Since the Lib-Tory pact stumbled into power, the economic newswires have been focusing wholeheartedly on the fiscal side of policy – the setting up of the Office for Budget Responsibility (OBR), the tough June Budget, and now all the shenanigans around the independence of the OBR, as Osborne desperately scrambles to repair the damage done by Cameron’s desire to bandy figures about at PMQs. The decision to give the Treasury Committee a veto on the next head of the OBR is a sensible one, but more will need to be done if it is to really take its place as one of the UK’s economic guardians. Meanwhile, however, something interesting – and largely unnoticed behind the first daft vote from Andrew Sentance for a rate hike – has been going on with monetary policy.
Before the election, Osborne displayed the full extent of his economic wisdom by talking about working ‘hand in hand’ with the Monetary Policy Committee (MPC). This was at best naive and at worst just stupid – as the whole point about an independent central bank is that it is, well, independent. As future Chancellor, you should not talk about working with the MPC at all – you just give the Committee its target and lever, and then leave it to work out what to do, in light of your plans for fiscal policy. Far less explicit remarks from Ed Balls earlier in the MPC’s life drew a stinging rebuke from Mervyn King – and, although there have been plenty of other Balls-ups, he gave monetary policy a wide berth thereafter.
I, for one, had assumed that Mervyn would react the same way if Osborne continued to step on his toes. But we have not heard much so far – in part, perhaps, because the MPC has been keeping its head down. It is probably hoping that people will forget its abysmal performance in the run up to the recession, when interest rates were only cut fully six months after the economy had started shrinking. And, despite the move into printing money – fully Â£200bn of it – the Committee’s forecasting performance has been woeful. I, for one, expect another downward revision to its growth forecast when the new figures are released next month – which, by my reckoning, will be at least the eighth downward revision in a row. That is a pattern of repeated errors that might have Einstein worried.
As a result, Mervyn and co have probably felt a little less able to defend their turf. Unfortunately, that means things have been getting worse. This week good old Vince himself was even at it, saying explicitly that there was an understanding that aggressive monetary policy could accommodate the coalition’s spending cuts, and sustain aggregate demand. Cable did at least acknowledge the MPC’s independence – but as a proper economist, unlike Osborne, he should have realised that politicians simply should not talk about monetary policy at all.
Politicians, at least, are manageable – they are normally distracted by something else before too long, and Vince’s graduate tax looks like a good candidate here. More worrying, perhaps, were the remarks this week from Lord Turner. Turner, the Chairman of the now-doomed Financial Services Authority, was talking about leverage and growth, and explicitly said that monetary policy – including unconventional policies like QE – could be used to reduce bank leverage while minimising the negative impact of deleveraging on economic growth, and should be looked at very carefully.
Given the impending folding of the FSA into the BoE, and BoE staff already starting to talk about banking regulation, Turner probably felt he could talk a bit more freely about monetary policy. The problem is, unlike some politicians, Turner knows what he’s talking about. His view that monetary policy and financial stability are intimately related is spot on, and the obvious dislocation during the crisis – where some MPC members were deliberately kept in the dark about the measures the BoE was taking to support the banking system – was another failing at the central bank. Even worse, the notion that QE should be used to help deleveraging sits absolutely in line with the economic literature. Faced with a banking liquidity crisis, the best thing the central bank can do is swap lots of cash for the illiquid assets on banks’ balance sheets (at a knock-down price, obviously). Banks could then use that cash to reduce their liabilities, and shrink their balance sheets.
Unfortunately, the BoE did not try this policy – because, while Ben Bernanke’s focus is keeping his economy afloat, Mervyn King thinks that sticking to his axioms is more important, as evidenced by his posturing on moral hazard while the biggest banking crisis for a generation erupted behind him. For Mervyn, central banks do not buy private securities (in a big way or outright, at least). And, as a result, the BoE ended up swapping lots of cash for assets that are, well, a lot like cash (gilts), meaning that the Â£200bn had a massively smaller impact than it could have had.
Politicians can be ignored or gently rebuked, as the memories of the MPC’s failings fade. But Turner’s intellectual prowess and reputation could well have more of an impact on Threadneedle St, especially if others follow in his stead. The government could do far worse than line him up to replace Mervyn in a couple of years. But in the interim, the new arrangements mean that the MPC may not find life quite as easy as before.