Bank of England (Economic Affairs Committee Report)

Lord King of Lothbury Excerpts

Thursday 2nd May 2024 Lords Chamber

[Lord King of Lothbury (CB)]

My Lords, I too was a member of the committee that produced this report, and I declare an interest, in every sense of that word, as a former Governor of the Bank. In addition to welcoming the noble Lord, Lord Moynihan, I also pay tribute to the noble Lord, Lord Bridges, for his chairmanship of the committee, and the way he brought us all together when assessing the evidence from an impressive array of witnesses.

I want to make just three points. First, I believe that operational independence of the Bank has served the country well. When I joined the Bank in 1991, interest rates could change at any moment, on any day, at the whim of the Prime Minister or Chancellor. They often reflected political considerations. If a Budget was well received by the markets, the Government would reward themselves with a cut in bank rate. If circumstances suggested that a rise in bank rate would be sensible, it was postponed until after an election. I remember a meeting between governor and Chancellor—I stress not the noble Lord, Lord Lamont, but another Chancellor—where the Chancellor began the meeting by saying “I want to make it clear that there will be no rise in interest rates today, but having said that, I’d now like to hear the evidence”.

A much more systematic approach to monetary policy was adopted after our exit from the exchange rate mechanism in 1992 under the noble Lord, Lord Lamont. An inflation target was introduced, and monthly meetings were held according to a pre-announced timetable. The Bank had a genuinely free voice through its new quarterly inflation report. These were very important changes, but it was only with the announcement of operational independence in May 1997 that the risk premium in long-term interest rates fell sharply, as the belief that political motives would influence the degree and timing of interest rates was removed.

Several speakers have referred to the Bank’s record since 1992, and there is no doubt that the noble Baroness, Lady Noakes, is right in stressing that it was not just in 1997 that the good inflation performance began; the Bank’s record between 1992 and 1997 played a role in leading to independence. But in the past few years, that record has clearly been tarnished by the rise in inflation to a peak of 11.1%. That leads me to my second point, stressed earlier in this debate, about the lack of intellectual diversity on the Monetary Policy Committee. Over its lifetime, there has not been a real lack of intellectual diversity on the MPC. We have seen many split votes; I was in a minority on two occasions as governor. More recently, after Covid arrived, at the point when it really mattered, we did not see a good deal of challenge to the prevailing narrative.

There continues to be a good deal of disagreement on the causes of the recent rise and subsequent fall in inflation. But many economists, both here and in the United States, pointed to the likely impact of a very substantial monetary and fiscal expansion boosting aggregate demand, at a time when the measures introduced to counteract Covid were lowering aggregate supply. Too much money chasing too few goods is, and always has been, a recipe for inflation. It is troubling that not just on the Monetary Policy Committee, but also on the Federal Reserve Open Market Committee there were no dissenting voices to challenge the view that inflation was transitory.

This lack of challenge is certainly not confined to the Bank of England. The academic economics profession has essentially jettisoned the idea that, from time to time, one should ask what the growth rate of broad money was telling us, especially at a time when, as in the United States, it was rising at the fastest rate at any point since the Second World War. The excessive reliance on models that ignored money altogether was somewhat foolish.

In 2020-21, when inflation started to rise, there was not a single dissenting vote on the MPC and no mention of the monetary data in the Bank’s reports. Bank rate exceeded its pre-pandemic level only in May 2022. I understand why this groupthink came about—because that had become an academic consensus—but, unfortunately, its impact on monetary policy led to the problems that we are now too familiar with.

Some commentators have concluded that a different way of presenting the Bank’s forecasts might solve these problems—which, I think, was the implicit suggestion of Ben Bernanke’s report—but the mistakes of 2020-21 were not the result of presentation. While the Bank used fan charts and the Federal Reserve used dot plots, it did not make any difference; they both made the same misjudgment. What really matters are judgments about the state of the economy and the way that monetary policy works. Our recommendation is to focus on the need for genuine intellectual diversity and, to meet that point, reform of the appointments process to senior positions in the Bank.

My third point concerns the mandate and remit given by the Chancellor and Parliament to the Bank. Since 2013, the Bank has acquired responsibilities for prudential regulation of banks and insurance companies, and has an even wider responsibility for financial stability through the Financial Policy Committee. It is also the resolution authority for the United Kingdom. Those new tasks have increased the number of staff in the Bank from under 2,000 to over 5,000, with an inevitable reduction in focus on its monetary policy mission. As others have said, the expansion of responsibilities has gone further with the introduction into its mandate of issues such as climate change, the competitiveness of the City and other secondary objectives.

The expansion of central bank mandates makes it more likely that governors will start to behave as politicians and try to cultivate popularity through venturing into areas well outside monetary policy. Trying to keep inflation close to the target and maintaining the stability of the financial system is more than enough for one institution. As many of our witnesses pointed out, climate change policy is a matter for government, and, frankly, it is ridiculous to suggest that central banks can have any major impact on it. Therefore, there needs to be a cull of the additional secondary objectives, remit letters and “have regards to” obligations imposed on the Bank since independence was granted in 1997. Too many responsibilities make it difficult for senior people in the Bank to think strategically.

Concerns about the lack of intellectual diversity and the burden of excessive responsibilities are not arguments against central bank independence. Rather, they are the opposite: they point to reforms that can reinforce independence and restore the mission of the Bank of England to ensure the stability of prices and the financial system. Whichever party forms the next Government, I hope that it will take a careful look at our report.