Bank of England (Economic Affairs Committee Report)

Lord Frost Excerpts

Thursday 2nd May 2024 Lords Chamber

[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.

Autumn Statement 2023

Lord Frost Excerpts

Wednesday 29th November 2023 Lords Chamber

[Lord Frost (Con)]

My Lords, I begin by welcoming my noble friend to her new role in the Treasury. I speak in this debate more because I feel obliged to than because I really want to. I am well aware that the Government have stopped listening to Conservatives with my opinions, but I will give them anyway. I had hoped last week that we would get a Statement and set of measures that acknowledged that Britain has been on the wrong track and that a radical change of direction is needed. I am afraid that instead we got some palliatives—obviously, these are welcome—some attempts to soften the direction of travel, which remains wrong. We got a Statement that, I am sorry to say, does all too little to persuade the British people that we, as the governing party, have solutions capable of solving the country’s problems, and that makes it far too easy for voters to believe the falsehood that there is no real difference between Conservative philosophy and those of the parties opposite.

If I am honest, I am tired of pretending that I think we are on the right track. I meet many Conservative members and voters—former voters, all too often, I am afraid—and even quite a few Ministers who do not think we are either. Even with the reduced tax increases that we saw in the Autumn Statement, we are still heading for the highest levels of tax and spend ever seen in this country outside wartime. Not surprisingly, economic growth is anaemic. Yes, as my noble friend the Minister said, we are outperforming the gloomiest predictions of the OBR, let alone the pre-Brexit Treasury prophecies of doom. However, as noble Lords will see if they look at the Angus Maddison database, which has been measuring this country’s growth for the last 700 years, we have had pre-modern growth rates since the financial crash, with a per capita growth rate roughly that of Britain during Queen Victoria’s reign.

Many, perhaps most, European countries are doing just as badly as us, if not worse, but we are one of the few that has the powers to solve the problems. Instead, what are we doing? We are spending more money than ever on the National Health Service—indeed, we are one of the top 10 spenders per head globally—and getting worse and worse results for it. We are paying huge sums on welfare and pensions, yet the only solutions we have are the very gentle carrots of encouraging people back into work, rather than a bit more of the effective stick of reducing welfare for people who choose not to work.

We are sucking in huge numbers of immigrants to try to fill the gap—or rather not, because we still have a million job vacancies. We are building nowhere near enough houses. We have heard from many noble Lords already many wishes, many calls—very well justified, I am sure—for more public spending on favourite causes, but the truth is that we are trying to provide public services as if the economy were growing by 3% a year when the real figure is 1%. That just cannot be done and we are now feeling the pain.

It is not as if any of this is a secret. Outside this building, people talk about these real-world problems all the time. They do not talk about smoking bans or A-level reform. The party I am a member of has been in power for 13 years and, I am afraid to say, bears much responsibility for problems I have just outlined. I spent the best part of three years working to get this country out of the EU in a way that gave us full optionality about the future, and I believe we largely succeeded in that. But we have not fully used those powers and often seem frightened to. The Windsor Framework—trumpeted as an achievement but actually doing significant political and economic harm to the unity of this country—makes it even harder to do anything differently.

But it is more than that. I worry we have all been captured by the socialist belief that government regulation and spending is the way to solve our economic problems, that vast taxpayer subsidies to all kinds of politically favoured industries—productive, or more often not—such as semiconductors, windmills, batteries, the hydrogen boondoggle, electric cars, zero-carbon steel or aviation are going to solve our economic problems, despite all the evidence that government direction of the economy never works out well. I would like to see policymakers paying less attention to the many snake-oil proponents of the so-called active state and spend a bit more time reminding themselves of Hayek’s essay “The Use of Knowledge in Society”.

The truth is that we need to get on to a different path if we are to boost economic growth, which is overwhelmingly what we need to do. The first duty we owe to the people of this country is honesty about the nature of our problems and how we can solve them. The only way we can get growth and incomes up again is to release the forces of the private sector—removing the crushing tax and regulatory burdens, dramatically reforming planning and building many more houses, slowing or halting the collectivist delusion of net zero, ending the war on SMEs and the self-employed, beginning to cut public spending by cutting the functions of government and by properly reforming the great public sector entities. At the same time, we must show that the Government have a grip and can perform their core functions, most obviously on immigration where we must be ready to shake ourselves free from the many constraints that seem to leave us frozen in immobility.

