It is worth recalling the background to the Bank of England’s “independence”.
The Bank of England was given the independent right to set monetary policy in 1998. This was done by Act of Parliament, removing the Chancellor of the Exchequer’s previous right to set interest rates.
In that Act of Parliament, the Bank was mandated to set monetary policy in accordance with an inflation objective of 2.5% (based on the Retail Prices Index). Subject to that (and note: only subject to that) it was mandated to try and sure financial stability. The 2.5% target was later amended to a target of 2% based on CPI inflation, but the primary objective was not changed.
The control of inflation is the primary objective and not anything else. That is the law, passed by our Parliament.
Furthermore, the right and duty to set monetary policy was given to the Monetary Policy Committee of the Bank, and not to the Governor alone. There were several occasions when Mr Carney’s predecessor, Mervyn King, was outvoted on interest rates.
What all this means is that Mr Carney is way exceeding his powers in making the assurances that he has made about interest rates. He is not entitled to commit the whole Committee to a particular route on interest rates. More seriously, neither he nor the Monetary Policy Committee are entitled to change their statutory duty to treat maintenance of inflation stability as their primary objective.
If Mr Carney wants that duty changed, he is perfectly entitled to argue that it should be changed, including in public if he wants to. What he is not entitled to do is unilaterally make that change himself.
It seems to me that this has been a growing trend in recent years – unelected public officials ignoring the fact that our elected parliament is sovereign.
We may well hold most of the members of that Parliament to be not very impressive. We may even despise some of them. But the fact remains that they are elected by the people as their representatives. If their power to set the law is overridden by public officials, then ultimately that counts as a coup d’etat, and means the end of our democracy.
Lord Mandelson famously stated that we are living in a “post-democratic age”. He was wrong. But if we allow our civil servants to usurp the powers of parliament then we soon will be losing our democracy – and for good.
Perhaps our Government should have appointed one of the perfectly good British candidates as Bank of England Governor instead of choosing one of their mates from the Global Elite who increasingly seem to hold us “plebs” in such contempt.
Let me say it again: Mr Carney does not have the power to set interest rates, and he does not have the power to change the Bank of England’s legal mandate.
The Financial Policy Committee of the Bank of England
QE2 has arrived. The Bank of England is to inject a further £75 billion into the economy to help the banks fund the government deficit – er, sorry, to “ease credit conditions”.
As George Osborne said when in Opposition:
Printing money is the last resort of desperate governments when all other policies have failed
As the Bank also held interest rates at 0.5% again, despite the failure of that policy to generate any growth so far, it is indeed pretty certain that all other policies have failed.
These two moves are in many ways contradictory in fact, since low interest rates restrict the supply of credit. But regardless of the merits or otherwise of the approach of the hapless Mr King, it is becoming clearer by the day that macroeconomic policy is not going to get us out of the mess we are in.
What is actually happening is that British living standards have been buoyed for years by living on credit. Now that the credit taps have been turned off by the world finance system, our living standards are declining towards the level that we actually earn.
There is nothing, absolutely nothing, that the Bank of England or the Government can do about that in the short term.
If we want higher living standards, we have to earn them. And that means fixing the fundamental problems in our economy:
A failing education system
Too many bureaucrats wasting time and money in pointless government activity
Too much red tape strangling our businesses
Green taxes strangling our economy
The European Union strangling the entire country from a European level
These are long term problems, and will require long term fixes. But they are fixable.
Unfortunately, none of our politicians seem at all keen on even making a start on fixing the issues. The old parties are too wedded to the failed old ways. They won’t wake up until a political firestorm hits them.
He has now warned that higher fuel bills may push inflation up to 5% this year. He is announcing his excuses in advance now!
The Bank remains statutorily responsible for ensuring that inflation remains as close as possible to 2%, remember. Fat chance.
Mr King said there is:
a great deal of uncertainty about the outlook for inflation
He said that inflation
may not fall back as strongly as expected
He said these were “short term” and “volatile” factors, and that:
Our medium term judgement about inflation and growth is broadly the same as in February.
He yet again said that inflation would “begin falling” next year closer to the 2% target.
This time last year he was telling us inflation would fall this year. Now it’s next year. With Mervyn, it’s always jam tomorrow and never jam today.
Gordon Brown’s decision to make the Bank of England responsible for setting interest rates was hailed as a master stroke, and also supported strongly by the Tories. It was supposed to take political considerations out of the process. And yet it seems that political considerations have never been taken account of more strongly than now. The Bank of England has openly been worrying about economic growth in its setting of interest rates, rather than worrying about controlling inflation.
