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.

Central Bank Digital Currencies (Economic Affairs Committee Report)

Lord King of Lothbury Excerpts

Thursday 2nd February 2023 Lords Chamber

[Lord King of Lothbury (CB)]

My Lords, I speak as a member of the Economic Affairs Committee which produced the report that we are debating. I thank the noble Lord, Lord Bridges, for his excellent introduction to the debate. I declare an interest as a consultant to Citigroup.

Central banking is not the most exciting of topics. Indeed, at the Bank, my ambition was to make it boring. But add “digital” to any title and you find a wave of enthusiasm overwhelming all those involved, with people feeling that this is the future and that we must be at the forefront of any development. The Government have said that they want the UK to be at the forefront of innovation of crypto assets and fintech, but we need to be selective and not driven by a misplaced enthusiasm for all things crypto. It is probably true that when the lemmings went over the cliff, some of the leaders said to one another, “Perhaps it wasn’t the best idea to be at the front of this particular wave.”

The first thing to say about a central bank digital currency—CBDC—is to repeat what the noble Lord, Lord Bridges, said: it is not a currency. If the Bank of England or the Federal Reserve were to issue a CBDC, it would be in sterling or dollars, respectively. CBDCs are about ways of making payments; they are not a new currency. Whether a country needs a CBDC is really about the state of its current payments system, hence the title of our report, Central Bank Digital Currencies: A Solution in Search of a Problem?

What are the problems in our payments system to which a CBDC might be the answer? The main conclusion of our report is that there are no problems to which a CBDC is the only, or even the most obvious, answer. Our payments system is more efficient than those in most other countries, certainly the United States. Most transactions are already digital, whether by tapping a card on a machine at the point of sale or making a digital payment on a computer for remote transactions. All of these are operated already by commercial banks and an increasing number of new payment vehicles.

Competition has moved us from a system that used to be based on paper cheques, which often took five days to clear, to one driven largely by digital payments, with virtually instantaneous clearing. It would be somewhat odd to try to increase competition in this area by creating a state monopoly of the payment system, as opposed to the role of a central bank in determining the value of a currency. That is a quite different function.

The Bank has played an important role in regulating and promoting the current payments system operated by private sector banks and other payment providers. There is no doubt that further improvements are possible—indeed, desirable—but none requires a CBDC. I invite noble Lords to think of the two different ways in which a digital currency might work: first, for retail customers, and, secondly, for wholesale payment providers. The Bank certainly does not want to offer bank accounts to any individual who wishes to open an account with it. The Bank has always limited the number of customers to the hundreds—not 50 million. I do not think Andrew Bailey or anyone else at the Bank wants to be on the receiving end of phone calls from Mrs Jones in Wrexham or Mr Smith in Guildford complaining that they cannot log into the website to transfer money to their grandchildren. This is not what the Bank of England is set up to do.

In countries without an effective banking system—there are some—the central bank might have to step in but that is self-evidently not true in the United Kingdom, hence the suggestion by some that a CBDC would take the form of tokens issued by commercial banks and guaranteed by the central bank. However, that is exactly the position we are in today: commercial banks issue bank deposits and they are guaranteed one way or another by government. So there is no obvious benefit to creating a duplicate arrangement that happens to have the sexy name of a “digital currency”.

The enormous risk is that, in a financial crisis, households would abruptly shift their deposits from banks to accounts with the Bank of England, forcing the latter immediately to transfer the deposits back to the banks to avoid a collapse of the system. In 2008, when the Bank, with approval from the Government, lent a large amount of money to RBS and HBOS to prevent their collapse, the operations were covert and revealed only some months later to prevent a system-wide loss of confidence. That would be impossible if households could switch without limit instantaneously from all commercial banks to the Bank of England. So a retail CBDC has risks but no obvious benefits.

As for a wholesale CBDC, we already have one in the form of reserve accounts with the Bank of England held by payment providers such as commercial banks. It has been used actively in recent years in the operation of, first, quantitative easing and, now, quantitative tightening. In evidence to our committee, the Bank of England made it clear that it saw no need for a wholesale CBDC.

Of course, there can always be improvements in our payment systems, but a CBDC is neither a necessary nor a sufficient condition for that. The major problem today concerns the cost and speed of cross-border payments but much of this results from regulation to prevent money laundering. There is certainly scope for central banks to link their payment systems together—many central banks are working on this—but that does not require, nor is it facilitated by, central banks setting up their own CBDCs.

