Bank of England (Economic Affairs Committee Report)
(Limited Text - Ministerial Extracts only)
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Lord Frost (Con)
My Lords, it is a pleasure to follow the noble Lord, Lord Burns, in this extremely interesting debate. I too thank my noble friend Lord Bridges for securing it, and all the committee members for their work on this thorough and interesting report. I congratulate my noble friend Lord Moynihan on his excellent maiden speech, with which, as noble Lords will hear, I have a good deal of sympathy in many areas.
I will make two points, one minor and one major. The minor point is one that other noble Lords have mentioned: the committee’s recommendations on the need for intellectual diversity in the Bank. It is still surprising that Bank officials and the MPC missed the significance of monetary policy in 2020 and 2021, and more intellectual diversity would surely have made this less likely. I would use the word “dismissive” rather than “defensive”, which my friend Lord Bridges used. The rather dismissive responses from the Chancellor and the governor suggest that they have not really taken this point on board. Indeed, perhaps they rather missed it by simply reiterating the existing processes and justifying them on the grounds of other kinds of diversity. As other noble Lords have said, since the report we have had the Bernanke review, with its heavy criticism of the modelling and forecasting, which perhaps reinforces the committee’s concerns. Perhaps the Minister, in responding, could indicate whether there is any chance of a rethink in this area.
I move to my major point. Although, like the committee and, I think, most noble Lords, I support Bank independence, one must acknowledge that, over the last couple of decades, central banks have, in practice, come to enjoy great economic powers with rather little accountability, scrutiny or democratic legitimacy. That is not generally because the Government have chosen to give them these powers—in this country at least. The gradual widening of the Bank’s mandate, set out so clearly by the committee, is a consequence rather than the cause of this development. The real underlying cause is the mistakes in global economic policy-making over this period. I will take a moment to spell this out a little more deeply. In doing so, I am in part indebted to the analysis of my friend, the brilliant economist Bernard Connolly, in his latest book.
Central banks and Governments the world over are now in a very difficult position because of policy mistakes over the last couple of decades. In brief, in the late 1990s and early 2000s, the Fed, and other central banks following it, held rates too low for too long and generated an unsustainable boom. When this became obvious, central banks had a choice between creating a recession by raising rates to choke it out or avoiding this by pushing rates down. That was an extremely political choice for a central bank to have to make. There was only one possible answer it could give in a democracy: to push rates down. This in turn generated another bubble, the credit bubble, which fed through to asset prices, which in turn collapsed in 2008. Central banks faced the same political choice, and again pushed rates down, this time to zero or sub-zero.
In 2020, we had the third crisis. The same choice was faced and the same solution was taken. Although there has been much criticism of the Bank for its massive boost to QE in 2020, I do not entirely blame the Bank authorities. I have vivid recollections of the atmosphere of panic and crisis in No. 10 at that time, as the economy came close to having a heart attack. Hindsight is a wonderful thing, and I am not sure the central banks could have taken any other decision at that point. The question is more: how did they handle the consequences and how quickly did they realise that some unwinding was necessary?
The negative supply shocks plus the huge US fiscal stimulus—let us not forget that—meant that there was finally a feeding through to inflation, which has had to be choked off by an effort at normalisation. Of course, we now have a financial structure, as we discovered in 2022, that has become used to very low long rates and is vulnerable if there is a sudden adjustment towards equilibrium. Hence the current situation. What can we do about it?
We can look at our economic performance, and one conclusion that I, and I think others, draw is that western economies generally cannot live with interest rates that would have been considered normal a generation ago, unless there is huge fiscal stimulus. That is a very serious problem, which opens the question of how long central banks generally, and the Bank of England specifically, can sustain the current near-normalisation. The impact of the US stimulus is now weakening and, very soon, central banks will face the same choice once again: will they hold rates relatively high, at the cost of a recession, or bring them back down, as so many are now urging, at the price of sustaining the imbalances and building them up further?
I have set this out at some length to underline just how political the decisions are that the Bank, and central banks generally, have had to take in recent years. Independent central banks may have started off as providers of inflation control services for Governments, but they now do much more than that. The political decisions that they have taken, in each case to defer difficult economic problems, have generated an environment in which we can only avoid liquidation and recession with super-low interest rates. Yet capitalism, as we have come to understand it, cannot function with super-low interest rates. The normal incentives do not work; there is malinvestment; asset holders are enriched and risk takers lose out; and—we are seeing this very much now—support for the system continually erodes, such that we have a whole generation now ready to take a punt on socialism.
