2017 Harold Wincott Memorial Lecture: My Response to Prof Sir Charles Bean, ‘Central Banks after the Great Recession’, 28 November 2017

[This response draws extensively on the M-RCG Working Paper I have written with Anna Stansbury and James Howat ‘Central Bank Independence Revisited: After the financial crisis, what should a model central bank look like?’. Grateful thanks to Anna and Eleanor Hallam for helpful comments on an earlier draft of this response and to Sir Richard Lambert for inviting me to participate.]

Thank you.

It’s a great honour to respond to Sir Charles Bean’s distinguished Wincott lecture tonight.

Like many of you here tonight, I have a history with the Wincott Foundation – it is a full 25 years ago that I was awarded the Wincott prize for the Young Financial Journalist of the Year.

At the time, I was an economics leader writer at the Financial Times, working closely with the FT’s then Chief Leader Writer, Martin Wolf, and I had just written a Fabian pamphlet advocating – highly controversially – that rather than repeat the ERM debacle by joining the Euro, the next Labour government should instead make the Bank of England independent.

Martin told me that it was a good essay, that he agreed with it, but that it would undoubtedly kill off any chance I might have of a political career in the Labour Party.

Ironically, five years later, it was the incoming Labour government that made the Bank independent, in the teeth of passionate opposition from the Conservative party, led by Shadow Chancellor Ken Clarke, who went on to vote against the legislation.

Of course, the Opposition soon changed its mind, as it did later on the national minimum wage. And these two big reforms have stood the test of time.

Because if there is one thing I have learned over the last 20 years in politics, it is that, for all the sound and fury, huff and puff and disagreement between the parties, the only reforms that actually last are those which become part of the cross-party consensus.

And 20 years on, Bank of England Independence is certainly one of few reforms that has lasted and become part of the national consensus.

Of course, one of the main reasons why Bank of England independence has worked well and become consensual has been the high quality of the members of the Monetary Policy Committee, internal and external.

Back in 1997, we consciously set out to build a cadre of economists who could move easily between the worlds of policymaking, academia and business and finance. I am pleased to say a number of them are here tonight.

And Charlie Bean is a doyen among them, one of the finest British economists of the last fifty years.

After more than forty years distinguished service, Charlie is continuing to straddle these different worlds as both an academic and a senior policy maker at the Office of Budget Responsibility.

The OBR, another controversial reform which I hope will remain part of the cross-party consensus. Although a warning: to take that status for granted would be very foolish indeed.

***

So to Charlie’s excellent lecture and his central message: that ‘independence’ is a misleading label, that a central bank can never be ‘a distinct and separate institution from government’ and that getting the institutional design and accountability right is vital.

That was very much the view we took in designing the new system in the run up to 1997.

Interestingly, senior Treasury officials had assumed the new Labour government would delay a decision on independence in order to then go for a Maastricht compliant ‘ECB-style’ model.

But that was not our plan.

We were certainly influenced by a recent 1994 Debelle and Fischer paper which had shown a goal-dependent but operationally independent central bank delivered better outcomes than Bundesbank-style inscrutability.

We were also conscious that to win the argument with the media, the trade union movement and the wider public, we could not be seen to hand complete power to set mortgage rates over to ‘inflation nutters’.

But – remembering past Chancellorial tensions with Governors Norman and Cromer – we were also very clear we needed to get away from what we saw as the destabilising personalisation of the ‘Ken and Eddie’ show.

So we consciously established a British-model of what we called ‘operational independence’ with the Chancellor setting a symmetric inflation target, appointing four external members to a nine-strong MPC and requiring named votes to be declared in published minutes.

I think it was initially a bit of a shock to Eddie George to find out that the Governor could be out-voted. But it is a great strength of our system that we established collective decision-making in which individuals could disagree publically with the consensus without fearing for their job.

Alongside the symmetry of the target and the open letter system, this open and public debate between MPC members was one of the reasons why the MPC quickly established its public credibility and ended up being much more flexible and activist than anyone expected. It certainly raised the level of public debate.

