Bank of England (Economic Affairs Committee Report)

Lord Gadhia Excerpts

Thursday 2nd May 2024 Lords Chamber

[Lord Gadhia (Non-Afl)]

My Lords, I declare my interest as a member of the Court of Directors of the Bank of England but speak today in a personal capacity.

First, I offer my compliments to the noble Lord, Lord Bridges of Headley, and his committee for the thoroughness of their evidence sessions, attracting a star cast of witnesses, to provide a timely review of the Bank’s 25 years of operational independence. Together with the review of economic forecasting commissioned by the court from Professor Ben Bernanke, the Bank now has a substantial body of independent input on which to propose forward-looking reforms. I know the governor and his colleagues are taking this process seriously and will provide a further update by the end of the year.

As someone who has experienced the Bank in close proximity for the past 18 months, I am pleased to share some observations and hope that I can dispel a few myths and add some nuance to this debate. At the outset, it is worth noting that in my brief time serving on the court, I have not come across anything remotely resembling the deep state, but instead a group of truly committed public servants who are faithfully seeking to fulfil their statutory remits.

The Bank takes accountability to Parliament incredibly seriously and devotes substantial time preparing for and participating in evidence sessions. In fact, if anything, the scope for improvement in scrutiny lies less with the Bank and more through enhancing the capabilities, attitude and co-ordination within Parliament. The decision to appoint separate committees of each House to review post-Brexit financial regulation is a case in point. If there is a democratic deficit of accountability, it is often a self-inflicted one. With due respect to the House of Commons, it should be especially mindful of the behavioural consequences of seeking “gotcha” moments which might generate media headlines but do little to gain deeper insight into the trade-offs which often lie at the heart of key policy issues. This makes our institutions more risk averse and contributes to a culture which incentivises overregulation and suppresses innovation.

The core conclusion of the report on the effectiveness of independence is not only reassuring but a timely reminder of the underlying rationale for removing political involvement from day-to-day monetary policy decisions. During this election year, we can be confident that, if and when interest rates start to come down, they will do so for economic and not political reasons.

The benefits of this policy credibility in anchoring expectations should not be underestimated. It is often difficult to prove a counterfactual or attribute cause and effect, but we saw the disastrous consequences when market confidence evaporated in autumn 2022. The emergence of the unfortunately named “moron premium” in UK gilts is a proxy for the type of cost that citizens would incur if political decision-making trumped economic reality.

Among the other key conclusions of the report were concerns about groupthink, mission creep and boundaries between fiscal and monetary policy. I shall touch on each. The Bernanke review demonstrated that the process of challenge is as much about the analytical tools available as the individuals. The court meets regularly with external members of the policy committees, who are a diverse and engaged group. They contribute positively to challenging the executive and each other, with little evidence of groupthink, as demonstrated by the historic voting record of the MPC. However, they require the necessary support and input. One significant gap in recent years has been deciphering post-pandemic changes in the labour market. That has probably been more significant in our understanding of inflation than monetary aggregates.

On the remit, the Bank is a rule taker, not a rule maker. The post-financial-crisis structure of the Bank, determined by Parliament and further embellished by the recent Financial Services and Markets Act, is a complex web of committees and mandates that hangs together and works largely as intended. In turn, it shapes the organisational structure of the Bank, which feels proportionate to the scale and responsibilities that it holds, but it places an almost superhuman requirement on the governor to be across a vast span of policy and organisation.

For the MPC specifically, given the limited policy instruments at its disposal, it is not clear how adding multiple secondary objectives achieves much more than a feelgood factor for politicians. Streamlining the remit letters would be welcome but remains a matter for the Chancellor of the day, subject of course to scrutiny from Parliament. I concur with my colleague David Roberts, chair of the court, that organisations work best when they have clarity and simplicity of objectives and goals.

It is entirely appropriate for fiscal policy to be asymmetric—namely, the MPC takes the Government’s fiscal policy as a given, and the onus is on the Chancellor to make tax-and-spend decisions that do not undermine price stability. It is right that this modus operandi is underpinned by close dialogue between the Bank and the Treasury but not by explicit co-ordination.

