In a 30-year rollercoaster, the Bank of England and Treasury have built resilience into the British economic and monetary system. Yet much could still go awry. Federal Reserve veteran Don Kohn, now on the Bank of England’s financial policy committee, summed up the mood at an OMFIF seminar on BoE modernisation: ‘Now we have a very good system of committees, it works well together, there’s good overlap. The Bank of England is unique in having so much authority in one place. That doesn’t mean that something isn’t going to happen that can catch everyone by surprise.’
The drawn-out transition at the apex of British economic policy-making, studded with setback, intrigue and relentless financial globalisation, has helped the UK weather the twin trials of the Covid-19 crisis and European Union withdrawal. At the 23 November broadcast launch of Princeton historian Harold James’ Making a Modern Central Bank, leading actors from across the policy spectrum in the UK, US and Europe examined the Bank of England’s restructuring and operational independence in 1979-2003 – as well as the consequences for today. The message was: the toughest tests are still to come.
Ed Balls, former shadow chancellor of the exchequer, a prime architect of the incoming Labour government’s 1997 move to give the Bank monetary policy independence, urged further reform. Balls suggested a Treasury-Bank of England oversight committee, firmly led by the Treasury as the repository of political and funding power, to protect the Bank from over-exposure to financial risks caused by its mandate expansion. ‘It’s worrying that the Bank has taken greater responsibility and de facto accountability [for financial risks] but this has not come with increased transparency.’
Norman Lamont, chancellor in 1990-93, who backed Bank independence before the 1997 election in exchanges with future Labour government leaders Tony Blair and Gordon Brown, voiced anxiety that central banks are overburdened with multiple responsibilities including climate change. Mervyn King, chief economist and deputy governor during the 1990s modernisation, who took over as BoE chief from Eddie George for 10 years from 2003, termed ‘a serious mistake …. that central banks are the answer to every problem, that any bad news should result in central bank action.’
Otmar Issing, president of the Frankfurt Center for Financial Studies, former Bundesbank and European Central Bank chief economist, energetically supported Lamont’s and King’s view. Central banks were deeply constrained by inability to stand up to politicians. ‘They are now responsible for anything, from green policies to redistribution. It’s a trap. Getting out of this trap is a tremendous challenge.’
DeAnne Julius, the US economist who was a founder member of the Bank’s monetary policy committee in 1997-2001, underlined the Bank’s difficulties in responding effectively to the Covid upset because of near-zero interest rates and diminishing returns from quantitative easing. Both she and Kohn rejected Balls’ proposed overhaul. ‘We already have enough committees,’ Julius said.
Paul Tucker, former Bank deputy governor, who narrowly missed the top job in 2013, now chairing the transatlantic Systemic Risk Council, called for change in the Bank’s financial policy committee to make it more transparent and accountable to parliament. He, like others, pointed to flaws in Bank and Treasury structures in the early 2000s that contributed to the 2008 financial upset. ‘We thought: “It will work in peace time but it’s not going to work in a crisis.”’
King confirmed how Britain’s September 1992 exchange rate unrest marked a parting of the ways. The former governor, who has since emerged as a proponent of EU withdrawal, emphasised how the UK was never close to joining monetary union. After Britain’s forced withdrawal from the exchange rate mechanism, when King took part in a humiliating journey to the Bundesbank in a vain bid to persuade the Germans that the UK had the right exchange rate, ‘It was clear that the UK and Europe were going to move in different paths.’ The ERM exit was a ‘shattering defeat for government policy’. But, King added, it freed the UK for a new monetary regime and set monetary union in train.
Issing – who first met King on his failed Frankfurt mission on 14 September 1992 – stated: ‘Fixed exchange systems force central bankers to lie [ahead of devaluations].’ After 1992, Issing said, the UK and continental Europe ‘followed different paths in terms of sovereignty’. He added that the dramatic meeting with King was the beginning of a long-lasting friendship ‘like in Casablanca’ – a reference to the encounter between Humphrey Bogart and the police chief in the celebrated 1942 film.
The seminar discussions served the wide range – often accompanied by financial market turbulence and political infighting – of the Bank’s 1980s and 1990s adjustments, as well as their relevance for today. Here are highlights.
Wider and narrower focus
Barry Eichengreen, central bank historian and professor at Berkeley, University of California, said no other developed country central bank had undergone the same amount of turmoil since 1979. The only other examples were Argentina and Brazil. James recalled that, up to the 1990s, the Bank had not had a clear mission statement in 300 years. Driven by the independence decision, prepared by Brown and Balls in secret and accompanied by a contested removal of banking supervision as well as transfer of the Bank’s debt management functions, the Bank narrowed its remit to focus on monetary policy – a shift favoured by King. Following the 2008 financial crisis, where King claimed the Bank had seen warning signals but was powerless to take remedial action, the Bank has now again widened its responsibilities. ‘You might think multi-tasking is a cool thing to do,’ James commented, ‘but you have to consider the problems it brought in the 1970s.’ Speakers left open whether a circular shift back to a narrower focus might take place in future.