I want to come back to this issue of ‘personalisation’ at the end, because I think there remains one important and troubling issue with the current regime and which Charlie does not address in his lecture.

***

As well as being clear that the case for delegation is sound and getting the accountability right, Charlie also rightly says that to work, delegation needs to have only a limited impact on other, wider objectives of government and highlights two, distribution and fiscal policy.

Of course, monetary policy has a distributional impact – individually and regionally. That is one of the reason why Eddie George unusually decided speak at the TUC conference in 1998 – to reassure its members that the MPC wasn’t partial, that it cared about stability and jobs in every part of the country. Thanks to his skill, and the MPC’s decisive response to the crises of 1998, this argument was won.

But as Charlie suggests, winning this argument with the public depends importantly on both the monetary policy objective being clear and intuitive and also on the policy instrument – the interest rate – being simple, the same for everyone and clearly cyclical.

Which is in marked contrast to fiscal policy, where the Chancellor makes conscious tax choices favouring one group rather than another. The fact that the distributional impact of monetary policy, while real, is both temporary and second order rather than overtly discriminatory is another reason why the consensus has held.

As for Charlie’s other wider objective, fiscal policy, over the first ten years of the MPC, the fiscal implications of monetary policy were benign and indeed beneficial, with lower long rates providing a fiscal boost.

***

One aspect Charlie perhaps underplays is the sensitivity of communication between institutions.

Because while the impact of monetary policy on fiscal policy was benign, this did not stop both the Bank and the Treasury worrying at the outset that the MPC commenting on fiscal matters – overtly or covertly – could be a source of tension and draw the MPC into politics, just as Chancellorial comments on interest rates might undermine independence.

As a result, on monetary policy Gordon Brown adopted a self-denying ordinance. The Chancellor simply chose not to comment. Indeed, the only time he was tempted to, pre-2007, was when we at the Treasury were worried that the MPC was being too tardy in raising rates. I certainly once attracted media attention for saying publicly that we would ‘back the MPC in all the difficult decisions they have to make’ with an emphasis on the word all. Mervyn was unhappy.

On fiscal policy, the self-denying ordinance went the other way with the MPC – and usually the Governor – deciding not to comment overtly on fiscal policy. Of course, in monetary policy actions speak louder than words and Chancellors were always aware that the MPC would inevitably act if policy was seen to be loosened irresponsibly. And this was an argument we regularly deployed to keep the Prime Minister and Cabinet colleagues in line – ‘it might look a good idea, but what if the MPC disagrees and then raises mortgage rates’? That was always enough to persuade Tony Blair.

The one area of the new system post-1997 where inter-institutional comment was expected, and indeed encouraged, was financial stability. With Eddie George’s strong support, and enhance the Bank’s oversight of systemic stability issues, we established a new Deputy Governor for Financial Stability and a regular Bank Stability report, as well as a private monthly Standing Committee with the Treasury and the FSA.

So it was disappointing to me to learn from Paul Tucker that, in the mid-2000s, the Bank and the FSA fell into a pattern of not properly scrutinising, let alone commenting on, each other’s actions.

That was never the plan. Any more than the MPC was discouraged to look at how financial risk could put the inflation target at risk.

Of course, as Charlie says, none of these structural issues – institutional, remit or communication – explain why the Bank, the FSA and the Treasury failed to see the 2007-08 crisis coming.

As John Kingman reminded me only last week, at our class at King’s, back in the summer of 2006 the Standing Committee looked hard at the question of whether British banks had too little capital and concluded that the had more than enough capital to cope with any likely eventuality. That was a misjudgement, which all three institutions shared with the boards of the banks themselves. As I have written, we also war-gamed our crisis-management procedures at the end of 2006. We just didn’t see the risks at the end of our noses.

***

Of course, as Charlie reminds us, after a successful first decade, the period since 2007 has been one of challenge, complexity and indeed purgatory for central bankers with interest rates bumping against the zero lower bound, massive QE dragging them into political controversy and fiscal policy doing little to pull its weight.