With regard to quantitative easing, I have sympathy with concerns about swapping out longer-duration gilts with short-term deposits. That makes the cost of servicing government debt more volatile, but it is something that the Treasury was fully aware of when it granted the deed of indemnity to the Bank to facilitate QE. In the context of quantitative tightening, as long as the Bank and the Debt Management Office are in appropriate dialogue, which they are, a memorandum, as suggested, would add very little.

The role of the court has evolved over time. It has modernised into a unitary corporate board responsible for everything up to, but not including, policy decisions. That includes resource allocation and budgets, investments, culture, capabilities, technology and delivery for a 5,000-strong organisation with an £800 billion balance sheet, which processes a similar amount in payments every day. The court is very much part of the accountability chain, as acknowledged in the committee’s report. Our ability to shape the organisational agenda and provide internal challenge is significant, and the current court is certainly up for shouldering that responsibility, as demonstrated by our commissioning of the Bernanke review.

However, there are limitations. Like a conventional private sector board, we do not possess hire-and-fire powers over senior management, unfettered rights to determine strategy, or absolute oversight. At times this is frustrating, but it is equally unrealistic to expect an elected Government to cede complete control. Instead, we exercise our mandate through influence, with much depending on the receptivity of the serving governor and deputies to receive the court’s input, as well as through collaboration with the Treasury. To make the court more effective and better use our expertise, I believe that closer involvement in making appointments and in setting budgets, especially with the introduction of the bank levy, would help to strengthen overall governance and accountability.

The Bank is a unique organisation that plays a crucial role in our nation’s economic life. We should certainly seek to improve its operations and hold it to proper account, something that I am personally committed to as a member of the court, but equally we shoot ourselves in the foot if we undermine the Bank’s credibility, standing and independence, which has largely served us well over the past 25 years and more.

Budget Statement

Lord Gadhia Excerpts

Tuesday 14th March 2017 Lords Chamber

[Lord Gadhia (Non-Afl)]

My Lords, I had the opportunity to watch the Budget from the Gallery in the other place last Wednesday alongside a handful of noble Lords, including my noble friend Lord Lawson. I could not help but reflect that he, and some of his predecessors, enjoyed more degrees of freedom than the present occupant of No. 11.

Our economy, while surprisingly resilient in the near term, is in a holding pattern until we have greater clarity on the road ahead after Brexit. The Chancellor is operating in a macroeconomic straitjacket defined by four important and mutually reinforcing constraints: first, the continuing high deficit and debt levels, which benefited from a windfall in 2016-17 but are otherwise largely unchanged from the Autumn Statement. The only saving grace is that while debt to GDP has more than doubled from under 40% prior to the financial crisis to well over 80% today, the cost of debt service, net of the Asset Protection Fund, remains constant at around 2% of GDP, underpinned by abnormally low interest rates.

Secondly, protected departments now represent 75% of the entire government budget, a point which the chair of the Treasury Select Committee, Andrew Tyrie, has also highlighted. It therefore makes finding savings ever more difficult. Thirdly, in a similar vein, the tax lock and commitment to reduce corporation tax now covers 80% of the base, which makes it difficult to raise revenue other than by increasingly creative means. The national insurance controversy should be seen in this context. In addition, with the tax burden rising above 37% of GDP, the highest for 30 years, I believe that we have reached the limits of what we can sustainably squeeze from taxpayers.

Fourthly, with the uncertainties ahead and OBR’s disclaimer that it has not factored in different economic scenarios for Brexit, the Chancellor quite rightly wants to build in some headroom for unexpected outcomes. With forecast net borrowing reducing to 0.9% of GDP by 2020-21 and a ceiling on the structural deficit of 2%, the implied buffer is about £25 billion—frankly, more of a contingency than a war chest.

