Twenty-five years ago today, just five days after New Labour’s 1997 landslide victory, the new chancellor of the exchequer, Gordon Brown, announced that he and the Treasury would no longer control monetary policy, but instead allow an “independent” Bank of England, working to a target established by government, to set its own interest rates. Kept secret even from the prime minister, Brown’s audacious move was heralded at the time as a master stroke and framed New Labour’s agenda for the subsequent decade. Previously, interest rate setting had been left to the chancellor, which attracted criticism from mainstream economists that this automatically introduced an “inflationary bias” into policy. The decision to delegate monetary policy to an independent central bank drew on the best available thinking in orthodox economics, supported an extraordinary decade of financial services growth and cleared the path to the catastrophic failure of the British economy in 2008, ten years of austerity, the evisceration of New Labour’s public spending programme and a lost decade for pay.
It is tragic, not laudable, that one of New Labour’s few robust economic legacies is an independent Bank of England, whose rate-setting Monetary Policy Committee (MPC) can today be found gawping at inflation driven not by domestic monetary factors but a series of global price shocks beyond the reach of the central bank – from failing wheat harvests to rising gas prices – yet still pushing interest rates upwards, seemingly for lack of any better ideas. Bound to and judged by its target for inflation, the central bank has to be seen to be doing something – even when that something risks a recession.
They are confirming the point, for which there is now a quarter-century of evidence, that central bank independence is either dangerous or meaningless. Dangerous, because in extreme cases a genuinely “independent” central bank, free from even minimal democratic control – such as the European Central Bank – is liable to monomaniacally pursue its target for inflation regardless of wider economic and social impacts. This is precisely what the ECB did in the early 2010s, helping to drive the economies of southern Europe into their worst recessions in decades.
Meaningless, since if an “independent” central bank takes a broader view, and coordinates its actions with its local government, it is no longer truly independent. At moments of stress in the last two decades, this is, of course, exactly what the Bank of England has done, working hand-in-hand with the Treasury to respond to the 2008 financial crisis and, more recently, Covid-19.
The central bank’s record during repeated crises urges a reassessment of the case for independence. The former US treasury secretary Larry Summers, one-time champion of Bank of England independence, believes that “the case for central bank independence today is much weaker than it was 20 years ago”. Even Ed Balls, whose 1992 Fabian pamphlet convinced Brown of the need for an autonomous central bank, now argues for its closer coordination with government.
The benefits of independence were always overstated. It wasn’t the flick of a Treasury pen in London that delivered two decades of low inflation in Britain and across the global north. It was the sweat of a vast, new, underpaid working class in Shenzhen and Dhaka and other rapidly industrialising centres of the global south. It was the ingenuity of the technologists cramming transistors into finer and finer slices of silicon. It was the simple innovation of placing goods into containers of a fixed size and shape for shipping, drastically cutting transport costs. And it was the cheap oil and raw materials that fed the globalised manufacturing economy, from factory floor to living room. The lower costs resulted in a decades-long pattern of falling goods prices.
Like the flea on the ox’s back, congratulating itself on a hard day ploughing the fields, the central bankers talking up their success are piggybacking on someone else’s exploitation. The real achievement of the major central banks, by the mid-2000s high-water mark of globalisation, was to facilitate a flood of cheap credit into the wallets of consumers in the global north. Falling material-goods prices and cheap, easily available credit sustained consumer spending, in Britain and across the developed world, even as real salaries and income growth lagged behind. Much of this flow of cheap money depended, in turn, on rapidly rising house prices that sustained borrowing: between 1997 and 2007, housing equity withdrawal in the UK came to £382bn – outstripping total GDP growth of £376bn. By the time of the 2007-2008 crisis, households in Britain were the most heavily indebted of all the major economies.
The Bank of England hardly blinked as the largest credit bubble in history was inflated on its watch. Concentrating fixedly on stabilising consumer prices, it chose to ignore mushrooming house prices. As late as 2007, the monstrous household-debt bubble was dismissed as irrelevant: “the view that the United Kingdom has experienced a long-lived consumption boom ‘funded by a tidal wave of debt’ is misleading.” Northern Rock failed a few months later, followed by the bursting of the debt bubble and the UK’s worst recession since the 1930s.
The decision to deprive the Bank of England of its regulatory powers over finance, made at the same time as independence was granted, and to create a new, toothless and emaciated regulatory body, the Financial Standards Authority (FSA), of course bears a major part of the blame. Britain was left with an institutionally weak regulator that allowed the rapid expansion of consumer borrowing on one side, and the proliferation of increasingly complex (and therefore increasingly risky) ways to manage and profit from the surging debt on the other. Britain was, as a result, among the worst hit by the financial crisis, the economy shrinking by 4 per cent in 2009.
In a fair world, this should have been enough to end both the dominance of financial services in policymaking and the role of the central bank as their dutiful supporter. It did not. The Bank of England, if anything, emerged more powerful, absorbing regulatory roles from the extinct FSA and taking on new responsibilities under its energetic post-crash governor, Mark Carney. The money-printing of quantitative easing and exceptionally low interest rates underpinned and abetted a drastic programme of public spending cuts enacted by the coalition government, supporting demand in the wider economy even as the Treasury cut back – at the cost of rising inequality, as the House of Lords Economic Affairs Committee found. By 2013, the status quo ante was sufficiently restored that Carney could be found speculating that by 2050 – thanks to UK-owned firms’ share in banking activities worldwide – Britain’s financial services sector could be more than nine times the size of its total economy.
It took the triple shocks of the latter 2010s – Brexit, Jeremy Corbyn and Covid-19 – to shatter the illusion. The first ended the dream of British financial services as the financier to Europe; the second, inducing Tory panic following Labour’s near miss at the 2017 general election, ended austerity; the third hastened the demise of cheap capitalism globally, as supply chains were broken by Covid and raw-material shortages were exacerbated by a succession of environmental and political crises, from extreme weather to Russia’s invasion of Ukraine.
Confronted by these rising real costs across the globe, central bankers and their academic hangers-on have been left scrambling. Blasé talk of “transitory” price rises in early 2021 has metastasised into alarmist chatter at the prospect of persistent inflation. Too many central bankers have retreated to their textbook comfort zone, urging “pay restraint”, as the governor of the Bank of England, Andrew Bailey, recently did, for workers in Britain whose wages remain, on average, below 2008 levels.
In response, £500k-a-year Bailey was widely mocked, but the orthodox arguments remain as surreal. It is generally admitted, not least by Bailey himself, that interest rate rises will do little to stem inflation arising from supply-side shocks like Covid and might even precipitate a recession – but it’s held that interest rates should go up anyway. The aim is apparently to preserve the Bank’s “credibility”; what happens to that “credibility” when the rate increases do little to nothing for inflation, but instead help push flagging economies into recession, is not clear.
Were the bank less independent and more open about the need to coordinate with the government, this credibility problem would matter less: supply-side inflation could be rightly treated as a supply-side issue largely outside of the bank’s control, not something it felt compelled to respond to. The problem of supply-side price rises could be left to the government, which could increase minimum wages, raise public sector pay, improve trade union rights, tax super-profits and regulate a few essential prices, such as domestic energy bills. Facing a recession, interest rates, if anything, should be lower. Instead, we are witnessing exactly the opposite: a government looking to cut real-terms pay and benefits, while allowing profits to balloon and overseeing rapidly rising energy prices, is backed up by a central bank set on hiking interest rates. As in 2008, institutional failure is deepening a crisis the government should be easing.