Where do we go from here? I think that there are two routes. The first, which I think it is the route cautiously, or implicitly, suggested in the committee report, is to accept this status quo, recognise the broader political power exercised by the Bank and try to give it some enhanced democratic scrutiny from this Parliament. I understand the logic, but I am slightly unconvinced about the constitutionality of such arrangements. It seems to me that it is for the Government to get the relationship right with the Bank. That perhaps will, and ought to, involve more vigorous debate in public, within the framework of bank independence, than we have got used to. Then Parliament should scrutinise the Government on how well they are managing that relationship and its results, in terms of both fiscal and monetary policy.
I also fear the consequences of simply accepting the status quo. It is a palliative, and a fig leaf for a situation that is, as I have said, really very unsatisfactory. If we continue to repeat the cycle of the past couple of decades, we will end up with continued fiscal stimulus, ballooning debt, accelerating inflation once again, greater government control of the economy, greater direction of investment and business efforts and, in the end, very likely a quasi-socialist economic system.
The alternative is to try to roll things back, to limit the Bank to focusing much more narrowly and specifically on inflation control again, and to find a way of dealing with the economic consequences of the normalisation that would follow. This would at least be to deal with causes not symptoms, but to make it work would mean a major effort to raise the productive capacity and potential growth of this economy through a radical programme of, if you like, “recapitalismisation”—an ugly word, but an important reality. That would mean huge deregulation; a determined and sustained effort to get tax and spending down; and an end to the crushing burden of net zero, planning reform, labour market liberalisation and much more. Perhaps we will also get lucky with AI and it will, as so many hope, give us a magic free gift in productivity increase. I suspect, however, at least over our time horizon, that it is unlikely to do more than smooth off the edges of the turbulence of reform. Embarking on such a reform programme would, in my view, be the right thing to do, but it would require careful planning and a Government who were ready to explain it, win a mandate for it and push it through. Noble Lords will have their own views on how likely such an outcome is.
To conclude, formal bank independence is one thing, and it is important, but the most important thing is to discuss, debate and engage with the underlying political and economic reality. No Government, of any political colour, can avoid that, or abdicate their responsibility for managing the economy with the central bank and ensuring proper democratic engagement in the consequences. We have not had that properly for some time, but we have some extremely difficult choices coming, so we will need it in future.
The Parliamentary Secretary, HM Treasury (Baroness Vere of Norbiton) (Con)
My Lords, what an outstanding debate. I particularly thank my noble friend Lord Bridges for so skilfully opening it, and the Economic Affairs Committee. So many of its members have spoken today, and I thank them for their contributions, for the thoughtful and detailed way in which they carried out the inquiry and the report on the Bank of England, and for the breadth of witnesses they chose to interview. I am delighted that my noble friend Lord Moynihan of Chelsea chose a Treasury debate in which to make his maiden speech—of course, I am not surprised. He will make a great contribution to your Lordships’ House for many years to come, and we look forward to it.
Price stability is essential for a strong economy and, consequently, strong public finances. It is widely recognised that an operationally independent central bank is the best way to achieve price stability. That is why the UK enshrines the Bank of England’s operational independence in law, with price stability as the primary objective of the Bank’s Monetary Policy Committee. The Treasury and the Government remain committed to not only independence but the objective of price stability, and I am delighted that I therefore agree wholeheartedly with the noble Baroness, Lady Kramer, and the noble Lord, Lord Livermore—not a frequent occurrence in my life—with both Front Benches also wishing to retain the independence of the Bank of England.
My right honourable friend the Chancellor wrote to the chair of the EAC in January this year. It is worth briefly summarising some of the commitments that he made in his letter. At the outset he noted the operationally independent monetary policy, which is so important within the broader macroeconomic framework, and indeed the importance of the separation of fiscal and monetary policy in the effective delivery of monetary policy. The Chancellor noted the negative impacts of inflation on so many elements of society and our economy when it is greater or lower than 2%, and he again resolved not to change the definition of price stability. This aligns with the view of the EAC, but it should also be noted that the Federal Reserve and the European Central Bank have the same inflation targets. The Chancellor also noted the Government’s previous review of the monetary policy framework in 2013, which drew the same conclusions.
