If you believe many of the comments in the broadcast media and from the City, Liz Truss is threatening to undermine the independence of the Bank of England and rip up a policy framework that has served us well for decades. One member of the Monetary Policy Committee (MPC), Michael Saunders, has already felt the need to warn her off.
But at best Truss’s critics have misunderstood what she is proposing. At worst, it is another example of kneejerk groupthink, and the resistance to any form of criticism or change, that too often surrounds discussion of the Bank of England.
Take what Truss has actually said. She pledged to “look again” at the Bank’s mandate “to make sure it is tough enough on inflation”. She added that she feared “some of the inflation has been caused by increases in the money supply”, and that she would “have a very clear direction of travel on monetary policy”.
It is hard to see why any of these comments have prompted such an outbreak of pearl clutching. Truss has not questioned the operational independence of the Bank, including the freedom to set interest rates. The issue is whether the MPC has the right mandate – which is still set by the chancellor – and sufficient accountability.
There are valid concerns here. Even the Bank is now forecasting that consumer price index inflation will top 11 per cent, way above the current target of 2 per cent. Its own Inflation Attitudes Survey confirms that the public is dissatisfied with how the MPC is doing its job. It would be odd if a potential future prime minister could not express an opinion on this too.
It is also reasonable for politicians to have a view on other aspects of the Bank’s work, including mission creep into new areas such as “green” finance.
Truss’s emphasis on the monetary drivers of inflation seems to have wound people up, as well. ITV’s Robert Peston even dismissed this as a “Right-wing trope”. This is bizarre. Most economists agree that monetary policy has been too loose for too long – and quantitative easing (QE) is a part of this.
A year ago, the House of Lords Economic Affairs Committee, which included former Bank governor Mervyn King, was worrying that QE could become a dangerous addiction. Prominent monetarists, such as Tim Congdon, were among the first to warn that inflation was likely to run out of control if this policy continued.
The call for “a very clear direction of travel on monetary policy” should therefore be interpreted as the desire for a fundamental rethink of what the Bank is trying to do, and where it might have been going wrong.
This should include a look at best practice elsewhere. Truss has suggested the Bank of Japan as an example, which might not be the best role model. If anything, Japanese monetary policy has been too credible, with the result that inflation has been too low.
Nonetheless, Japan is one of several countries, along with Switzerland and China, where inflation has failed to take off. It is surely worth asking why, rather than excusing the Bank of England by dismissing the recent surge in inflation as “global”.
It is, of course, important to keep an open mind on what changes might be made. But other central banks have different inflation targets and policy horizons. The Bank could also be asked to target other variables, such as nominal GDP.
At the very least, it might be good to choose independent members of the MPC with more diverse views, including on monetary economics. The selection process itself is opaque. Candidates are nominated by the chancellor, but more than one recent pick has raised some eyebrows, and their appointments are only rubber-stamped by the Treasury Select Committee.
Wherever any review ends up, the independence of the Bank of England should not be a free pass to avoid any scrutiny or criticism. Decisions made by central banks have a huge impact on the economy and on peoples’ wellbeing, including the distribution of income and wealth. They must be open to question and debate.
This piece was first published by the Daily Telegraph on 20th July 2022