set the remit and appoint the people in charge… although I am not expecting the call right now.
Third, markets would react. How? We don’t know but my guess is that people would assume the purpose of government taking control was to run looser monetary policy with an acceptance of higher inflation (than would be the case with higher rates). Short maturity gilt yields would fall, long yields? I don’t know – yields pulled lower by lower Base Rates, higher by higher inflation expectations… not sure which wins. Sterling? Lower due to expectations of lower interest rates. Now, I don’t think policymakers should be scared of markets – generally markets will recognise “good” policy and reward it… but it is risky.
So, in conclusion. The BoE is only “operationally” independent. The government has huge scope to bend it to its will…. and it should do so.
Thanks
” I want competence, co-operation with government and a broad balance of opinion (not just bankers/economists) throughout the whole institution”.
Here is the problem. If we were dealing with sectors which require professionals well equipped to operate the system under scrutiny; engineers, physicians/surgeons, scientists then there is a plausible case to be made. But here we are talking about banking and central banking; the professionals are bankers and economists. On what grounds should we have confidence in bankers and economists to run either banking or an economy? We could interrogate their track record, but I doubt if that will go well. Your argument (above) obliquely confirms the case I make. Bankers and economists are not masters of the subject they claim to have the expertise to run, independent of more oversight than subjects where there is well tested proof the experts are capable of a higher degree of independence than bankers or economists are entitled to be given, based on performance over long periods of time. This, frankly is rationally and empirically incontestable..
Thanks
Or, as the Queen is alleged to have asked after the 2008 crash ‘Why did no-one see it coming?’
‘Why did no-one see it coming?’
Because the only people to whom anyone was paying attention, were themselves part of the problem. Outsiders were excluded.
Rachel Reeves is an insider. Not merely my opinion, here is the FT:
“Reeves spent the years before the July 4 election schmoozing the City and now has a coterie of informal big name advisers including Mark Carney, former governor of the BoE, Sir John Kingman, chair of Legal & General, and Baroness Shriti Vadera, chair of Prudential. ‘She has the trust of the City,’ says one FTSE 100 executive, adding that the City wanted to see results.
Despite her background, Reeves is now firmly rooted in Britain’s economic establishment. ‘Being chancellor is what she always wanted to do,’ says one close colleague. ‘t’s like she has come home.'”
She has abandoned taxation and changing the current borrowing rules, and expects to produce “growth” in a country that hasn’t produced significant growth in many years. There are no grounds for her optimism, because the famed “markets”, the private sector, the entrepreneurs, have already demonstrated they are not investing in Britain. The FT describes the problem succinctly; “The UK has had the lowest rate of investment in the G7 for 24 of the past 30 years”. These are facts. In the improbable event that Reeves waves a magic wand on growth, it will take time to produce investment. And we do not have time. The FT again: “‘The state of the public realm is such that they will have to spend some money — and they need to spend it now,’ says one City grandee, arguing that Reeves needs a more ambitious growth agenda. ‘They have a big agenda on planning, but do they have anything else? What is their agenda on infrastructure, Brexit, skills, migration, higher education?'”.
Wher indeed. How do you spend money you do not have, and refuse to pull the levers you actually have? Indeed according to the IFS, the government is already short of £18Bn, that is fast coming down the track.
No answer. No explanation. No fix. There is now an effort to represent the desperate need of the electorate to rid themselves of the hellish Conservatives; that there is a spirit of “renewal” in Britain. Guff. I have been listening to this tripe after every election in more decades I now wish to remember; and I can confidently say that “change” in Britain is slow, painful, costly and always half-hearted; and ends the same way every single time – badly.
Or the corollary, how truly independent is the Bank? Are we to believe that the Treasury/chancellor cannot direct the Bank to do things it wants done and not do that which it doesn’t?
