On May 6, 1997, just 4 days after coming to office in what was to become Tony Blair’s retrogressive regime, the then British Labour Chancellor Gordon Brown announced that Labour would legislate the so-called independence of the Bank of England. The BBC claimed this was the “most radical shake-up in the bank’s 300-year history”, which gave “the bank freedom to control monetary policy”. Gordon Brown’s legacy to the British people, of course, is in his famous ‘light touch’ regulation, which he boasted about in the lead up to the GFC but went silent about soon after. But he has come out of the woodwork recently to reflect on his decision to set up the Monetary Policy Committee (MPC) within the Bank of England and abandon the practice where the Chancellor and the Governor of the Bank would meet on a monthly basis to determine interest rates. He claims that decision kept Britain out of the euro and was a great success. But then in the same speech he railed against the ‘political’ intrusion of the MPC into broader fiscal policy debates and its failure to conduct monetary policy correctly during the GFC. A very confused narrative. The point is that central banks can never be independent of treasury departments and the claims to the contrary were just part of the depoliticisation of policy that accompanied neoliberalism. Brown is also wrong that setting up a separate MPC kept the nation out of the euro. Britain realised the euro would be a disaster long before 1997.
Of course the Bank of England is wholly owned by the British government after being nationalised in 1946 under the Bank of England Act 1946.
That Act transferred the Bank stock to Treasury. And the Chancellor and Prime Minister still wields the selection wand.
When the British Labour Government gave the Bank of England its so-called ‘independence’ it abandoned the system where the Chancellor (representing the Treasury) would meet on a monthly basis with the Governor of the Bank and they would agree on interest rates.
Instead, it created a new Monetary Policy Committee, which according to the Bank of England Act 1998 shall consist of:
(a) the Governor of the Bank,
(aa) the Deputy Governor for financial stability,
(aaa) the Deputy Governor for markets and banking,
(ab) the Deputy Governor for monetary policy,
(b) one member (to be known as the Chief Economist of the Bank) appointed by the Governor of the Bank after consultation with the Chancellor of the Exchequer, and
(c) 4 members appointed by the Chancellor of the Exchequer.
And the Chancellor essentially vets the 4 members.
But even more significant is that the Court of Directors (which consists of the Governor, 4 Deputy Governors and 9 non-executive members) are appointed by Her Majesty on advice from the Chancellor and Prime Minister.
So to claim that their is no political role played in all these appointments and the Monetary Policy Committee is truly independent is rather farcicial.
The only difference after 1998 is that Governor and the MPC decide interest rates without a meeting with the Chancellor, which just means things operate indirectly now.
But more importantly, there is a crucial sense in which the central bank and treasury can never be independent and must work together to determine monetary policy.
Modern Monetary Theory (MMT) also considers the artificial distinction between monetary and fiscal policy as presented in the textbooks to be problematic and largely obscures the essential transactions that go on and their impact.
Please read my blog – The consolidated government – treasury and central bank – for more discussion on this point.
A more interesting way of thinking about fiscal and monetary operations is presented by MMT by analysing what happens to the net worth of the non-government sector as a result of a government policy change (central bank or treasury).
So a fiscal operation is considered to be one which changes the net financial assets (net worth) held by the non-government sector. A monetary operation does not and only alters the portfolio composition of net worth held by the non-government sector.
Now, the central bank is required to manage the reserves in the system – the liqudity that banks keep in special accounts with the central bank, which allow the payments system to operate.
In usual times, the central bank targets a non-zero policy rate and to maintain that rate it must ensure there are no excess or shortages of reserves in the system.
For if there was, competition in the Interbank market (where banks loan each other reserves) would shift the overnight rate up or down and away from the target policy rate.
Please read the following introductory suite of blogs – Deficit spending 101 – Part 1 – Deficit spending 101 – Part 2 – Deficit spending 101 – Part 3 – for basic Modern Monetary Theory (MMT) concepts in this regard.
As explained in this suite of blogs, treasury policies (fiscal deficits etc) have a daily impact on bank reserves. Fiscal deficits add to reserves after all the transactions have been finalised.