The Chancellor went on to note the Government’s commitment to ensuring that fiscal and monetary policy remain aligned to support the Bank’s efforts to return inflation sustainably to 2%. This is in agreement with the conclusions of the committee. This has meant reducing the level of government borrowing in a way that gradually withdraws support from the economy, as demonstrated by the declining path for the cyclically adjusted primary deficit.
On the relationship between the Bank and the Debt Management Office—the DMO, which many noble Lords have mentioned today—the Chancellor noted that monetary policy and debt management are distinct areas with separate mandates and decision-making processes. Given the institutional separation of monetary and debt management policy, in addition to existing public documents clarifying the relevant governance structure, the Government do not consider that an additional memorandum of understanding between the two organisations is necessary to clarify their relationship further.
On the committee’s call—and indeed that of many noble Lords, including the noble Baroness, Lady Liddell, and the noble Viscount, Lord Chandos—for the Government to publish the deed of indemnity, the Chancellor reiterated in his response that the Government would not. The deed contains operationally sensitive information relating to government cash management practices. It is not government practice to release information of this kind, and nor is it in the public interest. However, crucially, the Government are confident that this does not undermine the transparency of these arrangements, given the publication of other relevant reports and accounts, in addition to public comment and costings from the Office for Budget Responsibility, or OBR, on this topic.
Lord Bridges of Headley (Con)
Can my noble friend explain why, then, the Governor of the Bank of England told our committee that the publication of the deed of indemnity would not excite people?
Baroness Vere of Norbiton (Con)
I cannot comment on what the Governor of the Bank of England thinks other people will think about a document that has not been published. If I can get any more information, or encourage the Bank of England to provide more clarity on that, I will—but it remains the position of the Government, and indeed the Chancellor in his response to the committee, that the document will not be published.
I turn to the remits of the Monetary and Financial Policy Committees, which also attracted an enormous amount of attention during the debate. I will come on to them further after this opening section on the Chancellor’s views in response to the committee. The secondary objectives are clearly framed as being subject to the delivery of their primary objectives of price and financial stability. However, the Government have taken steps to simplify and clarify the FPC’s remit to make sure that its role in supporting the Government’s economic policy is absolutely clear.
I heard what the noble Lord, Lord Livermore, said about his party wanting to expand the remit letters once again. I believe that would be unhelpful. I will go on to state exactly why climate remains within the remit letters and the rationale for that. I believe that greater clarity is essential and is something that the Government will continue to focus on in future remit letters.
The report recommends that the Bank’s management structure be streamlined; however, the Chancellor affirmed that the current structure is appropriate. Finally, on the committee report’s recommendation that the Treasury and the Bank commission an independent review of appointments to the Bank, the Chancellor noted that the Government have no plans to commission such a review. However, he did highlight the Treasury’s interventions in relation to ensuring diversity, in its broadest sense, in public appointments.
As part of our support for the principle of the Bank’s independence, the Government do not comment on the conduct or effectiveness of monetary policy, but I reassure all noble Lords that I welcome the many insights I have heard today with regard to monetary policy and the Bank’s performance relating to it. I am sure that those who are responsible for monetary policy and the operation of the Bank of England will reflect on them, too—but I will go no further in my response.
It is the case that we have been living through a period of high inflation. It is too high. In the 20 years prior to independence, inflation averaged over 6%: in the 20 years subsequent to independence, inflation averaged closer to 2% and certainly volatility also declined. But, since May 2021, we have seen a period of particularly high inflation and I am very pleased that, due to the actions of the Bank of England, supported by the Government, it was at 3.2% in March.
I will now elaborate on a few key areas that I believe almost all contributors to the debate focused on: the MPC/FPC remit letters; appointments to the Bank of England; the accountability of the Bank of England; and forecasting. On other matters, I will probably write, because time is always the enemy of the Minister at the Dispatch Box.
