Comment: Welcome, but only as a first step

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The Independent Online
The policy changes announced yesterday at the Mansion House are fine as far as they go. But they will only be convincing to the financial markets if they become a first step along a path of reform for both the Treasury and the Bank of England.

What emerged last night is a patch. A profoundly unsatisfactory way of determining economic policy has been made a little less unsatisfactory. The humiliation of the Treasury and the Bank has been sufficient to make them realise that they have to explain to the world how they reach their decisions.

But neither the Treasury nor the Bank realises the degree of contempt in which their institutions are held. They realise they have to open up the system, but are not fully aware of the need to change it.

But it is a start. It is, given the evolutionary way in which British institutions are changed, quite encouraging to see any movement at all. It is sad that it takes something like the pound being kicked out of the ERM to force the authorities to feel they have to explain themselves, but now they are to do so it would be churlish not to welcome the change.

Critics of government policy may not be much clearer about the reasons for decisions, but at least they will be confused at a higher level.

The changes in detail - first, the publication of the monetary assessment. By all accounts this is not in reality the highly confidential document it is supposed to be. Rather it is the sort of thing that a couple of good postgraduate students could, with a bit of statistical support, knock up over a weekend. But it will be helpful to have it published and the publication will of itself probably improve the quality of the product, for it will be subject to external scrutiny.


Extending the practice, started at the last base rate change, of giving an explanation for changes in interest rates is of only marginal significance. The last base rate cut was perfectly justified on economic grounds but the timing, coinciding with the Tory party conference, was wholly political.

Any Treasury official worth his or her salt can drum up an explanation for a policy, however absurd the policy might be - that is something an Oxbridge training teaches people to do. Given the

fact that the authorities will be looking at a range of indicators, there is always likely to be at least one which will justify a change in interest rates, and the case for change can be wrapped round that.

Making the Governor of the Bank produce a quarterly report on the Government's performance on the inflation target will certainly focus attention on inflation in general. The problem, as is widely appreciated, is that the inflation figures are a lagging indicator of inflationary pressure - by the time the inflation shows in the figures it is too late.

Besides, the Bank already has the Quarterly Bulletin in which it can growl about inflation if it chooses.

One function of the report might be to increase the leverage of the

Bank if it starts to feel concerned, but ultimately the Bank's authority will turn on the intellect and determination of the next Governor.

Quite clearly, the Governor who will take office in the middle of next year needs to command respect for his intellectual grasp of monetary economics. It has to be someone who can talk confidently about his or her own judgement, which other people will genuinely respect. An amateur really will not do.

Finally, the panel of forecasters - this really does look like a tail-covering exercise for the Treasury. Tax any senior Treasury official for the poor quality of its forecasts, and the reply will be: 'If you think we have been bad, have a look at the forecasts of the other guys.'

Under the new arrangements it looks very much as though the burden of faulty forecasting will be shared between the Treasury and everyone else. It is a useful change, but no one should become too excited about its impact on policymaking. Independent forecasts have always been available for decision-makers because they are widely reported. These changes

do not make them more available.

The core of the problem remains. How do you construct a basis for policy which reduces the amount of discretion available to the Chancellor of the day? During the Bretton Woods period, when sterling was operating under a fixed exchange rate system, British inflation was close to that of Germany and the US.

Under the floating rate system which replaced it, British inflation was substantially higher. It was higher even during the period when Lady Thatcher, someone well aware of the socially destructive effects of inflation, was in office. We are just not a very self-disciplined country, in monetary policy as in other things.


There are ways of reducing discretion. Joining the ERM was one. Indeed, Norman Lamont, to his great credit, saw very well Britain's need for an external discipline over monetary policy. That was one of the prime arguments, in his view, for sterling's ERM membership.

The obvious way now would be to put

into prime position an indicator of monetary conditions. This could be a single indicator, such as the Divisia index, a weighted index of the various money measures. Or, if a single indicator risked becoming too much of a totem, it would be possible to calculate monetary conditions by taking into account all indicators, including the exchange rate.

Those calculations are being done implicitly under the new policy. The need is to make them explicit.

This particular Mansion House speech always risked disappointment, for expectations had run too high. But is it really enough? Try this test. Had Nigel Lawson made these procedural changes in 1985, would the errors of policy of the second half of the 1980s been avoided?

Surely the answer would be no. Maybe it would have been a little more difficult to have engineered, albeit unwittingly, the late 1980s boom, for the countervailing voices would have had a slightly better platform from which to warn.

But the plain fact is that the system of decision-making is unchanged. It is very hard to have confidence in it. These reforms make sense in themselves, but only have credibility if they are a first step towards changes in the system itself, in particular taking monetary policy away from the Treasury as in the US and Germany.