If the central bank is to manage the liquidity (reserves) at appropriate levels it has to take into account the treasury impact every day of the year. If there are excess reserves created by fiscal deficits then the central bank has to drain them with open market operations (selling public debt to the banks in exchange for reserves) or offer a support rate on the excess.
Either way, it has to work closely with treasury departments to ensure it can anticipate the pattern of spending and taxation likely each day and the extent it has to intervene to maintain the appropriate level of reserves.
So in that sense there is no way in which the central bank is independent.
It is also clear that central bankers have been increasingly making statements about the fiscal stances of various governments, and, in the case of the ECB, has become a quasi-fiscal authority despite the bans of such activity in the Treaty of Lisbon.
Central bank independence is thus only a convenient ruse – a chance to depoliticise (in the public eye) major macroeconomic policy decisions.
The UK Guardian article (September 6, 2008) – Don’t bank on the bankers discussed this move to depoliticise policy under neo-liberalism.
We read that:
… it is perhaps not surprising that even his most widely-celebrated policy innovation – the “independent” central bank – should come under scrutiny …
what is really remarkable about an independent central bank is that it is a major step away from democratic government. The price we pay, in other words, is not just an economic one, but is a significant weakening of our democratic institutions. What is identified as the over-riding issue in economic policy is now the exclusive preserve, not of elected governments, but of unaccountable officials.
The article also highlights the obvious points that the neo-liberals hide.
How this has been accepted is even more of a mystery when one considers that the “independent” central bank is in no sense objective or neutral. It is a bank. Its main clients are banks. It is staffed by bankers. It can be relied upon always to put the interests of the financial establishment ahead of those operating in the rest of the economy. Our economic policy is, in a very real sense, made in the interests of the holders of existing assets rather than of those who live and work in the real economy where new wealth is created.
This bias seems more extreme the longer one looks at it. Not only has the Monetary Policy Committee ensured that the productive sector should bear the burden of its counter-inflationary measures but it seems also to have deliberately averted its gaze from the factor that really is the primary cause of inflation – the huge rise in bank lending.
Further, it is also clear that banks like the ECB certainly doesn’t respect the concept of independence.
Article 127(1) and 127(2) define the role of the ECB. It is clearly not responsible for enforcing European Commission dictates with respect to the Member States about fiscal policy, labour market policy, product market policy or anything else like that.
Yet, over the course of the crisis, that is exactly what it has been doing.
Remember when on August 5, 2011, the head of the ECB wrote to the Spanish Prime Minister José Luis Rodriguez Zapatero. In that – Letter – the ECB esentially told the Spanish government to cuts deficits, cut wages, and further deregulate the labour market.
This was direct interference from the unelected central bank in the working of a democratically-elected national government.
It demonstrated how involved the ECB was in pushing the Troika line, which is not the impression it gave back at the time and also demonstrates that the neo-liberal concept of independent central banks is another one of those myths that allow policy makers to deflect responsibility for poor decisions that damage the prospects of people.
There are many examples I could give of such interference.
Please read my blog – The sham of central bank independence – for more detailed discussion on this point.
Extending that logic further, a reasonable application of MMT understandings would see central banks collapsed into a transparent Treasury operation.
Then all economic policy is accountable through the democratic process and this period of central bankers deliberately causing unemployment but not being accountable for their actions would be gone.
Which brings us back to Gordon Brown.
Gordon Brown’s record and that of the Blair government, in general, has been thoroughly discredited since their demise. Their approach to financial markets was nothing short of disastrous and that was demonstrated in spades when the British banking system crashed in 2008-09.
Remember Brown’s classic – Speech – to the Confederation of British Industry (CBI) on November 28, 2005:
The better, and in my opinion the correct, modern model of regulation – the risk based approach – is based on trust in the responsible company, the engaged employee and the educated consumer, leading government to focus its attention where it should: no inspection without justification, no form filling without justification, and no information requirements without justification, not just a light touch but a limited touch.
