Jeremy Warner's Outlook: How to reform the Bank of England

As is well known, the Government is not overly impressed by the way the Bank of England and the Financial Services Authority has handled the credit crisis and related collapse of Northern Rock.

This might seem like a statement of the bleedin' obvious. Who could have been impressed by the way this calamitous chain of events was dealt with? Yet ministers find it hard to criticise publicly because the current regulatory framework is one entirely of New Labour's own making. The buck stops at the top, and if the organisations set up to ensure financial stability have failed, ministers have no one to blame but themselves.

Still, duty obliges them to try and improve matters. If the banking system is to be essentially underwritten by the public purse, as was always implicit but has been made explicit by the events of the last year, then there has to be a quid pro quo in terms of more oversight and accountability.

This week, the Chancellor, Alistair Darling, lifted a little of the veil that surrounds government thinking on these matters. To address the Bank of England's supposed failings in maintaining financial stability, he proposes that the Governor be surrounded by more outside experts, who can both advise on the best course of action and act as his eyes and ears in providing a more effective early warning system.

This would be quite a good idea but for the fact that it already exists. It's called "the court" of the Bank of England, and little good it did too in the crisis just past. When it comes to "experts", you can no doubt always do better, but on the face of it a more savvy group of people than Roger Carr, chairman of Centrica and Cadbury, Amelia Chilcott Fawcett, formerly of Morgan Stanley, Paul Myners, a City veteran, Bob Wrigley, chairman of Merrill Lynch International, and so on and so forth, is hard to imagine.

All these people and more sit on the court and you would have thought that at least one of them would have been able to tell the Governor where he was going wrong if it had been so apparent.

All the same, something obviously needs to be done to beef up the Bank's function in maintaining financial stability.

Since responsibility for banking oversight was stripped from the Bank and given to the Financial Services Authority, the stability function has become neglected. The Bank seems instead to have focused all its attention on monetary policy. Working in financial stability came to be seen as like being banished to the Gulag. The Bank needs to give much more weight to what was previously regarded as the unglamorous side of its activities.

But it requires more than just a panel of experts. The credit crisis isn't at root a case of regulatory failure. Rather, it is the consequence of an uncontrolled credit boom. Again, these conditions do not occur because regulators have been asleep at the wheel and have as a consequence failed adequately to bring markets to heel, but because of the natural rhythms of the economic and banking cycle. Controlling these forces is a question not of micro-regulation, but of macroeconomic policy.

As I have argued before, the Bank of England's remit on monetary policy, forcing it to adhere rigidly to a particular inflation target, is far too rigid. There has been little scope in recent years to "lean against the wind" in the manner that would have been required to dampen down the credit boom. To function effectively across the water front of monetary policy and financial stability, the Bank of England needs more independence and freedom, not less.