The golden age for central banks is over. That much was plain from the two-day shindig held by the Bank of England to mark the 20th anniversary of its being granted independence by Gordon Brown within days of Labour coming to power in May 1997.
Many of the participants were critical of the bank – some sharply so. Adair Turner, former chairman of the Financial Services Authority, used a footballing metaphor to describe Threadneedle Street’s record: a game of two halves with a strong performance in its first decade but dire since the onset of the financial crisis in 2007.
The numbers do not lie. In terms of productivity and living standards, the last 10 years have been by far the worst in modern times. To extend Turner’s metaphor, it has been relegation form and in the Premier League such bad results over so prolonged a period would mean the sack.
When he was chancellor Alistair Darling fleetingly thought about firing Mervyn King, and relations between the Treasury and the bank were at a particularly low ebb in 2008, but the story of the past 10 years has been of governors being granted more power rather than being shown the door.
So whereas in the first 10 years after independence the bank was essentially a monetary policy institute that spent its time tweaking interest rates to hit the government’s 2% inflation target, it now also takes on financial responsibility.
Threadneedle Street has two powerful committees: a monetary policy committee that has been using interest rates and quantitative easing to try to get the right balance of growth and inflation; and a financial policy committee that has the power to rein in bank lending if it thinks there is a risk of the City repeating the mistakes that led to the crisis of 2008.
But although the bank has become more powerful it has also become more vulnerable. The tools used to manage the economy – ultra low interest rates and quantitative easing – have not led to a sustainable recovery. Rather, they have led to booming asset prices and excessively strong credit growth.
In recent months, the bank has been publicly voicing concerns about the 10% annual increase in unsecured borrowing but this is, to be frank, a bit rich. Credit is growing fast because 0.25% interest rates, QE and inducements to the commercial banks to lend have made borrowing easy and cheap. Put simply, the bank’s financial policy committee is now trying to mop up the problems caused by the bank’s monetary policy committee.
To make matters worse, the bank’s decisions have helped some sections of the population more than others. Soaring asset prices have been great for property owners but terrible for young people with dreams of getting a foot on the housing ladder. 
As Andrew Tyrie, the former chairman of the Commons Treasury select committee, put it at last week’s conference, many people have no memory of the years when inflation was routinely high but they are fully aware of the distributional consequences of the policies that have been used to fight deflation.
Clearly, there are other reasons for Britain’s housing crisis. Mark Carney, the bank’s governor, routinely (and rightly) states that Threadneedle Street does not build a single house. Yet the fact that the bank can influence the demand for property but not its supply suggests that the current structure of independence is not working properly. Housing policy is highly political, which is why Brown is suggesting the creation of a strategic oversight body – involving the chancellor and the governor – to look at financial policy.
Carney was pretty sniffy about this idea, but Brown has a point when he says such a system would provide the bank with some much-needed political cover by ensuring that ministers could not walk away from their responsibilities.
That said, the idea that the bank can be de-politicised is for the birds – and always was, because giving technocrats the power to set interest rates is in itself a political decision. The fact that the way the bank operated was relatively uncontroversial in the first 10 years after independence is neither here nor there.
What is true is that today’s central banks have become more overtly political. Mario Draghi, president of the European Central Bank, regularly lectures eurozone governments on the need for structural reform. Brown bridled at the way King called on his government to take action to reduce the budget deficit during the financial crisis. And, of course, the Bank of England courted controversy with its warnings of the potential economic consequences of both Scottish independence and Brexit.
Central banks have become more political as their performance has got worse and therein lies the danger for them. To take one obvious example, the Bank of England is currently gearing up to raise interest rates for the first time in more than a decade, with strong hints that the decision will come at the next meeting of the MPC in early November.
The thinking behind the move is that ever-decreasing unemployment will lead to higher inflation unless policy is tightened now. But there is not a lot of evidence of a looming wage-price spiral and unless one starts to develop, the annual inflation rate should start coming down over the next few months as last year’s drop in the value of the pound ceases to have an impact on import prices. At no time in the past 20 years has the bank raised interest rates when the economy is as weak as it currently is, so the dangers of the MPC getting it wrong are obvious.
Now, no politician is going to strip the Bank of England of its independence because it makes the wrong call on interest rates, especially since that decision could swiftly be reversed.
But here’s the position. Central banks failed to spot the last crisis coming, assuming wrongly that excessive credit growth didn’t matter because inflation was low. The tools banks deployed to deal with the crisis of a decade ago have boosted asset prices but not the real spending power of ordinary citizens. Household debt is rising and the whiff of Groundhog Day is unmistakable. All this at a time when voters cut elites far less slack than they once did.
So imagine the worst happens and there is another crash. At the very least, central banks will be forced to come up with some new ways of stimulating their economies. Ideas that are currently frowned upon – targeted QE or straight cash payments to voters – will become mainstream.
Central bank infallibility was always something of a myth. Much of the decline in inflation in the 1990s and early 2000s was due to globalisation rather than the brilliance of central bankers. The crisis has exposed that myth. It probably wouldn’t take that much for politicians to decide to take back control. In footballing parlance, one more heavy defeat would do it. – Guardian News and Media


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