The Autumn Statement dips a toe in all these waters, notably with the national insurance cuts and full expensing—these are to be welcomed, as they are a signal that there is understanding of what is going wrong—but it does all too little to challenge, let alone hold back, the tide of statism, miserabilism and nannyism that risks overwhelming this country. We can still change that, so I ask my noble friend the Minister and beg my Government to show that they are listening to our voters and the country, to stop being swept along by the collectivist current and to change course—to act before the election, before it is too late.

Financial Services and Markets Bill

Lord Frost Excerpts

2nd reading
Tuesday 10th January 2023 Lords Chamber

[Lord Frost (Con)]

My Lords, as has been said by many, this is very important legislation. It is crucial to giving effective support to the City and our financial services sector more broadly, and there is a lot of good stuff in it. I want to begin by highlighting three of those good things.

First, I welcome the broad approach taken to the onboarded EU legislation on our statute book. It has taken the Government a long time to get here, but the powers to revoke and replace with genuine UK legislation and rules are very important. They show that it is entirely possible to take an ambitious and potentially sweeping approach in this area, which I hope the Government will follow more generally in the other reviews of aspects of our domestic legislation which are under way, if perhaps not taking quite so long about it.

Secondly, the secondary objective on competitiveness is a very good thing. I fear it will be undermined by the duty of compliance with net zero as a regulatory principle as well, but nevertheless it is a very good secondary objective. Obviously, it is correct that regulators should have to pay due regard to our economic prospects in their actions.

Thirdly, the proposals in the Bill to support access to cash are very important. I support much of what the noble Baroness, Lady Twycross, said on this subject. Access to cash is important not just for practical and social inclusion reasons but also to preserve a bit of personal freedom and the ability to conduct transactions without the Government or institutions looking over your shoulder. There is of course no point in financial institutions ensuring access to cash if there is in practice nowhere to spend it, so I hope the Government will look in due course at the other side of this problem—the withdrawal of cash in the retail sector more broadly. Getting this right is in the interests of a free and inclusive society.

As others have not mentioned it yet, I mention in passing the commitment made by the Minister in the other place to keep under close scrutiny the PayPal issue—the withdrawal of financial services for essentially political reasons. I welcome the Minister’s commitment to follow up on that and possibly to use the powers in the Bill if necessary.

As with others, my main concern with the Bill is on the accountability of regulators. I have two concerns. The first issue is the quality of regulation. It seems a little pas comme il faut nowadays to criticise the independence of the regulators, but independence is not the same as immunity. It is right to acknowledge the concerns that the FCA and PRA potentially have powers that are too wide-ranging already and sometimes appear to act with impunity, and that sometimes firms are reluctant to challenge because of their relationship with the regulator. There is no statutory requirement on the regulators to make clear rules or act predictably or consistently and, as others have said, sometimes they are slow, risk-averse and reluctant to commit themselves, and that in itself can harm competitiveness.

The second issue is the politics of regulation. The way the regulators fulfil the objectives they are given is in practice highly political. There are many ways of fulfilling those objectives and in choosing how to do so they reflect a political view. They have to make such judgments; for example, and most obviously, on whether the City’s prospects are best protected by divergence—my view—or relative alignment with the way things are done in the EU. That is a political judgment, influenced by the Government’s view, yet the Bill gives the Government no way to compel regulators to act in line with such a political view. The prickly reaction of the regulators to the call-in power, which is now dropped—in my view, mistakenly—shows clearly that they want to keep discretion in this area. I worry that the Bill will create a system in which all the incentives are to go along with what regulators want in order to avoid public arguments.

To conclude, giving new rule-making powers to the regulators against this backdrop, without corresponding duties and genuine accountability, is pretty risky. The system it would put in place of only post-facto accountability involving only the Treasury Select Committee is not good enough. There are likely to be amendments on this subject and I hope the Government will look carefully at them. With those caveats, I am happy to support the Second Reading of the Bill, but I hope the Government will look to improve it in Committee.