Returning to the issue of the FPC and MPC remit letters, which was mentioned at the outset by my noble friend Lord Bridges, but also by my noble friend Lord Moynihan, both the MPC and FPC have complex roles—that is clear—and it is right that their remits reflect this complexity. But that does not necessarily mean that the remits therefore have to be complex in themselves. It is important that the committees’ secondary objectives, on supporting this Government’s economic strategy, are clearly defined, so that they are achievable. Clearly defining secondary objectives does not detract from the hierarchy of objectives for either committee, where the secondary objectives are framed as being subject to the primary objectives of price or financial stability. Moreover, the remit letters provide guidance on how the committees should consider instances where there are trade-offs between their objectives and how their assessment of any trade-offs should be publicly communicated so that they can be scrutinised.
The changes introduced in the 2023 FPC remit letter have improved its clarity and focus, with clearer relevance to the FPC’s specific responsibilities and toolkit. It is more streamlined. I accept that it is not as streamlined as many noble Lords would like, but it is 20% shorter compared with that in 2022. There is, of course, a balance to be struck. For example, it is important that home ownership is listed as a priority, so that the FPC is mindful of wider public policy aims when it is considering policy relating to the mortgage market. A further example is climate change, mentioned of course by the noble Baroness, Lady Bennett, but also by many other noble Lords. It is widely accepted that climate change poses systemic risks to the financial system. As such, the remit continues to emphasise the relevance of climate change to the primary financial stability objective. Delivering net zero is also referenced as a key component of the Government’s economic policy, which the committee has a secondary objective to support.
It is also important to consider the changes to the remit letter in the context of the Government’s wider work to ensure that the regulators are considering the impacts of climate change. For example, through the Financial Services and Markets Act 2023, both the Financial Conduct Authority and the Prudential Regulation Authority are required to have regard to the need to contribute, where relevant, to the Government’s progress towards complying with the Climate Change Act 2008 and the Environment Act 2021.
The climate and environmental components of this apply from August 2023 and January 2025 respectively. So it is not the case that, somehow, climate has been downgraded. The wording has changed but the legal obligation to get to our net-zero targets remains, and we must ensure that the financial system gets there—and that includes the Bank of England. However, the primary objectives of the two committees are very well set out in the remit letter.
In the MPC remit letter, the primary objective, set out in law, is maintaining price stability, defined as a 2% inflation target. The MPC’s remit includes the goal of increasing long-term energy security and delivering net zero. If that is not clear, I am not sure what would be. Specifying the Government’s economic strategy gives the Bank’s policy committees important information on the broader economic policy landscape, given their role in the UK’s macroeconomic framework.
Turning to appointments to the Bank of England and then to accountability, the Government recognise that, to be effective, public bodies need to have the broadest possible mix of skills, experience and backgrounds: diversity in its broadest sense. All appointments are made on merit and follow a fair and open competition process.
The Treasury has taken steps to ensure that a diverse range of candidates are considered for appointments to the Bank of England. To do this, the Treasury promotes vacancies to a wide group of people and, to improve the reach of an advert or opportunity, sometimes uses recruitment consultants.
The Government believe that there is a diversity of thought on the MPC and FPC, although the skill of hindsight remains elusive. The Governor of the Bank of England recently said that, in the last two years, about 25% of the MPC’s meetings have had a split vote among the executive members. I suggest that this demonstrates the intellectual and analytical diversity requested by my noble friends Lord Frost and of course Lord Effingham. The Governor noted that there is a larger proportion of external members of the Bank of England than in other central banks around the world. While the FPC makes decisions by consensus, the diversity of views expressed in the committee’s meetings is captured in published records.
As I have noted, the Bank of England has a unique arrangement compared with other central banks, as it has internal members and a greater proportion of external members on its policy committees. The external members are appointed by the Chancellor, and internal members who are on the Court of the Bank of England are Crown appointments.
Focusing on the MPC, each member has expertise in the field of economics and monetary policy. Members are independent and do not represent particular groups or interests. The MPC’s decisions are made on the basis of one person, one vote, and each member of the committee votes in a way that he or she believes is consistent with the MPC’s remit. A non-voting representative from the Treasury also attends the committee’s policy meetings.