It is just that now, with the Bank responsible for rates, the government can wash its hands of the matter.
The Bank of England’s record on getting interest rates right has been utterly disastrous. They have lurched from too loose money, to too tight, and back to too loose again. The reason seems to be that they are targeting economic activity rather than inflation. This was the tendency that Bank of England independence was supposed to tackle!
They are, under Mervyn King, taking us down a road we have travelled before, in the 1970s. “Just a little bit of inflation will help the economy grow.” “Just a little bit more can’t hurt, can it?” “We need to think about jobs! Inflation is just a number.”
And before you know it, inflation is out of control, there is a Sterling crisis, interest rates get rammed up into the teens and economic collapse follows.
The European Central Bank, of course, is made of sterner stuff, and has already begun increasing interest rates. But then the ECB is dominated by Germany, whose monetary authorities have a record that puts ours to shame.
Mervyn King and the others on the Monetary Policy Committee need to be reminded that if they do not intend to meet their responsibilities to keep inflation low, then they should resign. Maybe the Chancellor is the man to remind them?
George Osborne, the Boy Chancellor, read Modern History at University, spent some time as a data entry clerk for the NHS and then on the shop floor at Selfridge’s, then worked at Conservative Central Office, the Ministry of Agriculture, and the Political Office at 10 Downing Street. He followed that up with a stint as William Hague’s speech writer and political secretary, before becoming an MP. Eminently qualified to be Chancellor of the Exchequer then.
Meanwhile, the Tories have John Redwood, a former Merchant Banker and a former cabinet minister, who most certainly does understand economic policy, languishing on the back benches because David Cameron prefers the company of Liberal Democrats to that of real Conservatives.
The media, most economists, and more especially left-wing politicians, often claim that cuts in government spending will hit economic growth. The idea is that cuts in spending will reduce demand in the economy, and that in turn will cause the economy to shrink.
They also believe that low interest rates are needed to boost growth. They worry that as the Bank of England raises rates to hold down inflation, growth will suffer.
This is, of course, the now infamous Keynesian idea that recessions are caused by insufficient demand in the economy. Yes, the Bank of England, the BBC and others all seem still to be entranced by that old idea.
Think about it all for a moment. The theory on fiscal policy is that the government’s borrowing and spending huge amounts of money (over 12 percent of GDP currently) will boost the output of the economy.
This theory is based on a fundamental misunderstanding of how markets work.
We all know that if demand for a product rises, the price rises. That in turn encourages production of that product (and tends to reduce demand). This feedback mechanism is the “price mechanism”, which ensures that in a free market, supply and demand are always balanced.
If the government borrows and spends, pushing up demand, that will push up prices – in other words, inflation will result. Even Keynesians acknowledge that. But they go on to claim that the increased demand will encourage increased supply.
The truth is that the encouragement to increased supply from increased demand acts through the price mechanism. It is that rise in prices that transmits the fact of increased demand for a product to increased supply of it.
But what if the demand is spread across the economy? Won’t that same mechanism cause output in general to increase? Keynesians think so, but they are wrong.
If prices in general are rising, as opposed to prices of a specific product, then there will be no particular incentive to produce more. This is because input costs will have risen, and the value of any profits made will have fallen, in proportion to that inflation. All that has happened is that the value of money in the economy has gone down.
If demand for bread goes up, the price goes up, and producers produce more. They do so by diverting resources in the economy from other uses, where the price has not similarly risen. They expect to make more money by doing so.
But if demand for everything rises, the price of everything goes up, and producers will not produce more – they might make more profit in cash terms, but since the price of everything has risen, that profit will be worth less to them.
We currently have an economy where the government is borrowing and spending enormous quantities of money. We have stalling output, though, and resurgent inflation. None of that is a suprise, except to Keynesians. Keynesians think that government deficits boost output and cause inflation as a by-product. In truth, government deficits simply cause inflation, and have little or no effect on output. And because they increase the role of government in the economy, over the longer term, they actually depress output, because government provision is less efficient than private provision.
So what of monetary policy? We currently have very low official interest rates and a credit shortage. It is believed by Keynesians that low interest rates stimulate the economy and increase production. They do so, it is alleged, by stimulating borrowing and spending, and discouraging saving. Back to that demand management again – this time working by boosting private sector demand rather than government demand.
In normal times, it is true that low interest rates stimulate borrowing and spending. However, exactly like borrowing and spending by the government, private borrowing and spending stimulated by low interest rates simply causes inflation, and does not increase output.
