Bank of England (Economic Affairs Committee Report)

Baroness Noakes Excerpts

Thursday 2nd May 2024 Lords Chamber

[Baroness Noakes (Con)]

My Lords, I was a member of your Lordships’ Economic Affairs Committee when this report was produced last year, and I am delighted that my noble friend Lord Bridges of Headley has been able to secure this debate today.

As we have heard, the Bank of England acquired independence in relation to monetary policy as one of the Labour Government’s first acts in 1987. At the time, I was a non-executive director on the Court of the Bank of England and so had something of a ringside seat as this unfolded. It was hugely popular in the Bank and, I believe, with almost all the commentators at the time.

The Bank of England was not and is not completely independent of the Government. When it was nationalised in 1947, the Bank of England Act gave the Government various powers over the Bank, including the power to appoint the governor, the deputy governor—who was a singleton at the time, but there are now four—and its Court of Directors.

As was common for nationalisation legislation, which we have fortunately not seen much of in recent years, the Act contained a power of direction that can be exercised by the Treasury, although this does not extend to monetary policy. That power has never actually been used but, when I tried, during the passage of last year’s Financial Services and Markets Bill, to get the Treasury to give it up, it was absolutely sure it needed to keep it, so we must regard this power of direction as a live part of the constitution of the Bank of England. My point is that this means that the Bank of England has only qualified independence—but, importantly, the extent of its independence is in the hands of the Government and of Parliament.

Similarly, monetary policy independence is not absolute, either. The members of the MPC are appointed by the Government and statute defines the monetary policy objective—that of price stability. That is then amplified by letters from the Treasury which, inter alia, tell the Bank what price stability means: that is where we get the inflation rate target. This is just a roundabout way of saying that I do not think we should overstate Bank of England independence. It is not absolute but is always bounded by political decisions. I agree with what the noble Lord, Lord Burns, said about QE raising the important issue of whether further political decisions should be taken to change the scope of the Bank’s independence as we define it.

Our report set out to find out how independence was working in practice. In the inflationary turmoil of the last few years, it is easy to forget that the UK experienced a relatively long period of low and largely stable inflation, from the early 1990s until 2020. It would be wrong, however, to give the credit for that to Bank of England independence. First, my noble friend Lord Lamont, as he explained earlier, introduced in 1992 the concept of publicly targeting the inflation rate. By the time the Bank was given independence in relation to monetary policy, inflation was already at its then target rate of 2.5% in terms of RPI. So the Bank did not bring inflation down. Secondly, as evidence to the committee made plain, there were other factors at play—in particular, the impact of globalisation, which created a benign price environment. None of our witnesses claimed that the years of low and stable inflation were down to central bank independence.

We also looked at the strength of the independence model in light of the inflation experience of the last three years, which has clearly been less than impressive. The model appeared to do well for the first 20-odd years, but more recently it has been tested and found wanting. There have been serious misjudgments about whether the inflation spike which emerged was temporary, and we are still a way off the 2% target, as the OECD charmingly reminded us this morning.

As we have heard, the Bank’s forecasting record is not stellar. An independent review within the Bank in 2015 found that, while the Bank appeared to be in the pack with other central banks, its two-year horizon forecast—the important one in bringing inflation down within target—had, to use the bank-speak in which the report was written,

“statistically significant evidence of inefficiency”.

I think that means that the Bank was not very good at it, and its recent experience has raised even more questions.

As we have heard, last year the Bank commissioned an external review by Dr Bernanke, the former chair of the Fed. The Bank should take credit for that. The conclusion of the report was that the models needed a serious overhaul, and that it needed to move towards more scenario analysis and away from fan charts. However, the narrowness of its terms of reference, which has already been referred to, meant that it did not shed any real light on what went wrong.

As has already been referred to in this debate, several of our witnesses drew attention to what was happening to money supply—fuelled by the continuing QE—in the two years or so before inflation took off. But this barely got a mention by the Bank or MPC members at the time. Some serious thought about what was happening would have been useful, but the Bank is part of a global central bank consensus that has largely ignored money supply for a considerable period of time. I was disappointed, but not surprised, to find that the Bernanke report made no comment on this.

The committee’s conclusion that the Bank’s independence should be preserved was in line with that of our witnesses, but I think the conclusion owes more to sentiment than to hard evidence of the success of the model. I am not arguing that monetary policy independence should be done away with, but we need to see it as a pragmatic judgment which suits politicians and central bankers alike, rather than one with a firm evidence base, and we should be prepared to modify what we mean by independence as new facts emerge.

Of course, the key issue becomes whether the accountability framework surrounding the Bank is strong enough to underpin continuing monetary policy independence. I believe that the Bank failed the British people when it let inflation get out of control, but what has happened as a result of that? The governor has had a few uncomfortable appearances before parliamentary committees, and he has had to write a few letters to the Chancellor. Who takes responsibility for the dire state of modelling found in the Bernanke report? Who carries the can for the damage inflicted on the economy from excessive inflation and the resulting interest rate hikes? It seems that no one does.

I believe that there is outstanding business here. The Government have confirmed their commitment to monetary policy independence, but independence cannot exist in a vacuum. The Government need to reflect on whether that independence has sufficient checks and balances built into it, because independence without strong accountability is a recipe for disaster. The modest recommendation in our report is for a five yearly review by Parliament, and that would be a very good start.