Charles Goodhart, speaking at the Bank of England’s recent conference celebrating 20 years of central bank independence, was reported to have said ‘it was nice while it lasted’. Andrew Benito of Goldman Sachs, speaking on a panel at a Money Macro Finance conference on monetary policy, made a similar point.
Is this right? Is central bank independence really over? Some of the daftest Brexiteers, like Ruth Lea and Diane James, think so.
As these tweets reveal, they imagine that the Bank of England taints its forecasts to make them overly negative in service of the Government’s supposed desire to have the softest possible Brexit.
But this is not what Charles and Andrew had in mind. What they are thinking about is the capacity for the Bank to act – in good faith – independently of the government, in pursuit of its inflation objectives, given that at the zero bound policies are needed that are fiscal, or require the support of the fiscal authority.
Going back to 1997 when ‘independence’ was granted, Ed Balls and Gordon Brown opted to assign what we term ‘instrument independence’ to the Bank: operational control over the instruments of monetary policy. Labour reserved for itself the task of assigning the goals of monetary policy.
Other central banks have elements of ‘goal independence too’. For example, the Fed, given an unquantified inflation objective in its dual mandate, opted to quantify the objective itself – in the UK, the Chancellor does this every year. The ECB ‘interprets’ [translates, sets itself the practical objective that follows from] the mandate enshrined in the EU Treaties.
New Labour’s solution was elegant, because it harvested some of the benefits of ‘independence’ – reducing suspicions that interest rate setting would be used for political ends – while avoiding some of its costs – that central banks would pursue aims that were not consistent with the populations they were supposed to serve.
The Bank of England has not lost any of its ‘instrument independence’. On the face of it, it can do whatever it wants, provided it can be defended. I say ‘provided’ since in extremis the Chancellor can seize control of monetary policy under the provisions of the Bank of England Act. In fact, the Bank has gained a degree of independence over the operation of other instruments like asset purchases.
What has changed is our assessment about whether interest rate control was not just necessary, but sufficient to achieve the mandate handed to the central bank by the government. In 1997 it seemed inconceivable that the UK could experience a financial crisis such as was occurring in Japan, driving interest rates there to the zero bound. We were to learn differently in 2007.
So independence is as intact as before. But the likely performance of the Bank in achieving its objectives – say the minimisation of deviations from the inflation target and of unemployment from its natural rate – absent cooperation of the government we now realise is less than we did before. If we are prepared to say that the likelihood of that cooperation being forthcoming is no less than it was in 1997, we might say simply that the expected performance of the inflation target regime has declined on account of realising that the economy will hit the zero bound more often than we first thought. Note that the true probabilites of things have not changed. It’s just that our estimates of them in the light of lived experience have changed.
Stepping back a little further, we can appreciate that these statements are conditional on the existing legislation remaining in place; and the government support for the 2 per cent target, and other somewhat discretionary aspects of the regime [like the letters delimiting what assets the Bank can buy and in what quantities] enduring. We can then ask whether the likelihood that these features of the regime endure has changed relative to 1997. This is another way of posing the question ‘has independence had its day?’.
My reflection on this is to think that the chance of revoking aspects of the institution has risen.
On the right, the hard Brexit faction of the Tory party have revealed that in pursuit of their European policy they are prepared to weaken any institution – including the Bank – that offers analysis that is inconvenient.
Theresa May herself mentioned the concerns of another constituency – hard to apportion to the right or the left – that in my view incorrectly seeks to lay the blame at the Bank’s door for aggravating inequality with its post crisis monetary policy response.
And on the left Corbyn and McDonnell themselves – and some prominent supporters like Paul Mason – have advocated subordinating monetary policy to fiscal policy by compelling the Bank to finance directed public expenditure, badging this as ‘People’s QE’.
If one adds to this the general sense that the chance of policy choices following from rational and evidence based assessments by governments has diminished [what else is one to conclude from Brexit?], it is easy to draw the conclusion that monetary policy regime change is more likely than before.
So, returning to the question: has central bank independence had its day? Yes and no. We need to dig a little deeper into the meaning of the term, and its implications for monetary policy outcomes to make progress.