There have been rather more political tensions than before: Ben Bernanke’s view that US fiscal policy should have done more, Congressional complaints about the Federal Reserve’s new powers, Bundesbank worries about the ECB’s mandate and Gordon Brown, at the recent Bank of England ‘20 Years On’ conference complaining angrily about Governor Mervyn King’s personal fiscal commentary in 2009 and 2010.

And after a period of – the ECB excepted – international convergence in central banking towards inflation targeting and operational responsibility, we have seen both new powers and a new divergence in central banking structures, as I have documented in a recent Harvard paper with my co-authors Anna Stansbury and James Howat, which Charlie kindly cites.

Many of these new reforms are, of course, untested. It is not yet clear what the new model for convergence will be.

Not least because, as Charlie says, we do not know how long this unusual period will last and what will come next.

I do not know if Charlie is right that the current period of very low real interest rates will, in time, come to an end and that we will return to something more recognisable. I hope he is right and that it happens soon.

But in the meantime, I share his scepticism that forward guidance, helicopter money or changing inflation targets will do any good.

On the latter, Charlie argues that it would be risky to shake-up the public consensus we have built around the current inflation target. I would add that – shocks aside – central banks have found it trouble enough to meet their current ones let alone a higher target.

I also share his frustration at some of the more conspiratorial arguments against QE, not least from our own Prime Minister, which also persuade me the Bank was right to require a political direction to stray into wider asset purchasing – actions which quickly become first-order distributional. There is a lesson here, I believe, for macro-prudential policy, which I will return to.

One aspect of policy Charlie didn’t address today is whether central banks have been left to do too much of the aggregate demand heavy lifting. He has made the case before that, with long-term interest rates so low, fiscal policy could have played a great role.

Indeed, this was an argument – in a UK context – made then and subsequently by senior staff at both the IMF and the OECD, albeit they were then publically contradicted by the most senior political leadership of the organisation they worked for.

One proposal that Anna, James and I have floated is whether, in the exceptional circumstances of the zero lower bound, the central bank should have the right – if they choose – to send the government an open letter explaining how fiscal policy is making it harder for to monetary policy to meet the inflation and asking for help. I can see the case. But the circumstances have to be exceptional. And even then, there is a risk of the central bank being led into politically deep and treacherous waters.

***

Let me end, like Charlie, by talking about financial and macro-prudential policy where we have seen significant reforms since 2010:

– splitting prudential and conduct regulation;

– establishing the Prudential Regulatory Authority as an arm of the Bank;

– legislating for new capital requirements, macro prudential tools and regular stress-testing;

– and establishing a new Financial Policy Committee in the Bank of England to use those tools.

As Charlie says, judged by his criteria – clarity of purpose, effective accountability and concerns about fiscal and distributional impact – the case for delegation and operational independence in the operation of these powers is, and I quote, ‘weaker – or at least more complex – than for monetary policy’.

Prima facie, as with interest rates, there is definitely a case for politicians to delegate technically difficult and contentious macro-prudential decisions to independent experts.

But there are risks. There is clearly a big overlap between the remits of the MPC and the FPC; relative to the inflation target, the definition of financial stability is opaque at best; the transmission issues are much less well understood by economists let alone the media and the public; and, as a result, the minutes of the FPC are much less well understood, scrutinised and debated.

Moreover, in the operation of macro prudential tools, the distributional impact of FPC decisions are much more likely to be first order, with different levers overtly discriminating between different groups of individuals or institutions. While if and perhaps when things go wrong, the direct fiscal impact of financial policy interventions can be very substantial.

This is not an argument against delegation. But there is a real danger of the FPC and the Bank being drawn into deep political waters – making very unpopular decisions in pursuit of poorly understood objectives which, given the huge concentration of power now in the Bank, could well leave the institution with a lot of egg on its face if things go wrong. I worry this could also put the consensus for monetary policy independence at risk.

In our paper, we do not argue for throwing the baby out with the bath water and going backwards on the recent reforms. Instead, as Charlie discusses, we advocate adding a new and additional strategic oversight entity, modelling loosely on the US FSOC, chaired in person by the Chancellor, with the Governor and Deputy Governors all present.