Excessively loose monetary policy does not stimulate economic growth. It simply causes inflation. That was the great revelation of the Monetarists in the 1980s.
But now it’s worse. Credit is no different from any other commodity. If you reduce the price (interest rates) then you encourage demand. But you also discourage supply. And lo and behold, we now have a credit famine, with credit-worthy businesses complaining that the banks will not lend.
Governments across the world are tackling the recession with historically low interest rates, far lower than the markets are signalling is appropriate, and with high borrowing and spending. The result is inflation, a credit famine, and recession. Economists and politicians are puzzled. How can these be the result of the policies that they have been brought up to believe are appropriate to tackle such circumstances?
In order to stop being puzzled, they need to rethink their whole concept of how the economy works.
To tackle inflation, we need much lower government spending and borrowing, and higher interest rates. That much is at least dimly understood by most.
What is not understood is that these policies will not adversely affect output. The truth is this: output cannot be massaged by managing the level of demand in the economy.
Indeed, by creating a credit shortage, the current monetary policy at least is hurting our output figures. Higher rates would help with this aspect at least.
To more comprehesively boost output and cut unemployment, we need supply side measures. That means reduced regulation and red tape, better education, lower taxes and so on. These are not a quick fix. They need concentrated work over many years to really get right. We embarked on that in the 1980s under Margaret Thatcher and Nigel Lawson, and then lost our way on it again with Tony Blair. We haven’t found our way again yet. Unfortunately David Cameron and George Osborne seem only too keen to believe the quick fix nostrums of the quack economists who seem to dominate debate.
This time it is the producer price figures (“factory gate inflation”), which last month rose to a headline 4.2%. (In other words, prices rose by 4.2% over the last year to December.)
That figure, though, was due to an increase of 0.5% for the single month of December. At an annualised rate, that is 6.2%.
We shouldn’t read too much into one month’s figures, of course. Except that it isn’t just one month’s figures. Inflation figures have been “higher than expected” repeatedly for many months now.
It is becoming ever clearer that the Bank of England is asleep on the job. The longer they wait before raising interest rates, the harder will be the shock when they finally do go up – and go up they will, eventually.
Of course, the government will tell us that interest rates are not their business, that the Bank of England is “independent”.
How convenient. The truth is, our elected politicians are still responsible. They can’t simply opt out of running the economy. If inflation really does get out of control (and it nearly is already, in truth), the current government will bear its share of the blame as much as the last.
The Consumer Prices index stayed at 3.1 percent, ending a run of three months in which the rate was falling (economists had expected a fall to 2.9 percent). The Retail Prices Index, which includes housing costs, fell from 4.8 percent to 4.7 percent (economists had been expecting 4.6 percent).
The BBC article says:
The unexpectedly high rate was boosted by strong rises in air fares, clothing and food. Fuel prices fell.
but then points out:
More worryingly for economists, the core inflation rate rose to 2.8%, from 2.6% in July.
Core inflation strips out volatile food and energy prices, and is used to gauge the underlying longer-term inflation trend.
I would have thought that was worrying for all of us, and not just for economists.
Maybe eventually the Bank of England will start trying to control the inflation rate rather than simply writing letters to the Chancellor explaining why it is above target.
He points out that inflation is becoming a stubborn problem, and says the excuses of the Bank of England are beginning to wear thin. And then goes on to urge the continuation of the policies that have led to it.
With the economy so precariously poised (both business and households have stressed how important low rates are to survival), it is vital the Bank stays ahead of the game.
Businesses and households haven’t stressed how important low rates are to survival. They have stressed how important the availability of credit is to survival. Low rates means lower supply of credit, just as low prices for bread means lower supply of bread. It’s called the price mechanism. Higher rates would increase the incentive to deposit money with banks, and increase their incentive to lend that money to borrowers.
GDP growth, though, will be lower than predicted due to the Government’s spending cuts – making “loose monetary policy”, or low rates, ever more urgent.
Government spending doesn’t create growth. It reduces output in fact, regardless of how it is financed (by taxes, borrowing or money printing). The spending cuts will lead to growth. (Yes, really.)
Loose monetary policy doesn’t create growth either. It simply increases prices – i.e. causes inflation.
There is no quick fix for this. Regardless of the actions of the Bank of England, Britain has been living beyond its means for years and we have to stop now.
All the government can do is be responsible – which means getting the deficit down (to release resources for the productive economy and allow growth to occur) and putting interest rates UP (to control inflation).