Two Decades of Crisis and Calm Leave BOE Powerful But Battered

  • Former Governor King says government relies too much on BOE
  • 20th anniversary of autonomy more subdued than 10 years ago

Two decades after the government set the Bank of England free, it faces the future with more responsibility than its liberators ever imagined.

On the one hand independence -- granted 20 years ago on Saturday -- insulated the BOE from political interference, but on the other it raised expectations for the central bank to cure all the economy’s ills. After the financial crisis, it was also charged with maintaining stability and had regulatory powers powers returned to it. Governor Mark Carney says he’s ready for the “15 minutes of fame” to end, and his predecessor Mervyn King agrees.

“The big challenge for central banks and the MPC over the next 20 years will be to retreat from the position in which it was seen as the only game in town,” King said in an interview. “Monetary policy has clearly done what it can.”

The establishment of the autonomous nine-member Monetary Policy Committee coincided with an era of calm, but then crisis came. Now its freedom is being challenged by accusations that it’s too politically partisan and that it’s exacerbating inequality with its ultra-loose policy. Even Ed Balls, one of the key architects of independence, said it needs a rethink.

To mark the anniversary, the BOE this week opened a new museum display on the MPC at its headquarters in London. Plans for further public events were postponed until later in the year due to speaking restrictions ahead of the general election. The lack of fanfare contrasts with the 10-year anniversary in 2007, when the occasion was celebrated with speeches and parties.

Mervyn King Reflects on BOE Independence Day

“It was enormous. I sat alone with Eddie George in the bank on the bank holiday Monday, the day before the announcement was made. He was told on the Monday morning. I went into the bank and that was the last I saw of the sun for quite a time. We sat together alone and realized how momentous this would be and it would change the bank he had known for his entire career.”

Still, things are different than they used to be. Prior to 1997, interest rates were decided in a “politically rather random” manner, with changes announced with little warning, King said.

Then-Chancellor of the Exchequer Gordon Brown decided to end that, setting up the MPC within days of his Labour Party’s landslide election victory. He also gave banking regulation to a separate body that was famous, and later infamous, for its light touch.

Two Halves

As the BOE’s chief economist, King was a key designer of the MPC when it was formed, and the panel flexed its muscle from the outset, raising interest rates at its first three meetings. The MPC’s first decade started halfway into a period King dubbed NICE -- non-inflationary consistently expansionary.

The second could not have been more different.

The worst crisis since the Great Depression ushered in a deep contraction; surging commodity prices pushed inflation above 5 percent; and the BOE slashed rates to a record low and bought assets equivalent to a quarter of U.K. gross domestic product. Annual economic growth averaged only 1 percent from 2008 through 2016, compared with 3 percent in the previous decade.

According to Charles Bean, a former BOE deputy governor and an adviser to the Treasury at the time of independence, the MPC went from a “pretty predictable relationship between manipulating bank rate and its subsequent impact on demand and inflation, to a world where it’s inevitably been policy making on the hoof.”

The BOE’s independence is being questioned and there are doubts about whether it will last, said Charles Goodhart, a founding member of the MPC. “The basic failing was an assumption that if monetary policy got the macroeconomics right, that financial stability would follow.”

That’s meant that other objectives -- the resilience of the financial system and more oversight of lenders -- were needed to buttress the central bank’s efforts to prevent boom and bust, and, as a result, policy making now is much more complex.

Politically Sensitive

This has brought central banks into sensitive territory and left the BOE much bigger and more powerful that it was in 2007. The challenge will be not promising too much, and accommodating the extra responsibility in a way that’s consistent with democracy, said Bean, currently an executive at the government’s fiscal watchdog.

Brexit has added to the pressure, creating a politically charged atmosphere that has entangled the BOE. British lawmakers have attacked Carney for appearing to take sides in the debate and for being too gloomy in his forecasts. Some have said that ultra-loose monetary policy only benefits wealthy asset holders, and Bean said rising populism and protectionism is the single greatest economic worry for the future.

“If the central bank’s actions in these other fields is creating political tensions, or seen as democratically illegitimate, that might also lead to changes to the monetary policy side, which I think would be unfortunate,” he said.

Still, it’s important to separate criticism of the BOE’s economic performance from the structure of the MPC, which has stood the test of time, King said.

“Given that you’ve got a framework that works then don’t mess around with it,” he said. “Just keep it as it is.”

    Before it's here, it's on the Bloomberg Terminal.
    LEARN MORE