The new model of regulation can be applied not just to regulation of environment, health and safety and social standards but is being applied to other areas vital to the success of British business: to the regulation of financial services and indeed to the administration of tax. And more than that, we should not only apply the concept of risk to the enforcement of regulation, but also to the design and indeed to the decision as to whether to regulate at all.
The risk-based approach badly failed and was always going to fail.
Now Gordon Brown is still trying to remain relevant in some way by claiming that the Bank of England is getting hijacked by “populism”.
Last week (September 28-29, 2017), the Bank of England hosted a conference – Independence – 20 Years On – which reflected on the two decades of operation since Brown set up the Monetary Policy Committee.
Gordon Brown gave the first keynote speech on “The history of independence”. You can watch the stream of session – HERE – although I wouldn’t waste time (as I did).
The recent UK Guardian article (September 28, 2017) – Bank of England at risk from populism over economy, says Brown – discussed the Speech.
Brown claimed that the discord in society over the failure of neo-liberalism – although he didn’t express it this way, rather calling it ‘popularism’ as a put down – might lead to pressure on politicians to reverse the decision to create the MPC – “take back control” is how he put it.
He proposed another layer of farce to keep up the pretence – “the creation of a joint Treasury-Bank strategic oversight to assess risks to the economy, saying it was unfair for Threadneedle Street to be blamed for policy failures in areas it did not control.”
He now claims that “leaving decisions solely to experts was not feasible” which is an admission of failure if there ever was one.
Brown, correctly pointed out that when he set up the Monetary Policy Committee it was intended that the Bank would only comment on monetary policy (ostensibly, at that time, interest rate settings) and never comment on fiscal policy.
However, at the recent Bank of England conference, Brown said that:
The Bank should also not meddle in areas that were the exclusive preserve of politicians … launching a strong public attack on its calls for action to reduce Britain’s budget deficit during the deep recession of a decade ago.
The Bank of England, like other central banks, engaged in high-profile and politically damaging public commentaries about fiscal matters and other economic policies beyond their ‘legal’ remit, thus compromising the public divide between monetary policy and fiscal policy.
The politicians thought they were creating some division between the two arms of policy in the eyes of the public but these central bank interventions just reinforced the obvious fact that politics was woven through the entire structure of macroeconomic policy making, which then raised questions of accountability and democracy.
The central bankers were appointed and not directly accountable to the people. Their constant interventions into broader economic policy matters thus blurred the link between voters and decision makers.
This was one way in which economic policy making had been depoliticised although in this case the external authority often turned against the elected representatives rather than gave them a convenient scapegoat to divert political blame.
Brown documented the several ways in which the Bank overstepped its remit during the GFC. After failing to cut interest rates when Britain entered recession:
A few months later, the Bank was trying to tell the government what to do about fiscal policy … If we do not understand that in an democratic system you’ve got to get the right balance between expertise, accountability and leadership, then anti-globalisation protests will rise.
And “‘take back control’ movements” will “gain even more support in the years to come”.
And that point, he presented a confused story. While criticising the central bank for its interventions into fiscal policy and its failure to cut interest rates in 2008, he then claimed that:
Independence for the Bank of England has been not just been a technical success, but also avoided many of the problems that might have taken us into the euro early, and pushed us out of the euro very quickly afterwards …
He also inferred that “the depoliticisation of interest rates had kept Britain out of the single currency, because it had created a better monetary regime than that of the eurozone”.
So which way is it?
Britain didn’t enter the euro because Margaret Thatcher clearly understood that surrendering national currency sovereignty would be disastrous. She used that currency sovereignty for ill but at least she understood its importance.
She knew that fiscal policy control was crucial. It was British Labour (and John Major) that were obsessed with ‘more Europe’ but economic events curtailed their ambitions in this regard.
When Margaret Thatcher’s star began to wane and the pro-European John Major replaced Nigel Lawson as Chancellor, the Tories turned towards joining the European Exchange Rate Mechanism (ERM), the precursor to the euro.
The decision confronted British jingoism (Thatcher’s anti-German sentiment) with the ahistorical ideology of Monetarism, which were both in play during the Thatcher years.