The UK should certainly aim to be at the forefront of fintech but we need to be careful in determining the respective roles of the state on the one hand and competitive private sector players on the other. My motto for a central bank is: only do what only you can do. Central banks are important regulators of payment systems. The case for them to be direct providers of digital retail payments is yet to be made. That is why I conclude by going back to the title of our report, Central Bank Digital Currencies: A Solution in Search of a Problem?

Queen’s Speech

Lord King of Lothbury Excerpts

Thursday 4th June 2015 Lords Chamber

[Lord King of Lothbury (CB) (Maiden Speech)]

My Lords, I am extremely grateful for your Lordships’ patience in allowing me to wait until after the general election before burdening the House with my views, and for the warm welcome that I have received. Parliament is a forbidding place for a central banker—our experience is usually confined to appearances in the other place before the Treasury Committee. I can report that, contrary to that body, the Economic Affairs Committee of this House offered not only greater decorum but also a superior quality of discussion.

With the general election behind us, I shall say a word about the economic challenges facing the country. Before that, I add my welcome to the noble Lord, Lord O’Neill, who will be responsible for many of the policies aimed at improving the performance of our economy. He will add expertise to the experience of the House at a time when economic issues loom large in our politics, especially in relation to Europe.

Over the past five years, the UK economy has expanded by almost 10%, faster than official statisticians initially estimated but still slower than expected at the beginning of the previous Parliament. The task now, as then, is to rebalance the UK economy away from private and public consumption and toward investments and exports. Monetary policy is in good hands, fiscal policy is tackling the structural deficit and banking is being reformed.

We have made progress, but we face two challenges. The first is to raise productivity throughout the economy—easy to say, hard to do. Several noble Lords today have made convincing contributions to explain what we need to do. Despite recent official data, we should be optimistic about the long-run growth rate of the British economy. Innovation is our strength. If we support research and encourage its application to commercial ventures, I believe that we will make up the output lost in the financial crisis. We have not yet fully resolved the problem of “Invented in Britain; developed abroad”, and I hope that the Government will look closely at any inhibitions to the development of British discoveries at home.

The second challenge is the continuing slow recovery of the world economy. No major economy has found it easy to generate a sustainable recovery. Indeed, most countries today could argue that if only the rest of the world was growing at its normal rate then they would be fine but, since it is not, they are not. With interest rates close to zero and fiscal policy constrained by high debt levels, many countries have resorted to pushing down their exchange rate. One does not have to employ the emotive language of “currency wars” to see that this is a zero-sum game. And one of the costs is that the appreciation in sterling’s effective rate of over 10% over the past 18 months is holding back the rebalancing of our economy.

Most problematic is the position of monetary union in Europe. The first crisis weekend to deal with Greece was almost exactly five years ago. Since then, the crisis has spread to other countries. It ebbs and flows with little sign of any permanent solution and, as all the options for the euro area are unpalatable, the inevitable result is drift. This feeds directly into the problems facing the Government in renegotiating our relationship with the European Union.

I hope that the Government will approach those negotiations not with a British shopping list but with a simple principle for the future of the European Union: the nature and speed of political integration required for monetary union to survive is wholly different from that appropriate for countries outside the euro area. The reality is that for the foreseeable future there will be two types of member of the EU: those in the monetary union and those outside it. This is not a temporary state but one that will continue for a considerable time. Failure to recognise that reality will threaten not only monetary union but the wider Union, too.

I echo the views of the noble Lord, Lord Higgins. I think that a deal could be based on a binding declaration that countries outside the euro area would not prevent further political integration among the “ins” in return for a guarantee that those steps would not apply to the “outs”. That is not a British demand, but an attempt to save Europe from itself. This is as much a challenge for Chancellor Merkel as it is for our Prime Minister. It will be her taxpayers who foot the bill for greater integration of the euro area.

There are two challenges: raising productivity at home and, in Europe, a more realistic approach to the development of the Union. In both cases the process would be helped by what John Maynard Keynes once described as “ruthless truth-telling”. We in this House can show that it is not only the child but also men and women of a certain age who can say that the emperor has no clothes. Interest groups at home and a few of our partners in Europe may not always like what we say, but they will listen. And who knows, with good arguments, we might even change some minds.