Sunday, 20 September 2015

Is the Bank of England independent?

The conventional answer is “yes”. But that’s challenged by Richard Murphy (who is an economic advisor to Jeremy Corbyn, the new leader of the UK’s Labour Party).

He claims that BoE independence is a sham for two reasons. First, part of the relevant legislation says the finance minister can override BoE decisions in extreme situations. Second Murphy says the BoE didn’t start QE off its own bat a few years ago: rather it was on orders from the UK finance minister that QE started.

I’ll argue below that Murphy is actually wrong there. However the argument is a bit complicated. Here goes.

What does “independence” mean?

First, no CB is truly independent in the dictionary sense of the word and for the simple reason that ultimate power always rests with politicians. Politicians in any country can take direct control of their CB anytime, sacking the existing CB governor if necessary.

What the word “independent” in relation to CBs means is something like this. The CB has for the time being the power to use interest rate adjustments and other elements of monetary policy to determine stimulus, and if necessary override any stimulus decisions by the treasury or politicians. Plus the CB has responsibility for meeting the inflation target.

Indeed, market monetarists, Scott Sumner in particular, are forever make much of the fact that independent CBs can and do override stimulus decisions taken by treasuries: market monetarists call that “monetary offset”.

Murphy’s arguments.

Murphy’s first reason for claiming that the BoE does not have independence appears in his article entitled “Why the Bank of England’s independence is just a charade”. He points to section 19.1 of the Bank of England Act 1998 which says “The Treasury, after consultation with the Governor of the Bank, may by order give the Bank directions with respect to monetary policy if they are satisfied that the directions are required in the public interest and by extreme economic circumstances.”

Murphy concludes from that that: “…that is precisely why the Bank of England has always done what the Treasury wants.”

Well that’s just nonsense: the Treasury (aka the finance minister) might well want interest rates cut before election time and purely with a view to winning votes. But there’s no way an independent central bank would do what the finance minister wanted.

In fact that section 19.1 is really just a restatement of the basic political point made above, namely that politicians have the ultimate power to withdraw or override CB independence (CBI) any time. However, actually invoking 19.1 would be a big step for a finance minister or Treasury to take: it would mean a diminution of CBI as defined above. And FREQUENT use of 19.1 would mean the end of CBI.

Moreover it would be difficult to abandon CBI in that way while still pretending that CBI existed. That is, I doubt the “charade” to which Murphy refers is actually possible. Put another way, if CBI were actually withdrawn, it would be difficult to hide the fact, thus any attempt by the finance minister to claim it HADN’T BEEN WITHDRAWN (perhaps with a view to blaming the CB for excess inflation) would just make the minister look idiotic.

Diminution / abandonment of CBI is also a big step to take because it is likely to result in the CB governor asking in a very loud and clear voice what exactly his or her job description now is. That is, the CB governor might say something like: “When first taking this job I was given responsibility for hitting an inflation target and give various tools to do that, but now the treasury seems to have taken over that job. That is breach of contract. So I’m resigning with a view to finding a job that involves real responsibility and power.” As it happens, the former governor of the BoE very nearly did resign when Gordon Brown gave the BoE more independence in 1997.

Let’s summarise so far. Politicians can withdraw independence from CBs any time. But if they do so to any great extent (e.g. by invoking the above section 19.1 too often) then CBI ceases. But in the UK, the existing treasury minister has not done that. So the conclusion is, contrary to Murphy’s suggestions, that the BoE still enjoys independence. QED.

Murphy’s second argument.

His second reason for claiming that BoE independence is a charade is based on a letter from George Osborne to the BoE saying that the BoE can go ahead with £200bn of QE. Murphy concludes: “The fiction of Bank of England independence is blown apart by this letter.”

No it’s not. All that Osborne is doing there is granting new powers to the BoE.

Remember that the QE implemented in the recent crisis was a very novel departure from previous CB practice. That politicians should have a say in granting that new power is not surprising.

And far from REDUCING the powers and independence of the BoE, giving the BoE new powers is arguably an INCREASE in BoE independence.

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