In normal times, its task would be to set, monitor and keep under review the remit of the FPC: delegating to the FPC the operational responsibility for using macro-prudential tools to meet the remit, but making clear that this remit has direct and immediate political backing.

Charlie is right, of course, that it is always possible – as now – for the Chancellor to weaken the FPC remit if pulling the macro-prudential levers gets uncomfortable. But, unlike now, such a decision would have to be discussed, debated and minuted at the new oversight entity, making any such change harder rather than easier.

I also believe that in a crisis, the fact that this body already exists and has been operational would lead to better decision-making. Already under the rules, if the Bank expects the possible use of public money, it has to trigger the formal engagement of the Chancellor. But the discussion forum would be ready and well-established.

***

And there is another reason why I believe this reform is necessary.

I said at the start that I would return to the issue of personalisation.

Even before the reforms of this decade, the job of being Governor of the Bank of England was an onerous one. In the new system we expect the Governor, as Chair of the MPC and FPC, to be a monetary and financial policy expert, to be skilled in the most complex economic policy communication and also to manage an onerous but opaque system of accountability.

As I wrote in the FT a few years back, when a vacancy last arose, ‘Wanted: a Governor of the Bank of England – only super-humans need apply’.

Now currently, of course, we are blessed by a Governor who, if not super-human, is certainly doing an excellent job.

But I do think the concentration of power in the Bank and the personalised nature of aspects of the role makes the job harder and the risk of conflict with the Government greater than necessary.

Not in monetary policy-making, of course, where the clarity of the inflation target and the collective processes of the MPC prevent personalisation.

Nor in fiscal policy where, while the occasional stray remark from a Governor can cause consternation, the collective responsibility of MPC decisions, minutes and the inflation report generally prevent personalised fiscal commentary.

In macro-prudential policy, the FPC also operates collectively, although the fact that FPC votes are not published is a weakness. And I am also a little concerned that only the Governors, and no external members, attend both the MPC and FPC, meaning there is a danger of outside members not being fully in the loop. One solution would be to merge the two committees. Another would be to follow the Malaysian model and allow any member of either committee to trigger a joint meeting if they have concerns that their remit is being jeopardised by the action or inactions of the other committee of which they are not a member.

But there is one aspect of personalisation which remains unaddressed.

At present, as I understand it, it is ‘the Bank’, which triggers the involvement of the Chancellor in an impending crisis if public money might be at risk.

Which means the Governor, advised by a Group of deputy Governors who managing separate and sometimes conflicting objectives.

Imagine the Deputy Governor and head of the PRA having a big concern about an institution. The Governor has a meeting. Hears these concerns. And then sums up that, in his or her judgement, the situation is not so serious or that moral hazard concerns dominate and therefore that there is no need to call the Chancellor.

Far-fetched? Absolutely not in my experience.

Here again, I think our proposed strategic oversight body can solve the problem. All the Deputy Governors would be statutory members. All would have the right to trigger a meeting and share their concerns. There would be no Governor-veto. Any Deputy Governor has a direct line to the elected Chancellor.

In his excellent lecture, Charlie has highlighted a number of complexities and challenges which arise from the Bank’s new wider remit. I have added to them in my response. Because while many of the reforms introduced in 2010 are sensible enough, I do believe they remain work in progress.

I do believe we can reach a long-term consensus, which secures operational responsibility in monetary and financial policy for the long-term. But there is still some work to do. And I certainly don’t think we should wait until the next crisis before we try to get this right.

Thank you

ENDS

References

Debelle, Guy, and Stan Fischer (1994). “How Independent Should a Central Bank Be?” Working Papers In Applied Economic Theory.

Balls, Ed, James Howat and Anna Stansbury (2016). “Central Bank Independence Revisited: After the financial crisis, what should a model central bank look like?” Harvard University Mossavar-Rahmani Center for Business and Government Associate Working Paper 67.

You can read Professor Sir Charles Bean’s lecture here

 

Posted November 29th, 2017 by Ed's team