By Sascha O'Sullivan
ONE OF the most surprising things to come out of the race to replace Boris Johnson as leader of the Conservative Party has been the space the Bank of England has taken up in the discourse. One unsuccessful candidate argued the government should have more oversight of the Bank’s activities and current frontrunner Liz Truss has said she will look at the mandate of Threadneedle Street if she became prime minister.
Often monetary policy and the work of central banks can seem difficult to understand and sometimes detached from our everyday lives. This was underscored by Andrew Bailey’s suggestion, earlier this year, that workers shouldn’t ask for a pay rise in order to help keep inflation down. Economically speaking, he has a point, but it did nothing to help cement the importance of the Bank of England’s job in our lives. It impacts all of us. It’s not just our savings or mortgages, it also has an impact on house prices and, as we are all too well aware right now: inflation. In the most serious cases central bank mistakes can lead to recessions or make them longer and more painful.
It is then, of course, right that we give proper scrutiny to the activities of the Bank of England and look at how things can be improved. But the suggestions the Bank’s independence should be questioned is a transparent attempt to deflect blame and make a scapegoat out of the rate setters. Having monetary policy set by independent experts with a focus on stable growth both now and in the long term is preferable to politicians meddling in the system to give the economy a quick boost regardless of the long term consequences in order to win an upcoming election.
For its 25 years of independence, the Bank has, for the most part, been successful in fulfilling its mandate. This is not to say things can’t be improved. The communications from the Bank have been mismanaged. The forward guidance from Governor Andrew Bailey has been confusing and muddled and inflation forecasts have left a lot to be desired.
There is, indeed, a case for more scrutiny of the Bank and its staff. Under the current system, if inflation moves away from the target by more than one percentage point in either direction, the Governor is required to send an open letter to the Chancellor explaining why inflation has moved away from target and what action the Bank is taking to bring inflation back to target. This is no doubt embarrassing, but hardly the most effective way of ensuring mistakes are not repeated.
Indeed these inflation targets are part of the problem with the Bank’s current mandate. The Bank is often placed in a difficult situation on how best to respond to inflation – a situation where there are both too few goods or too much money sloshing around in the economy. Before the Great Recession, high oil prices raised cost-push inflation. In order to meet the two per cent target, interest rates remained high when it would have been far more appropriate to tolerate a level of higher inflation, in order to support economic growth. Eventually, both the Bank of England and the Federal Reserve in the US did eventually lower interest rates.
But the situation in the EU highlights the danger of a strict inflation target. The European Central Bank (ECB) actually raised interest rates in 2011 as they were concerned with inflation being higher than the target even though economic growth was stagnant and unemployment very high in Southern Europe.
This of course does not mean that central banks should not tackle inflation. It is right that interest rates have been raised and are likely to be raised further. This is the beauty of nominal GDP targeting – it would allow the Bank of England to tackle inflation without hindering economic growth.
Instead of merely looking at inflation targets, the Bank’s mandate should be refocused to look at nominal GDP targeting, rather than just price rises. This would give the Bank the flexibility to target the total amount of nominal spending in the economy as well as ensuring stable growth and keeping inflation down.
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