In many countries the independence of the central bank is a constitutional priority, explicitly laid out and safeguarded in the supreme law of the land. Kenya’s constitution, for example, declares that the central bank ‘shall not be under the direction or control of any person or authority in the exercise of its powers or in the performance of its functions’. The UK, however, has had a different path in creating an independent central bank.
Chartered as a company to help finance William III’s military pursuits, the Bank of England was only nationalised in 1946. It was only in 1988 that a serious examination was given of the possibilities of removing the Bank from political control. That failed, apparently because then-PM Margaret Thatcher thought independence would amount to the government admitting it lacked the credibility to tackle inflation. Nevertheless, the idea caught on and was proposed repeatedly during the remaining years of Mrs Thatcher’s tenure and then under Sir John Major. Labour, in an effort to gain economic credibility, warmed to the policy (at the initiative of Ed Balls) in the early 1990s, even as the OECD and the EU began to promote independence for central banks. The EU’s stance was a particular influence on Labour given it was a serious possibility the UK might join the new European single currency in the near future, requiring such independence. Even then, the idea of independence was not uniformly popular amongst Labour; in 1993, Peter Stone MP said his party would ‘die of shame’ if it were to make the central bank independent.
Nevertheless, just five days after the 1997 general election, then-Chancellor Gordon Brown transferred rate responsibility directly to the Bank. This was, a year later, codified into a model whereby the Treasury would set the goals of monetary policy but leave the Bank to determine the results. The Bank had to update the public and Parliament on the work of its Court of Directors (the governing body of the Bank), but, for the first time in its history, it would not change rates by political whim.
Assessing central bank independence is difficult, because the institutional arrangements undergirding the Bank can be less important than the effect of credibility – that is, the confidence of the public and the markets that the Bank can be trusted to make decisions in the national interest (as opposed to, say, in the interest of a short term boost ahead of an election). This depends on trust both in the government and in the Bank itself. That trust can be fragile. For instance, while it’s too early to say what impact these might have, concerns have been raised about the Bank’s transparency to Parliament in evidence about LIBOR rigging.
Consequently, the arrangements for scrutiny take on a crucial role in reassuring the public and markets that the Bank is both functioning free of government interference and that it is exercising its central bank role in a responsible way. The Bank’s own study, 20 years ago, found that the UK Parliament was above average in calling in central bank officials to give testimony, but also that it had noticeably lower parliamentary staffing for the supervisory committee when compared to other peer legislators. Yet, appearances alone do not necessarily add to credibility; the report notes that the pre-Euro Bundesbank, the image of prudent German credibility, did not appear before Parliament at all.
One point of concern about scrutiny and transparency is that, in true British fashion, some of the arrangements are grounded in convention rather than in statute. They are hidden in the periodic monetary policy committee remits the Chancellor issues to the bank, which could be changed at any time. In the most recent remit, Chancellor Jeremy Hunt instructs that the Bank ‘should’ in public communications report various data and details about the targets and outlook. If there is a missed target with regards to inflation, the Chancellor ‘shall expect’ a letter from the Bank. The Chancellor further ‘suggest[s]’ that the Treasury Committee get a copy of all these letters.
There is no basis for this requirement other than this suggestion in the remit, which is changed periodically. This reflects a fragility in the scrutiny arrangements, a consequence of the independence of the Bank originating as an informal arrangement in 1997 not codified until 1998. The governing statute, the Bank of England Act 1998, while providing some scrutiny of actions by the Treasury’s Financial Policy Committee, is silent on actually overseeing the work of the Monetary Policy Committee.
For credibility, scrutiny arrangements should be taken away from the whim of governments. While it is unlikely, it is unhelpful that the Bank’s transparency on missed targets could be abolished by the stroke of an unwise chancellor’s pen. The fact that all remits to date have included requirements to inform the Treasury Committee with details regarding mixed targets is not enough to inspire confidence that all future governments will be as prudent. Independence alone is not sufficient if the public and markets do not believe the Bank is held to account where it misses targets. This is particularly urgent where the actions the Bank has taken have serious consequences for individuals that go beyond macroeconomis. The noticeable and (for those with mortgages) painful rate increases brought in by Andrew Bailey, the Bank’s governor, have failed to tame inflation, while leaving already stretched households worse off. The continued rise in both prices and interest rates may continue to undermine the Bank’s credibility, but even worse is the fact that there seems to be no effective mechanism to correct the Bank’s apparent missteps.
This is the paradox of independence. The economic consensus is that a central bank free of government interference can be more credible to markets in forming monetary policy. Yet, a central bank without permanent scrutiny by the legislature, particularly in times of scandal or controversy (which the LIBOR allegations may soon initiate), loses credibility because it becomes a black box and faces no correction when it fails to reach its targets. The strange balance achieved after 1998 failed to construct a stable infrastructure for scrutiny. 25 years on from independence, the time has come to consider a more permanent arrangement.
Elijah Granet.
Elijah Granet studied politics at Columbia University and the University of Cambridge. He has worked as a law lecturer both in Germany and England, as well as working for the Harwood Institute in the US.
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