The answer to that is not clear – most especially at present
Section 19 of the 1998 Act said:
19 Reserve powers.
(1)The Treasury, after consultation with the Governor of the Bank, may by order give the Bank directions with respect to monetary policy if they are satisfied that the directions are required in the public interest and by extreme economic circumstances. https://www.legislation.gov.uk/ukpga/1998/11/section/19
Ah, Reserve Powers. The ‘go to’ way to say the Government is doing one thing, when it is actually doing the complete opposite. In Scotland it is called Section 35.
Section 35, incidentally is the proof that all Starmer’s ‘stuff and nonsense’ that he is changing Labour’s relationship with the devolved Governments. Take Starmer’s guff at face value, and allow for him being completely sincere. It remains meaningless. The Government of Scotland is not in Starmer’s gift of patronage for life. It lasts only as long as he is in power. It doesn’t even guarantee another Labour government, or another Conservative Government, is not back waving a Section 35 notice in the Scottish Government’s face; and find some tenuous claim that allows them to use Section 35 (already confirmed by the Supreme Court, on grounds that opens Holyrood legislation to demands for Westminster approval). And that was after the Sewel convention, long understood to determine a degree of freedom for Scotland’s Parliament was shown to have no authority whatsoever. There is nothing in the Labour Manifesto to rein in the use of Section 35. Starmer will go; sooner or later. He is content to leave it to a Government no different from the “guilty men” of the Conservative Party, to be back waving a Section 35 notice in the face of Scotland’s Parliament; just because it can. Starmer plans no change to this scandal. Which means he too is culpable.
If Starmer was serious about having a viable Union that served Scotland’s real interests, h would completely reform the Union, enhance subsidiarity by transferring substantial new powers to Scotland, notably over taxation. Now that would be genuine “change”, and not what it is; puff, spin and window dressing for substantively changing nothing.
Much to agree with
“Mythbuster: The Bank of England is independent”
https://www.taxresearch.org.uk/Blog/2020/06/04/mythbuster-the-bank-of-england-is-independent/
That needs reposting….
I understand that one member of HM Treasury is a member of the BofE Monetary Committee but has no voting rights. Perhaps a middle ground between BofE independence and taking back control by the Government of the day might be to beef up the representation on the Monetary Committee by more members of the Government (and opposition parties?), though not a majority, but including voting rights?
Why?
And why a minority?
Democracy matters
Why a minority? because as you say, democracy matters and if it the Government of the day took total control it could become undemocratic and used for their own narrow economic view. Democracy tends to last fleetingly in the UK, during an election. Once in power, due to the FPTP system Governments often have unfettered control and this could extend to the BofE. My suggestion was to install a kind of proportional representation to it.
Gordon Brown made the BoE independent in 1997. It’s very unlikely that Ms Reeves will overturn this decision.
The fiction that an independent central bank or other “approving” organisation, think OBR, knows best and is better is just that a fiction.
They are the buffer that allows politicians to claim “not our fault”.
Will the sky fall in if the BoE is abolished, probably not. But fear of admitting being wrong is a big driver in lack of change and maintaining the status quo.
I’d expect an all-out attack on the govt, as a warning to other govts. Not ostensibly re central bank independence, but a ‘monstering’ campaign against the leader, endless skeletons exposed from MPs closets, a rash of ISDS claims, “inward investors” threatening to pull out, etc. Market reactions, while probably not catastrophic, would be relentlessly portrayed as such in the media.
A Labour govt should do it anyway IMO, but we don’t have one.
Richard, will you be doing a video on this? I suspect some of your younger viewers might be surprised to learn that changing the BoE’s status is even an option.
There is a blog coming this morning
It seems to me that because of the lack of economic knowledge amongst politicians in Britain’s political parties a very useful role this blog could perform is to create what I would term a Body of Work – Sane Economic Controls for Human and Planetary Well-Being. This would seek to identify all the controls needed both national and international and readers as well as yourself would contribute them and debate them with pros and cons arguments. A continuously running poll would be available to gauge over time support or opposition for a particularly control. The controls would be individually numbered and named of course in a list.
Let’s start with some economic truths….