HAMISH MCRAE: What to do with the Bank of England? We need fewer smart academics and more people with proven financial judgment
Under pressure: bank boss Andrew Bailey
What to do with the Bank of England There will be tremendous political pressure to change the way monetary policy is run, but there is a real risk that the new prime minister and cabinet will make things worse, not better.
The bank made a monumental failure not only to control inflation now, but a year and more ago to understand how serious the threat could become.
This is a collective failure of central bankers. The bank seems to think the inflation outlook is worse here than in the US or Europe, and that may be true.
But the most recent numbers are broadly similar: 9.4 percent of the CPI here (and 8.2 percent of the CPIH measure, which includes housing costs). This compares to 9.1 percent in the US and 8.9 percent in the euro zone.
What is different is that the Bank of England is in full panic while both the Federal Reserve and the European Central Bank are even more bullish. Fed Chair Jerome Powell said last week that he was not trying to trigger a recession by raising interest rates, nor did he see a need to do so. The central scenario of the ECB is that there will be no recession either this year or next.
In contrast, the Bank of England expects the economy to contract both next year and the year after. This is far worse than the financial markets are expecting. Bloomberg City Economists Consensus Views expect growth to be 0.6 percent in 2023 and 1.5 percent in 2024. I would side with the markets in this regard.
As for inflation, well, maybe the bank is right in warning of a peak of 13 percent by the end of this year, but that also seems overly pessimistic. Much depends on wholesale gas prices, which could skyrocket if Russia shuts off supplies entirely. But overall energy prices are falling. Brent oil was trading at $93 a barrel on Friday.
That’s well below its peak of $122 in March, and actually a tiny bit lower than on Feb. 23, the day before Russia invaded Ukraine. Sterling has fallen against the dollar, which is why petrol and diesel prices have not fallen much. But this is really a strong dollar story. At €1.18, the pound is at the top end of its five-year trading range against the euro.
In short, I think the bank overcompensates for its past complacency by being overly gloomy now. But this newfound caution will not stop calls for reform. What are they supposed to be?
Let’s let go of the idea that the bank should be under more direct political control. That would be crazy. Not only are politicians probably even worse at setting interest rates than central bankers, no smart person would want to take the blame when things go wrong. However, as part of the democratic process, central bankers must ultimately be accountable to society. So the challenge is to take what we have and try to make it work better. I see two ways to do this.
Firstly, the mandate of the Monetary Policy Committee must be considered. For now, inflation is to be kept around a central point of 2 percent and offset by maintaining jobs and growth. It makes sense to keep that. It’s simple and straightforward.
But I propose to add something: the need to maintain financial stability. So if there is a disruptive force, such as a rise in house prices or even a collapse, the bank would have to take that into account. A year ago that light would have been blinking red. That’s not original. It’s classic central banking.
In 2005, Paul Volcker, the legendary Federal Reserve chairman who crushed the inflationary spurt of the 1970s by raising interest rates to 20 percent, was with us in Oxford – he was giving a lecture and my wife was a college principal. I asked him about inflation targets. He dismissed them as potentially misleading.
What was required above all was stability. That was three years before the bank crash when he was recalled by President Obama to help shape the crisis response.
The other idea is to look at the composition of the MPC to avoid groupthink. This is not to criticize them individually, although the so-called doves who have been pushing against rate hikes must now feel silly.
What we need are fewer smart academics and more people with proven financial judgment. In other words, less reliance on economic models and more on common sense. We certainly need more of that in these troubled times.