How much ‘modernisation’?
Charles Goodhart, emeritus professor at the London School of Economics and Political Science, who joined the Bank in 1969, was chief adviser in 1980-85 and was on the first monetary policy committee in 1997-2000, queried the degree of ‘modernisation’. It was less that the BoE was amateurish or unprofessional pre-‘reform’, more that the institutional framework required it to be focused on ‘markets’ rather than ‘economics’. He said: ‘There wasn’t much modernisation from the 1990s into the mid-2000s. Procedure determines performance. The structure changed but this was not modernisation.’ Lamont said: ‘Any idea that the bank was hopelessly amateurish in 1970s and 1980s is wrong – governors were very professional.’ William Keegan, senior economics commentator at The Observer, who worked at the Bank in the 1970s, probed another aspect. He recounted ‘stuffy’ BoE personnel procedures in the 1980s which had subsequently been reformed.
Impotence and inaction ahead of 2008 crisis
Several speakers dwelled on how monetary stability in the early 2000s created moral hazard by convincing financial actors that they would be protected from the consequences of excessive risk-taking in what appeared permanently benign conditions. This was a time when warnings abounded about a possible financial crisis, not least from William White, chief economist at the Bank for International Settlements. The advice was heard – but no action followed. Responding to King’s admission about signals of stress in the monetary policy committee, Tucker opined, ‘They [in the bank] saw financial crisis coming but had no powers.’ Balls said, ‘Paul is right – we knew by 2006-07 that the system wasn’t working.’ He admitted that he and his team of advisers at Gordon Brown’s Treasury ‘war gamed’ securitisation-driven financial failures. ‘What became clear was that the Financial Services Authority, BoE and Treasury weren’t looking hard enough at what was happening in the real world – the war games highlighted this.’ Patricia Jackson, who headed the Bank’s financial Industry and regulation division in 2004-13, said after the separation of supervision in 1997, the BoE ‘was not close enough to what was happening in the banks… There was a belief held by some in the Bank that asset price inflation should not be dealt with by monetary policy. But a better understanding of the risks building up in the banks might have led to a different answer. Monetary policy should have been used for that purpose.’
Supervision – past, present and future
The counterpoint to establishing an independent monetary policy committee was transfer of the Bank’s supervisory activities to an enhanced Securities and Investment Board (later the FSA). Jackson opined: ‘The FSA didn’t have sufficient data and concentrated on conduct risk, not prudential risk. Regulators failed to heed the risks built up in commercial bank ownership of residential mortgage-backed securities.’ As for the future, Jackson said the biggest risks came from non-banks. ‘Risk is like water, it flows around the system.’ The question was how to track the interlinkages. ‘It’s almost impossible for national supervisors to get global information – there is a fault line running under this multi trillion market.’ One of the aims of the present-day Financial Stability Board was ‘to get more information on global markets’.
Steps behind technology
David Scholey, former chairman of SG Warburg, a BoE director in 1981-98, answered the question: ‘If banks don’t know what is going on, how can their regulator?’ He said ‘scientists in Chicago’ took two years to work out the derivatives position of UBS, the Swiss bank which subsumed the Warburg business after Swiss Bank Corporation took control of Warburg in 1995. ‘There was not a hope in hell for regulators to know what’s going on.’
Peter Middleton, Treasury permanent secretary in 1983-91, Barclays chief executive and then chairman in 1998-2004, said he was ‘not very confident about the future of supervision’. In view of technological advances, ‘How will you know you are supervising the right thing at the right time?’
Ian Plenderleith, BoE executive director in 1994-2002, who then became deputy governor at the Reserve Bank of South Africa, said, ‘The art of financial regulation is to be only one step behind.’ Middleton countered: ‘That is becoming a bigger and bigger step.’
Exchange rate- to inflation-targeting
Eichengreen emphasised the speed of the BoE’s post-1992 shift from exchange rate- to inflation-targeting. He highlighted that no central bank around the world had ever abandoned this policy. Lamont related how the path to inflation targeting was a more gradual approach laid down not by the Bank but by the Treasury. He stated that James’ book was overly based on BoE documents and didn’t pay sufficient heed to Treasury work. Parts of the book reminded Lamont of the Tom Stoppard play about Rosencrantz and Guildenstern – ‘people offstage discussing events elsewhere that they were not involved in.’
Lamont – who was against ERM membership in 1990 and tried to convince Prime Minister John Major to leave the system earlier – confirmed the view from James’ book that without ERM membership the UK would not have had the discipline and tools to bring down inflation. King termed as the major lesson from the 1980s that exchange rate pegs were extremely vulnerable to speculation when shocks altered the underlying exchange rate. Germany required revaluation after reunification in 1990. ‘In hindsight, maybe it might have been better for British policy in the early 1980s to focus on the exchange rate and in the late 1980s to have focused on domestic monetary indicators. The reverse of what happened.’ Once inflation targeting was established and the independent MPC set up, Julius highlighted the importance of diversity on the nascent body. ‘We all had different personalities and different approaches of looking at the data. The MPC was supposed to independently challenge others in the Bank.’