The irony, of course, is that if consumers and companies did what the Chancellor is doing and held back, then their individual prudence would, at an aggregate level, have led to a sharper slowdown—something which economists will recognise as the fallacy of composition. We are therefore fortunate that UK consumers have done exactly the opposite. When the going gets tough, the Brits go shopping. However, this predilection comes at a clear cost in terms of rising household debt and eroding savings rates, now at negative levels excluding pension saving. The most recent retail data from the high street indicate that this party is ending as price squeezes from sterling’s depreciation come through and real wages are squeezed. Therefore, we are in the awkward position that our future economic trajectory will largely be determined by factors beyond our control.

Apart from Brexit, I would highlight two other factors. The first of these, which has worked in our favour so far, is the more benign global growth environment, particularly in the US where we have seen the “Trump Bump”, China’s relatively soft landing and signs of economic life from the EU. Indeed, the Eurozone PMI Index has just crossed 55 for the first time in six years while the comparable UK data are heading in the opposite direction. Mark Carney, in the Bank of England’s latest quarterly inflation report, attributed about a quarter of our economic outperformance to more robust global growth. The financial markets are also chiming in, with the VIX Index, commonly known as the “fear index”, currently enjoying its longest period below average levels since the crash. It goes without saying that these favourable trends might easily reverse.

The second factor is potentially more seismic—namely, our preparedness for future interest rate increases. The financial markets have already factored in three US rate increases from the Federal Reserve this year, starting later this week. Although UK rate increases do not appear imminent, their eventuality is now closer on the horizon. We have enjoyed almost a decade of morphine from quantitative easing. The process of weening us off will involve some major adjustments and I would encourage Ministers to pay close attention to the consequences.

So with few macro levers available and big external influences at play, what should we do? The scarcity of options is thankfully focusing the Government’s mind on supply-side reforms which address the underlying structural challenges of the UK economy and prepare us for the consequences of Brexit. It is a strange paradox that we are close to full employment, which the OBR estimates at around 5%, but capacity utilisation is 81.7%, towards the upper end of its historical range, and the output gap has turned positive for the first time since 2008. Yet productivity has been downgraded yet further in the OBR forecasts, so we cannot grow much faster without risking inflationary consequences.

We are effectively stuck in a rut of relatively low growth, low inflation and low productivity, which might be compounded in the future by lower immigration. I therefore welcome the measures and resources allocated to improving skills and vocational training such as the T-levels and offering maintenance loans for further education. There are some additional areas raised by honourable friends in the other place which we should also consider carefully. One of these is from Alan Mak, chair of the All-Party Parliamentary Group on the Fourth Industrial Revolution, who has advocated a skills audit at the start of each Parliament. This strikes me as highly sensible since disruptive technologies such as artificial intelligence or robotics can make seemingly valuable skills obsolete almost overnight while other more emergent skills become highly sought after. Another welcome idea has been put forward by my honourable friend Rishi Sunak about the creation of a vocational skills equivalent of UCAS, targeted particularly at apprenticeships, creating a unified portal. I would like to ask the Minister whether that is being investigated seriously.

As well as human capital, our physical capital is equally important in galvanising an enterprise economy and wealth creation. This was recognised in the Autumn Statement with the creation of the £23 billion National Productivity Investment Fund. If you delve into the OBR forecasts for growth, it is apparent that a rebound in both public and private investment is essential in taking up the slack as household consumption falls off. I would therefore urge Ministers to make every effort to crowd-in private sector investment, particularly attracting capital which is trapped offshore by our tax system and should logically find the UK an attractive destination at current exchange rates. At the Autumn Statement, it was announced that business investment relief would be simplified and made more attractive. I ask my noble friend the Minister: what progress has been made on this front?

In conclusion, I make one final observation. Large sections of the business and financial community are currently biting their lip until they see how the Brexit negotiations progress, but we should not mistake their compliant behaviour for acquiescence. More than ever, we need strong, evidence-based policy-making grounded in economic realities and facts and not a blind pursuit of ideology. This is a time, more than ever, when our national trait of economic pragmatism must be unleashed and allowed to prevail.