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How the Bank of England failed to keep pace with inflation – according to its former policymakers

·6-min read
Bank of England
Bank of England

The Bank of England's mission hasn't changed in more than 300 years. Founded in 1694 to bankroll a war against France, its job then was to "promote the public good and benefit of our people".

Those words survive in today's mandate, though much has changed.

Operational independence, granted by the Government in 1997, was one of the biggest. Every six weeks, Governor Andrew Bailey and eight others, four from within Threadneedle Street and four from outside, meet to decide what the cost of borrowing should be.

Decisions still leave traders on the edge of their seats, but at least their timing is predictable.

In the twilight days of the so-called "Ken and Eddie" show, then-chancellor Kenneth Clarke announced live on BBC radio that rates would be kept on hold, against the advice of Sir Eddie George, the Bank's governor at the time.

But sustained double-digit inflation is calling the Bank's credibility into question. Price rises are expected to hit 13.3pc in the coming months, and remain well above its 2pc target into 2024.

So is it time for a rethink? Many who used to work there think so.

Almost a dozen rate setters told the Telegraph that the Bank was too slow to respond to signs of an overheating economy. Almost all say Bailey and the rest of the Monetary Policy Committee (MPC) failed to spot that domestic price pressures last year weren't "transitory".

Several believe the Bank continued to print money when it was clear the economy was too hot.

Martin Weale, who served on the MPC between 2010 and 2016, says an implicit pledge to continue its almost £900bn bond buying programme tied the Bank's hands. "Putting up interest rates at the same time as continuing quantitative easing (QE) would have seemed very odd. It is almost as though QE became a ball and chain around interest rate policy late last year."

Weale says complacency also played a role. "An important issue globally was central bankers getting scared of finding themselves in a situation of falling prices, where they wouldn't be able to cut interest rates," he adds.

Marian Bell, who served on the MPC between 2002 and 2005, suggests another reason why the Bank was slow to react. She says: "The MPC’s secondary objective of supporting the Government’s goal of strong economic growth may have led the MPC to err on the side of softer policy. This speaks to the risk of having more than one target."

Adam Posen, a rate setter between 2009 and 2012, says "broad-based" inflation in the latest data suggest rates will rise to at least 3pc from their current level of 1.75pc and "potentially" to 5pc because of permanent changes to the jobs market caused by Brexit. He believes both the UK and US will be forced to play catch-up because inflation is starting to become entrenched.

"This applies much more strongly to a small, less credible UK with a depreciating currency, than to the US," he says.

Credibility is the key word here. It's for these reasons that almost everyone believes changing the mandate now would be unwise.

Liz Truss, the favourite to replace Boris Johnson as prime minister, has pledged to revisit the mandate to ensure it is "tough enough on inflation", highlighting that it has not been reviewed properly since it was established by Gordon Brown more than 25 years ago.

Sir Charlie Bean, a former deputy governor who up until last year was an official at the Office for Budget Responsibility, says periodic reviews of the mandate are "sensible" and "improvements always possible".

But he says reviews must be on a "pre-set timetable [...] in order to avoid raising expectations of political interference and destabilising markets". Any sign of political meddling would lead to an "immediate and substantial rise" in borrowing costs. "This would [reverse] the more than 50bps fall that took place when Bank of England independence was announced back in 1997."

Others say unfunded spending pledges could spell trouble. Sir John Gieve, a former deputy governor and senior civil servant, warns: "The Government seems bound to spend more heavily both to protect households against price rises and to increase the budgets for public services; if alongside that they cut taxes and increase borrowing there could be a loss of confidence In the face of persistent slow growth, domestic price pressures, excessive borrowing and a huge current account deficit. This would drive the pound down and interest rates up."

Growing concern over the strength of the British economy has hit the value of the pound in recent months. In addition, faster interest rate rises in the US have seen sterling slide 15pc against the dollar since the start of this year.

More meddling could create a perfect storm for the pound, says Weale, now a professor at King's College London.

"To the extent that politicians may become more involved in setting interest rates, that will weaken the value of the pound," Weale says. "And if you're doing that at the same time as having a marked increase in government borrowing, that could feed into a sterling crisis. Foreign investors would sell sterling because they feared future inflation. And a falling exchange rate would then itself aggregate inflation."

Even those in favour of a radical overhaul say it must be done carefully.

Danny Blanchflower, who sat on the MPC during the 2008 financial crisis, says there needs to be "full analysis of the consequences".

But he adds: "I would certainly change the composition of the MPC which has suffered from groupthink. Blanchflower would strip the Bank's three deputy governors and chief economist of their votes and add more regional representation to the panel. "You certainly don’t need nine members who all live in London and think the same and have no business experience."

Targets are also in focus for the Liz Truss camp. The front runner to become the UK's next prime minister has suggested a new goal for the Bank that would focus on keeping the cash value of the economy growing.

But unlike inflation data, economic growth figures are often revised up to several years later. For example, a double-dip recession in 2012 was later revised away by the Office for National Statistics.

Charles Goodhart, a founder MPC member, says: "These data are less frequent, slower to arrive and are often revised considerably from first estimates. DeAnne Julius, another founder member goes further: "The MPC would be making real-time judgments on interest rates based on data that are inherently unreliable and harder for the public to understand," she says.

Public understanding is of course crucial. Sushil Wadhwani, who joined the MPC in 1999, says: "A full two years after BOE independence, I still encountered confusion about the new framework on regional visits. Any changes to the remit should therefore be approached with care."

So simpler is sometimes better. Many former policymakers were critical of forward guidance, the policy introduced by Mark Carney when he became governor in 2013. Both Weale and Goodhart say it's not the Bank's job to be "clairvoyant", because the outlook for the economy will inevitably change. Goodhart adds: "The less forward guidance, the better. Preferably none."

Founder MPC member Willem Buiter is a fan of the current mandate. "I like [its] lexicographic nature: price stability comes first, and employment, growth and all other things bright and beautiful (climate change etc.) can be pursued only if that can be done without threatening price stability."

Weale is more succinct. "Central banks should just stick to their knitting."