The Chancellor is assisted in his decision-making on appointments by advisory assessment panels, which include internal members from the Treasury and the Bank, but also an independent external panel member. It is for the Chancellor to choose the person they wish to appoint and make a recommendation to the Prime Minister. The Treasury is committed to enabling proper parliamentary scrutiny of the appointments that it makes to public bodies, which is a valuable and important part of the process. The Treasury Select Committee conducts pre-commencement hearings before a successful candidate is appointed to the Bank to start their role.
All noble Lords—far too many to namecheck—have spoken about the accountability of the Bank of England. It is worth discussing this in further detail now, and I am sure there will be opportunities to do so again in the future. I am particularly grateful for the forensic opening remarks of my noble friend Lord Bridges, and of course for the reflections of the noble Lord, Lord Gadhia, who sits on the Court although speaks today in a personal capacity.
The Bank is held to account both by Parliament and by the Treasury. A key role of the Treasury and elected Treasury Ministers is to legislate for and maintain the overall regulatory architecture in a way that allows the Bank to meet its objectives. There are many ways in which Parliament, stakeholders and the public can scrutinise the performance of the Bank of England. Key publications include the Bank’s Financial Stability Reports, which are published biannually, and the Monetary Policy Reports, which are published quarterly. Indeed, a Monetary Policy Report is due to be published this time next week. Executive and external members of both the MPC and FPC typically appear before the Treasury Select Committee following the publication of those reports. The governor also appears in front of the EAC, as he did in February this year.
The Government implemented reforms through the Bank of England and Financial Services Act 2016 to increase the accountability of the Bank and to improve the scrutiny of the Bank in terms of financial stability. Those reforms were made once the expansions in the Bank’s remit had time to bed in properly after the financial crisis. Measures introduced in the 2016 Act included making the FPC a full policy committee of the Bank and creating a clear accountability line to the Bank’s Court of Directors. It also implemented the recommendations of the Warsh review, published in 2014, including to increase the transparency of the MPC’s decision-making by publishing a detailed policy statement as soon as practicable after each policy meeting.
The Bank’s remit letters were commented on frequently in today’s debate. They are published online and laid before Parliament, typically as part of a fiscal event. After a fiscal event, parliamentarians have the opportunity to debate it—it happens in your Lordships’ House and in the House of Commons. Parliamentarians can and do raise concerns about the remit letters during those debates. The issues are then considered as part of the process to update the remit letter the following year. Parliamentary committees offer further scrutiny of the remits by calling bank executives, committee members and government Ministers to appear before them—the EAC’s inquiry is an excellent example of parliamentary scrutiny in action. Given the frequency with which the remits are updated and that there is the opportunity to provide input, the Government do not intend to publish draft letters. However, on many of the report’s other recommendations on accountability, it is for Parliament to decide whether to conduct a review of the remit, and indeed the operations of the Bank outside of existing processes, or to create a standing committee.
The Treasury meets with the Bank of England regularly to discuss its assessment of the economy and financial services. That includes regular meetings between the Chancellor and the Governor of the Bank of England. The Chancellor and governor are also legally required to discuss the FPC’s Financial Stability Report.
Finally on accountability, the Court of Directors is a key element for keeping the Bank’s performance under review and for looking at the way that the Bank exercises its statutory functions.
I note that many noble Lords have made requests for the Government to intervene in the operation of the Bank, particularly on the allocation of resources. Obviously, the Government will not do that to an independent Bank of England, but I am confident that the suggestions and points raised in today’s debate may well be heard by those who are responsible.
I have been given a one-minute warning, so I will try to speak on forecasting and Bernanke within the time limit, because many noble Lords raised this incredibly important issue. All of us who have ever worked in finance—including me—know that forecasting is sometimes a mug’s game, but sometimes it can be incredibly helpful. The review led by Dr Ben Bernanke is incredibly helpful to highlight the areas in which the Bank needs to improve. I think that the Bank is welcoming it, and I note that I will do a full report on its response to the Bernanke review by the end of the year.
As ever, I will write on many of the remaining points that I have not been able to cover. I am again enormously grateful to my noble friend Lord Bridges and his committee for all their contributions, not only to the report but to today’s debate. The Government will continue to support the independence of the Bank of England and will ensure that its remit and the framework in which it operates, including through fiscal policy, create an environment in which it can carry out its duties efficiently.