Bank of England Independence – 20 Years On

It’s hard to believe that it has already been 20 years since the incoming Labour government made the Bank of England independent. Back in May, our Strand Group team at Kings’s organised an anniversary seminar to discuss why it happened and how it worked in practice. You can watch it here.

A few months on, the Bank of England is now holding a conference on the same subject tomorrow and Friday. I will be discussing our Harvard paper on how the financial crisis changes the case for, and design of, central bank independence around the world. You can read it here.

But reflecting on those dramatic days now over two decades ago, I decided to look out my copy of the letter from the new Chancellor to the Governor of the Bank of England, Eddie George, that I drafted in the days before the election and which Gordon Brown handed over to the Treasury Permanent Secretary, Terry Burns, when we arrived the day after the general election.

You can compare my draft to the revised letter that was actually sent the following Tuesday after a weekend of discussion within the Treasury.

I’ve not looked at either of the two since those heady days back in 1997 and, comparing them now, they are actually remarkably similar in content and language. There are a few minor tweaks – 9 members of the Monetary Policy Commitee and not 8 with the new Financial Stability Deputy Governor on the MPC; 5 year terms for Deputy Governors not 7; the addition of legalistic ‘without prejudice’ language to establish that low inflation was the Bank’s primary objective;  and we decided that weekend to move immediately to appoint external members rather than wait for the legislation. Although the name of the new Debt Management Office is not in the final letter, the transfer of debt management from the Bank to the Treasury is there in both drafts.

Famously the paragraph on removing banking regulation was removed from this letter and given to the Governor in a separate letter that weekend. But it is clear from my draft that the Deputy Governor (Financial Regulation) was intended to play a vital role in macro-financial stability within the Bank, with ‘conduct’ regulation moved to a separate institution. As is well known, some senior figures at both the Treasury and the Bank wanted a more decisive break. And the final compromise evolved progressively, and problematically, over the following decade as the Bank’s engagement in financial stability steadily eroded.

There are two clear omissions from my draft: the symmetric inflation target and the Open Letter system. We had decided on the former many months before, but decided we wouldn’t destabilise the independence announcement by also changing the inflation target at the same time. So the vital change in the target from ‘2.5% or less’ to ‘2.5%’ was deliberately held back until the Mansion House speech the following month.

The Open Letter system, on the other hand, came after the announcement following detailed conversations with Chief Economic Adviser Sir Alan Budd, who then left to become one of the original members of the MPC.

Of course, back then, these reforms were hugely political controversial. And although the Bank of England’s role in financial stability has evolved since the financial crisis, it is striking how much the monetary reforms have become part of the furniture of British economic policy – another example of the fact that it is only those reforms which become part of the consensus that ultimately stand the test of time.

Posted September 27th, 2017 by Ed