vaudeville act was swept away in 1997, to be replaced by a model of central bank independence worked up in opposition by Brown and Balls, with help from some US policymakers, including Alan Greenspan, and a few Bank and Treasury moles. The model, which was implemented almost exactly as they drafted it, differed from both the US Federal Reserve System (the Fed) and the European Central Bank (ECB) and also from the Reserve Bank of New Zealand, which had been the first to implement an inflation target regime eight years earlier. The architects were sensitive to the complex history of the Bank–Treasury relationship. The Treasury was fearful that the Bank would be overzealous in its pursuit of low inflation, that it had a strong, enclosed, internal culture generating powerful ‘groupthink’ and that it was too hierarchical, with all decision-making roads leading to the Governor’s office. These points were made to me forcefully when the Treasury appointed me Deputy Governor in 1995. There was much truth in that assessment, I discovered.
So unlike the Fed and the ECB, which were left to themselves to define what they meant by price stability, the Bank of England was to operate under an inflation target regime, with the target set by the Treasury. That amounted to instrument independence – the Bank had full control over short-term interest rates – but not target independence. Most independent central banks in other developed countries have the latter as well as the former. The Treasury could change the target if it wished, and indeed has once done so.
The new Bank of England model is distinctive in other ways too. Unlike the Fed, which has a parallel objective of maintaining full employment, the Bank’s objectives are hierarchical. Meeting the inflation target is the prime aim, and only subject to that should it contribute to the government’s other economic objectives. In that respect it is similar to the ECB. Brown recalls that his initial thinking favoured a model more closely aligned to the Fed, with an employment objective: ‘The early papers we put to the Treasury had that idea included. But we could not find a legislative way of implementing a dual target. It involved revising Acts going back hundreds of years.’1 But while the new Bank is similar to the Fed and the ECB in some ways, it departs from both the other main models in having four part-time outsiders appointed to its Monetary Policy Committee (MPC). That was specifically targeted at the groupthink point. Their power is buttressed by a requirement to publish individual votes of MPC members after every meeting. The Fed publishes ‘dissents’, while the ECB does not produce a voting record. The latter argues that to do so would put intolerable pressure on the voting members from national central banks, which would be expected by their governments to vote according to the circumstances of the economy of their country, rather than the Eurozone as a whole.
The UK model has been criticized by other central bankers for its excess of transparency. The publication of individual votes creates pressure on members to justify their views outside the meeting. The number of monetary policy speeches emanating from the Bank has escalated dramatically, as each member of the MPC tries to explain and defend their policy positions. That has generated a lot of ‘noise’ in the system. If monetary policy works through influencing expectations, it is not clear that these conflicting views help. The markets can become confused and on occasion the Governor has found himself in a minority, obliged to defend a position which is not his own.
In spite of these criticisms, the main architecture of monetary policymaking remained intact throughout the period. The original inflation target was set at 2.5% plus or minus 1%. The target was therefore symmetrical, unlike the target the ECB set for itself, of maintaining inflation below but close to 2%. There are strong arguments for a symmetrical target.
The significance of the range was that if inflation moved outside it, on the upside, or the down, the Governor should write an open letter to the Chancellor explaining why and what would be done to return to the target. For many years, the Governor’s pen remained capped, causing Mervyn King, in office from 2003 to 2013, to quip that the art of letter-writing was dead. After the financial crisis, letter-writing came back into vogue. But in structural terms, the changes since 1997 have been relatively minor. In December 2003 the centre of the target range was moved down to 2%, when the basis of measurement was changed from the Retail Prices Index (RPI) to the Consumer Prices Index (CPI). The Bank has, since 2010, maintained inflation at an average very close to the target, while the ECB has been well below. The symmetrical target may be partly responsible for that difference. In 2021 the ECB acknowledged that criticism by shifting to a symmetrical approach.2
A potentially more significant change, at the end of the period, was the insertion into the Bank’s mandate of a reference to climate change. In March 2021, Chancellor Sunak reaffirmed the 2% target, but said that monetary policy should ‘also reflect the importance of environmental sustainability and the transition to net zero’.3 The Bank responded that it would change its approach to corporate bond-buying ‘to account for the climate impact of the issuers of the bonds we hold’. There will also be implications for banking supervision. Since at least 2017, when the Network for Greening the Financial System was created, a number of European central banks have been seeking to incorporate climate goals into their monetary and supervisory policies. That has been controversial, with some commentators arguing that an activist approach to climate change would put their independence at risk. At an ECB conference in November 2020, John Cochrane of the Hoover Institution at Stanford argued: ‘This will end badly. Not because these policies are wrong, but because they are intensely political, and they make a mockery of the central bank’s limited mandates.’4 The Bank of England is less exposed to that risk, but Sunak’s rather vague formulation puts a heavy burden on the Governor’s shoulders. Mervyn King sees risks for the Bank’s independence: ‘Central banks’ increasing focus on climate change is particularly odd … Most important, the central banks’ new and broader ambitions have profound implications for their independence.’5
How did Bank independence affect the Treasury? The staffing implications were minor. The Treasury team of officials and economists preparing interest rate advice was small, and already depended heavily on the Bank of England for market intelligence. There is a Treasury observer on the MPC, who needs to be briefed, but he or she is genuinely an observer, except on fiscal policy where the individual may offer a view on the likely fiscal stance. There is certainly no equality of arms on monetary policy between the two institutions, or indeed on macroeconomic policy more generally. As Gus O’Donnell points out, the Bank employs far more economists than the Treasury, and in the Treasury those in the macroeconomic area ‘are typically young and lacking in experience. There is an advantage, though. Younger staff have been trained more recently, and are not slaves to some defunct economist.’6
When the change was made, it was widely assumed that Brown would find it hard to restrain himself from commenting on interest rates. That assumption turned out to be incorrect. Brown was scrupulous in avoiding public comment on the Bank’s policy, whether in Parliament or elsewhere, and his successors have adopted the same self-denying ordinance. We cannot be sure that in their regular lunches the Chancellor and the Governor do not discuss upcoming decisions, but there is no evidence of any attempt to exert inappropriate influence, which – given the voting structure – would in any event be unlikely to have a decisive impact. The Treasury also stopped its previous practice of censoring, or as it used to put it, ‘offering helpful drafting suggestions’ on, the Bank’s publications. There are more examples of Governors commenting on fiscal policy, which is equally inconsistent with the 1997 division of responsibilities. That created tension, between Alistair Darling and Mervyn King in particular. But for the most part the new arrangements worked well. The implicit assumption was that were a loose fiscal policy to threaten to generate inflation above the target, the Bank would react with a rise in interest rates. There was no particular need for active coordination of fiscal and monetary policy. In the meantime, the Treasury benefited from lower long-term gilt rates. For a long time, the British government had paid around 150 basis points more than the German government for its long-term borrowing. That spread narrowed rapidly after Bank independence promised tighter control of inflation in the future.
For a decade this new dispensation caused few problems, though stocking and restocking the MPC was sometimes a challenge. The