Drawing on the Monetarist influence, Major and Foreign Secretary Douglas Hurd argued that Britain could expunge the high inflation left over from the oil price shocks if it tied the pound to the German mark, which was equivalent to saying that the Bank of England would passively follow Bundesbank interest rate policy.
At the time the Bundesbank was pushing interest rates up beyond the level that would be considered appropriate for a recessed British economy.
Major and Hurd won over Thatcher and Britain joined the ERM on October 8, 1990, while mired in a deep recession with an overvalued currency (2.95 marks per pound).
Once Major took over as Prime Minister in November 1990, following Thatcher’s demise in the same month, the British Government touted Britain’s membership of the ERM and the so-called ‘inflation anchor’ as its major anti-inflation strategy.
It was a very misguided decision.
While the pound was allowed a 6 per cent fluctuation band as a starting point, informed observers believed that the Bank of England would never be able to sustain the currency within that band.
The obvious happened and while tying the pound to the mark lowered inflation, it was at the expense of a deepening recession and worsening unemployment.
By the ‘Summer of ’92’, the pressure on the pound was unbearable. The foreign currency markets clearly believed that the pound would be devalued despite the on-going political resistance to the idea.
The Government’s response was to push up interest rates to 10 per cent and instruct the Bank of England to intervene heavily in the currency markets to maintain strong demand for the pound.
This just worsened the recession. It was also a finite strategy because eventually the Bank’s international reserves would be depleted if the speculation against the pound continued.
By September 1992, the only buyer of the pound in the currency markets was the Bank of England such was the speculative sentiment against it.
Then Black Wednesday (September 16, 1992) arrived and the rest is history. Britain was forced to withdraw from the ERM and float the pound and regained its policy independence.
At that point, it distanced itself from the madness that was going on in Europe, which would become even more insane by the turn of the century.
The crisis was a chance to distance itself from the EMU forever. Brexit is just finishing off the work really.
But that history suggests that Brown’s revisionist claims are just to save his own face. It was not his actions in 1997 that kept Britain out of the euro. The reality that it would be a disastrous shift was driven home on Black Wednesday, 5 years earlier.
Yet he is correct in noting that democracy is compromised if technical and unelected elites (even if they are appointed by the government) take it on themselves to criticise economic policy decisions taken by elected politicians.
That, unfortunately has been the legacy of these so-called ‘independent’ central banks.
As I noted above, the preferred Modern Monetary Theory (MMT) position is to do away with ‘independent’ central banks and situate economic policy making within the elected government.
I have outlined the logic of that preference and the implications of it in the blogs I have cited above.
Reclaiming the State Lecture Tour – September-October, 2017
For up to date details of my upcoming book promotion and lecture tour in Late September and early October through Europe go to – The Reclaim the State Project Home Page.
The updated correct details for the Paris event on October 6 are now available.
Today, I am travelling to Helsinki from Milan for private meetings. There is no public event in Helsinki today. Last night’s event in Milan was quite different and a video will be posted in due course – the event highlighted the depth of the European Groupthink with one Italian official claiming the euro had been a massive success delivering benefits that were beyond imagination. He clearly hasn’t looked out the window of his very well-paid office job.
But that has been a repeating narrative. The elites in the system – bankers, economists associated with the Commission, politicians – have made comments at our events along those lines. Massive benefits – far outweighing any costs. Yet, all the other participants that attend – workers, students, and people from all walks of life – say the direct opposite.
Tomorrow, we will have a dual book launch – Reclaiming the State (William Mitchell and Thomas Fazi, Pluto) and Exits and Conflicts: Disintegrative Tendencies in Global Political Economy (Heikki Patomäki, Routledge).
The event will be held in PIII in Porthania, University of Helsinki, City Campus starting at 11.15. It will go for around 90 minutes and entry is free and all are welcome.
On Thursday, October 5: I will be giving a public lecture at the University (Lecture Hall 5, Main Building) from 16:00. Entry is free and all are welcome.
The next and last stop after that is Paris.
That is enough for today!
(c) Copyright 2017 William Mitchell. All Rights Reserved.