Saturday, 12 February 2011

It is time to close this farce down

One should always be suspicious of simple solutions to complex problems. For a least four decades inflation bedevilled the UK economy. In the early 1990s it was fashionable to believe that an independent central bank would resolve the problem. If we simply handed over monetary control to a hard-nosed banker, inflation would more or less disappear. Monetary policy would be determined by a rational consideration of economic data. Political factors would have no influence on interest rates.

Gordon Brown was a believer. As soon as Labour were elected in 1997 he made the Bank of England independent. He created a monetary policy committee and told them to keep inflation under 2 percent. He also promised that the government would not interfere in monetary policy decisions.

Roll forward 14 years, and the independent Bank of England has given up the fight against inflation. Apart from a few lucky months, it has missed the inflation target consistently since about 2006. It irresponsibly kept interest rates low for over a decade and provided the necessary conditions for an unprecedented asset price bubble. When the bubble burst, the financial system teetered on the brink of total collapse.

Since the bubble evaporated, the Bank has ignored its remit to keep inflation under control. Instead, monetary policy has been directed towards recapitalising the banks at the expense of savers. The consequences are now apparent in prices. Inflation is rising and there is no prospect in sight of any remedial action by the monetary policy committee.

Despite some appalling inflation numbers in December, this week the MPC decided to keep interest rates fixed at near zero. Like clockwork, the appalling inflation numbers keep coming. Today, the ONS published producer and output price data. Output price inflation rose 4.8 per cent in January 2011, while input price inflation rose 13.4 per cent.

It is time that the denial stopped. The Bank of England is incapable of maintaining price stability. It is time to close the show down. It is time to disband the monetary policy committee and re-establish political accountability. If the government again managed interest rates, they would be answerable for their decisions at the ballot box. In any event, they could do no worse than the Bank of England.


Jim said...

It just goes to show, when push comes to shove, the govt always gets what it wants. During the 'nice' years, 97-07, there was never really any conflict between the govt economic objectives and the 2% inflation target. The wave of cheap Chinese imports prevented inflation getting out of hand, despite the massive house price boom that went on for 10 years. So there was never a 'time to take the punch bowl away' moment.

Now its different. If the BoE were truly independent and working to its stated mandate of 2% inflation, they would be raising rates and reversing QE sharpish. But they won't because they know that all hell will break loose politically if they do. Or they've been leaned on and told what to do, or else.

Either way the result is plain to see - inflation is being let rip and the 2% target is flapping in the wind.

They did give a good indication what was going to happen - I believe about a year ago it was revealed that the BoE pension fund is heavily invested in index linked gilts.

Not rocket science, this prediction lark is it? said...

I agree that the Bank and the government have lost the place as far as economic management is concerned. It is obvious that no one in the Bank or in Government knew what they were doing in the last 50 years.

In 1960 we were a buoyant economy; our children were well educated; houses were affordable; we had no unemployment and our economy was well balanced between services, manufacturing and finance.We were in a Commonwealth of nations that could have wiped the floor with the up an coming European Common Market because we would have been dealing with countries and people who produced and required different products. The Commonwealth was an ideal set of countries in which to trade together without taxes and import/export restrictions because each member was strong in different products and services.Europe on the other hand is largely made up of countries who can't really compete effectively with each other because they are all doing the same thing.

The reason we are in a mess is because, our leaders of the past did not have the skill, knowledge or competence to see further ahead than the next election. several myths were bandied about and the press ensured that the British people swallowed the myths:

Myth one: we must become part of Europe as we can't survive out of Europe

Myth two: we must become global in our thinking and treat the globe as our shop window

Myth three: Agriculture and Manufacturing are labour intensive and inefficient so we must ensure that our economy is based on financial services and banking

Myth four:We will all benefit from having a strong financial services business that trades internationally.

Myth five: we can stop expensive scientific and technology research programmes and dumb down our education standards as such requirements can be outsourced to cheap labour parts of the world

Myth six: we can trust our bankers, politicians, financial service leaders to make us world leaders in the global economy

Myth seven: We can become much more liberal in our policies towards criminals, social status,immigration,public safety and order and we don't need to control our borders or ports.

Myth eight: As long as we buy property and use it as our main asset, we shall always be a strong economy amnd our people will always be liquid.

Myth nine: buying pensions will ensure that we all have a well financed "pension". The charges for private pensions are miniscule and make pensions the best investment for anyone saving for old age

Myth ten: The Coalition new style government will solve all of our problems by bringing in Big Government and cutting costs and all the surplus labour in the public sector will be absorbed by the expanding private sector


ASaverWrites said...

If the members of any body are appointed by a government which is known to micromanage ( often none too competently ), and is known to pack any such bodies with party sympathisers and hacks. How on earth would it be assumed that any such body is "independent"?

Germany managed it. What is wrong here? Too many old friends perhaps? Or is it that Germans put their country above their own interests?

It is an independent MPC we need. But one which is apolitical and is bound legally to its remit of controlling inflation. Writing a few letters to the Chancellor does nothing to the prices at Tesco.

I see McDoom ignored the IMF on his quest to save the world. When will he be put on trial?

james c said...

The picture is rather different if you look at measures that strip out the effect of the VAT rises.

H said...

And yet, if we take the record of the "Ken and Eddy Show" period together with that of the MPC, so from say 1994 to the present, you would have to say that the record is not too bad - 7 out of 10, maybe? You would have to go back to the time before 1970 to find longer sustained periods of lowish inflation, with the big difference being that before 1970 the Bretton Woods system of semi-fixed exchange rates operated, so that government discretion was limited by its fear of devaluation. Before 1948ish, of course, we were on the Gold Standard and had a genuinely independent Bank of England, which had given us several centuries of price stability. Happy days.

Jim said...

@H: But in that 94-07 period we never had a divergence of interests. In 94-97 the economy was emerging from a severe recession, house prices were stable in real terms (I believe they only reached pre 90s recession levels in 97). So inflation was muted, so interest rates could stay low.

Then from 97-07 we were in the Golden Decade where Gordo had abolished boom and bust, inflation stayed very low, long term rates fell consistently. There never was a traditional UK style 'house price boom overheating the economy' rise in inflation. So the BoE never had to take any decisions that ran contrary to the ruling party's wishes.

This is the first real crisis that the MPC has had where they had a choice of working to their 2% inflation target, or doing what the politicians wanted. And they have fallen at the first hurdle. Their previous 'success' is irrelevant - they never had to face down elected politicians to achieve it.

Tomrat said...


We let the markets set interest rates.

H said...

@Jim - all I am saying is that, if the present rate of inflation is the worst that the MPC achieves, it will have substantially outperformed all previous elected governments not subject to the Gold Standard or Bretton Woods; in short, that RPI in, say, a 3% to 6% range is historically low. Of course, things could get worse!