Accountable Old Lady

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The Chancellor announced last week that he is firmly 'sitting on the fence' on the question of independence for the Bank of England, and that 'nothing would happen in a hurry'. But he made a further comment that will not have encouraged those who favour independence for the central bank. What mattered, he said, was ensuring that the right decisions were made over interest rates. Then he added that 'it doesn't matter who the hell takes the decision'.

Perhaps inadvertently, Kenneth Clarke put his finger on the kernel of the debate with that remark. For the whole case in favour of central bank independence rests on believing that it does matter who the hell takes the decision.

If the Chancellor maintains this line, the financial markets may soon begin to ask some pertinent questions. For instance, if the Government is so reluctant to give up the control of interest rates, what does it intend to use that control for? What exactly does the Chancellor want to do with interest rates that Eddie George would be less likely to do?

And does this have anything to do with the fact that Mr Clarke cares at least as much about growth and employment as he does about inflation (a 'rounded bloke at the Treasury', as the Financial Times puts it)? Should this in turn be connected to the fact that Mr Clarke reckons that 'candle ends matter, but guys at the Treasury are too bright to bother all the time about candle ends' - an attitude that does not seem to augur well for the Gladstonian control of public spending.

Markets are naturally uncharitable, and they will answer these questions in their usual churlish way whenever they next decide to focus on inflation as a key issue. When that happens, the UK will pay a higher risk premium on its interest rates (especially on its long rates) than it might have done with a more boring and austere finance minister in Number 11. Unfortunately, the more Mr Clarke treats the Exchequer as 'essentially a political post' (his words), the more the markets will be minded to extract their price.

On the crucial issue of independence for the Bank of England, the Government's position seems to be in a state of flux; indeed, it actually changed quite markedly in the 20 minutes it took for Norman Lamont to deliver his resignation speech in the Commons last month. Until then, there had been no official recognition that independence might be a good idea in any respect. But as Mr Lamont was speaking, the Prime Minister scribbled himself a few notes which crucially changed the Government's line.


He said he recognised the economic case for an independent central bank, but it was difficult in our Parliamentary system to overcome the obvious problem of political accountability. It is this issue of accountability that is said to stand in the way of an independent Old Lady.

I do not know whether the accountability 'problem' is intended to provide a political fig-leaf for a government that has decided to do nothing on this issue, or whether it is meant to be taken seriously. If the latter, then I must admit that I find the argument incomprehensible. Surely the Government does not believe that Britain is the only democracy that has faced these problems.

There is nothing inherent in the Westminster system that makes the matter more difficult to handle than in the United States, Germany, New Zealand, France and several other democracies every inch the equal of our own. In fact, as far as I am aware, political accountability is not thought to be a problem in any of the countries that have tried to operate with an independent central bank.

The truth is that there are several gradations of independence, at least one of which could be perfectly well adapted for the UK. At one extreme, there is the Bundesbank model, where the constitution of the central bank simply requires it to achieve price stability, and leaves its central council to decide what this means. The president of the Bundesbank is not required to account for his actions in detailed verbal examinations by elected politicians, and the Finance Minister is allowed to attend meetings of the central bank council only as an observer.

In fact, German politicians are kept as far away from monetary policy as is decently possible, and this is officially seen by all the political parties as a good thing. Although there has admittedly been an increasing amount of moaning by politicians about the Bundesbank's recent decisions, the German system follows a rigorous logic: if an independent central bank is held to be economically advantageous, then it makes no sense to compromise these advantages by allowing politicians to interfere in any significant way with monetary policy.


The American view is somewhat different. The Federal Reserve is left to determine its own macro-economic objectives, but its chairman is then required to account for them in frequent cross-examination by congressional committees. In theory, the freedom to set interest rates is untrammelled.

In practice, the Fed is an institution with highly tuned political antennae, operating against a background of continual fear that its independence will be removed by an angry President and Congress, should it make obvious mistakes in the setting of policy. Consequently, it it is loath to depart too far at any given moment from what will 'sell' in the political world.

The modus operandi of the Fed has been developed over several decades of experimentation, and it cannot be reliably transplanted into untried territory. This is why New Zealand decided to opt for a much more formal monetary system which precisely draws the lines between the politicians and the central bankers. The constitution of the central bank requires it to achieve price stability, but the government defines at any given time what exactly this means.

For example, the central bank might be asked to achieve price inflation of 0-2 per cent, measured by a particular index, over a given period. If the government wishes to change the central bank's marching orders - perhaps because of a burst of imported inflation - then it is free to do so. But it needs to explain itself in public, which means that it is most unlikely, for example, to increase the inflation target simply because it wants to win an election in two years' time.

The result is that the ultimate objectives of monetary policy are open to intelligent public debate, while the detailed means by which these are achieved are devolved to competent 'technicians'. These technicians can then be called to account for their actions on a frequent basis by elected politicians.

Many other areas of policy are already handled in a similar fashion in the UK. So while there may be several good reasons for doubting whether an independent central bank is an unmitigated blessing - such as the greater difficulty such a system creates in co-ordinating fiscal and monetary policy - the 'problem' of political accountability, on which the Government has chosen to focus, does not happen to be one of them.