After Labour’s fiscal shambles over the past week, it is depressing to see the only genuine economic radicalism in British politics emerging from the right. Reform deputy leader Richard Tice’s recent claim that “everything is up for debate” on the Bank of England once again shows why the party is setting the pace on national political discussion. It doesn’t exactly hurt the party to have a strangely enamoured mainstream media, and an alternate news ecosystem around GB News that is mainlining its alt-right talking points. But Reform’s willingness to seize the policy initiative shows that the party grasps the extent of Britain’s economic dysfunction. From demanding the nationalisation of British Steel, to insisting taxpayers shouldn’t foot the bill for quantitative easing (QE), Reform has been unafraid to challenge the orthodoxy. Its opponents urgently need to raise their game, or risk continuing to play catch up from now until the next election.
The blunt truth is that the claims made for central bank independence were always overblown, and today, in a world of chaotic, repeated, overlapping crises, sacrosanct independence is a luxurious relic few countries can afford to maintain. The Bank of England’s current mandate is not fit for purpose and in any case the Bank has operated well outside of it since the financial crisis. The arrival of so-called unconventional monetary policy in early 2009, in the form of QE, represented a major expansion of its powers. The Bank’s balance sheet grew alongside its remit, with huge short-term impacts on wealth inequality (since shamefacedly admitted by the Bank) and with the longer-term costs to the Exchequer that Tice highlighted. There have been more graphic examples of over-reach: it wasn’t “markets” alone that removed Liz Truss as prime minister but the Bank of England governor Andrew Bailey’s extraordinary intervention, in a press conference at the International Monetary Fund, that helped to stoke the market panic which forced her resignation in September 2022. “Independence” for the Bank has turned, over the three decades since Gordon Brown granted it, into something dangerously close to “dominance”.
But killing this sacred cow will require a confrontation with the high priests of modern economics. Since the mid-1990s, the doctrine in mainstream Western economic thinking has been that central banks should be “independent” of government, meaning that decisions over what has become the central economic management tool of interest rate-setting should be made by the banks without the broader, elected government involved. Central banks would be granted a simple mandate by their government to achieve a certain target for inflation, usually around 2 per cent, and expected to vary interest rates as they saw fit to achieve that.
[See also: The QE theory of everything]
The theory behind this was that if governments were left to set central bank interest rates themselves, they would game the system – cutting interest rates ahead of elections, for example, to stoke up the economy in the short run, at the risk of higher inflation. But knowing this, consumers, businesses and (crucially) those in financial markets would not believe governments when they also claimed to want to fight inflation. These promises would not be credible. Expectations of future inflation would be higher, and this would, in turn, feed back into actually higher inflation today.
By breaking the link between elected governments and the central bank, independence was supposed to restore credibility to monetary policy. Sticking tightly to their mandate, ruled over by wise technocrats, independent central banks would act as credible guardians of price stability. Some costs were clear, even at the time. Excessively high interest rates maintained by the Bank of England following independence in 1997 were blamed, largely accurately, for further waves of deindustrialisation under New Labour. The pound was held at a value that made manufacturing exports uncompetitive: 1.5 million manufacturing jobs went, largely ignored at the time, between 1997 and 2009.
Factory closures here may have appeared to be a price worth paying. Inflation remained low, interest rates manageable, real wages grew and a great expansion of consumer borrowing fuelled wider economic growth. The Bank of England governor at the time, Mervyn King, claimed to have midwifed the “Nice” decade – Non-Inflationary, Continual Expansion.
This was pure hubris. The arrival of central bank independence as a doctrine coincided with the extraordinary transformation of China, in particular, from one of the poorest countries on the planet to what is, by some measures, the world’s largest economy. The relationship wasn’t coincidental: the freeing up of global financial systems that “independent” central banks were a component part of enabled the spread of consumer borrowing on a heroic scale throughout the Global North and this, in turn, helped lubricate the flow of cheap consumer products opened up by the mass industrialisation of East Asia. But what, plausibly, has more impact on consumer prices: a letter from Gordon Brown to the governor of the Bank of England, or 300 million Chinese moving from the countryside to work in factories? If you can buy a 50-inch flatscreen TV today for a fraction of its price even a few years ago, that isn’t because the Bank’s Monetary Policy Committee managed to keep voting the right way.
It’s the ending of this cheap flow that really heralds the end of the low-inflation decades. The halting of globalisation, rudely made permanent on Donald Trump’s 2 April “Liberation Day”, and more fundamentally the conjoined crises of the climate and nature, all point towards a sharp and permanent reversal of those long decades of falling prices. Climate change means economic activity becomes harder and more costly. And today, it is rising food prices that have started to push up overall inflation in both the US and the UK. Staples like chocolate have soared in price in recent weeks, directly linked to adverse weather worsened by a changing climate.
Conventional central bank policy is useless here. Putting up interest rates in London does not make more cocoa grow in drought-struck Ghana. If anything, by restricting future investment, it is likely to worsen this supply-side inflation over time. Nor do interest rates stop the new profiteers of shortage and disruption, like the fossil fuel companies and global agribusinesses, generating all time-record profits from this ecological cost-of-living crisis.
This new high-inflation world is wreaking havoc with structures inherited from the old. Higher interest rates, and attempts by central banks to “unwind” earlier QE, are now creating notional “losses” on central bank balance sheets – losses that the Treasury has agreed to indemnify. Work by the New Economics Foundation suggests these now run to an extraordinary £130bn over the rest of the decade, after peaking at over £40bn last year. These are payments from the Treasury that go, via the Bank of England, to paying those commercial banks that hold accounts with it. It is these payments that Tice has targeted but which, to their credit, the Bank’s former deputy governor for monetary policy Charles Bean and Gordon Brown have both flagged as an extraordinary indulgence in a time of austerity. “Tiered reserves” – the Bank paying interest on only part of the accounts held – would be a smart, partial solution.
The transformation has to go further. Dealing with a world of repeated price shocks and crises from non-monetary sources will require coordination between fiscal and monetary authorities. A very useful recent paper from LSE’s Centre for Economic Transition Expertise calls for “adaptive inflation targeting” from central banks, giving them greater flexibility and time to respond to climate and other shocks, while coordinating with the fiscal authorities. Strategic stocks of essential supplies, as called for by the economist Isabella Weber, and Swiss-style price controls (a quarter of consumer prices in Switzerland are regulated by the government) should all be part of the mix.
Common-sense solutions remain anathema to the partisans of central bank “independence”, who tend to see any attempt at coordination between parts of government as clearing the route to the dreaded “fiscal dominance” of monetary policy – an inflationary spiral of government deficits and money-printing. But the greater risk today is inaction in the name of orthodoxy, drifting further into instability and shortages with our most important economic institutions unable to cope. It shouldn’t be left to Tice and Reform to make the case for radical change.
[See also: Who’s afraid of Gary Stevenson?]
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