The Bank and Whitehall
Treasury veteran and former Barclays chairman Middleton said: ‘There isn’t a perfect structure for the central bank and Treasury, this relationship changes depending on the system it operates in.’ Julius affirmed it was ‘extremely important’ that the Bank retained its independence given its role in purchasing very large quantities of government debt under present-day QE. Tucker underlined ‘very complicated relationships between the personalities’ in the 1980s-2000s. He related how the Treasury tried to stop George from becoming deputy governor in 1990 and warned him, when appointed, this did not mean he would get the top job. Prime Minister John Major tried to block George from the governorship in 1993, although Lamont as chancellor backed him. King said the Bank had not been expecting independence in 1997, which was not in the Labour party’s manifesto and had not been discussed in the British cabinet. It was a ‘big surprise [but] the view was: “Even if it means giving up debt management and bank supervision, it is worth it.”’ Balls justified the pre-1997 election secrecy because his boss Gordon Brown did not wish to politicise interest rates. The Bank was known to favour higher interest rates than the Tory government. Labour didn’t want to impede its chances of election success by suggesting that voting Labour would bring tighter credit.
Goodhart emphasised how James, in describing the episodes of the 1980s, had been ‘too kind’ to Prime Minister Margaret Thatcher, whose knowledge of monetary affairs was based on instinct rather than analysis and was too dependent on insufficiently informed foreign advisers. James recounted how Alan Greenspan, the Fed chairman, and Karl Otto Pöhl, Bundesbank president, both played important roles in the changes in the UK monetary regime and development of Bank of England independence. (Greenspan played a role in the granting of operational independence under Gordon Brown.) John Major and other ERM sympathisers arranged for Greenspan to telephone Thatcher on the eve of joining the ERM in 1990, to tell her that the mechanism was a new form of gold standard. Thatcher regarded Pöhl as a model central banker. She told Robin Leigh-Pemberton, governor in 1983-93, to sign up on the late 1980s Delors committee on monetary union to anything that Pöhl agreed. She later told interlocutors – including Issing, who met her in 1995 – that she was disappointed that Pöhl had not blocked the euro. ‘He was not a fighter.’
Accountability, communication, independence
The Bank of England modernised its communications at the end of the 20th century away from written missives to verbal interactions. James emphasised how George, governor in 1993-2003, was known as ‘silver-tongued.’ David Walker, the high-flying executive director responsible for finance and industry in the 1980s, was named ‘Walker the talker’. James added how the 1990s saw a new move on the provision of BoE data and statistical presentations to a wider audience than the internal debates (written or verbal) that constituted the old UK ‘macro-economic executive’. Goodhart emphasised how Bank economists gained much greater standing after 1997. ‘Previously, the chancellor listened only to his own economists.’ This meant that the Bank, to gain leverage in the Treasury, focused on market analysis – a style epitomised by George – telling ministers ‘markets won’t wear that’. Today, Goodhart said, ‘It is the Bank forecasts that matter more than the Treasury’s.’
Getting the message across
Plenderleith stressed the importance – irrespective of the supervisory framework – of effective communication between monetary policy-makers and the different regulatory branches. This applied to his view on the future of supervision: ‘Financial structures always change, they are pretty puzzling. Eventually you do find a way to understand what is going on – through dialogue, codes, laws.’ Balls recalled that independence in 1997 was the alternative to the UK joining the euro rather than a step towards it. ‘It was right to frame it in the appropriate institutional arrangements.’ In view of interlinkages between monetary and fiscal policy, Balls highlighted the importance, two decades later, of communication and clear structures between the Bank and Whitehall. ‘It’s not clear where the BoE lender of last resort ends and then government balance sheet starts.’ He raised questions on information flows within the Bank of England and its committees, the Financial Conduct Authority and the Treasury. ‘How does this information flow at times of crisis, what is the level of accountability?’
In terms of today’s central bank-government structure, Plenderleith argued for a pragmatic approach which recognised the linkages between fiscal and monetary policy. ‘We shouldn’t be perfectionists, one has to do the best one can in these difficult circumstances – the Bank has clear set of core responsibilities, but also clear that it is being drawn into more peripheral activities. The critical question is where the Bank can make a useful contribution and where it can’t. Today, the Bank has to do whatever it can to help, it can’t say in the face of one of the biggest crises (whether Covid or climate) that we can’t do anything about this.’ Keegan pointed out one of the notions behind the MPC was that the Bank governor should not become a dominant public figure. Reality had turned out differently. ‘Mervyn King was, and Mark Carney was – will Andrew Bailey [the present governor] be the same?’
David Marsh is Chairman and Ellie Groves is Deputy Head of Programming and Europe Manager at OMFIF. Contributions from Diana Berbece, Danae Kyriakopoulou, John Orchard, Pierre Ortlieb. Read the book reviews by John Nugée and Paul Tucker.
Photo: Mark Cornelius