In May last year, Labour inherited an economy in which monetary and fiscal policy were too loose, sterling had appreciated substantially and underlying inflation was set to rise above 4 per cent this year. Decisive action has been taken to put the economy back on track - through higher interest rates and the largest in-year fiscal tightening since 1981 - but the lags are long and risks remain.
What can be said, with greater confidence, is that the new monetary arrangements have worked impressively well. To be sure, some details have been refined since the Chancellor's letter to the Governor last May. The content of the monthly minutes have become much fuller and clearer as the year has progressed. Some argue that six weeks (the maximum specified in the Act) is too long a period between monetary meetings and the publication of minutes.
Nonetheless, the new Act confirms in law a new institutional framework which represents a decisive improvement on what came before. The previously confusing and unsatisfactory inflation target has changed: the target is now precisely defined. The suspicion of political manipulation of interest rates which dogged the previous chancellorships is gone: there is a clear division of responsibility between the government, which sets the target, and the Monetary Policy Committee, which sets interest rates to meet that target and, without prejudice to that objective, to support the Government's objective of high and stable levels of employment. The appointments to the MPC have been well received. The Court is now far more representative - geographically and from both sides of industry. And the House of Commons Treasury Committee has an enhanced role in scrutinising monetary policy - a challenge to which it has more than risen.
More important, the new monetary arrangements place the higher standards of openness and transparency, as well as accountability, at the heart of British economic policy. In so doing, they reflect a trend towards open policy-making which is gaining increasing international acceptance.
The globalisation of the world economy means that policy-makers must pursue stability - a necessary pre-condition for sustained growth and full employment - through new means. But far from rendering governments impotent, global capital markets actually make governments more powerful in their ability to do good or bad. Governments which pursue monetary and fiscal policies which are not seen to be sustainable in the long term, or attempt to conceal the fact through short-term deceptions, are punished hard these days - and much more rapidly than 30 or 40 years ago. When mistakes occur, and credibility is lost, it takes a long time to repair the damage. Conversely, governments which pursue, and are judged by the markets to be pursuing, sound monetary and fiscal policies can quickly attract significant inflows of new investment capital.
Gone are the days of fixed policy rules announced in public, and secret deliberations behind closed finance ministry doors, with little or no justification or explanation of policy decisions or mistakes. Fixed policy rules were the old route to credibility. But, as the UK monetarist experience shows, persisting with fixed monetary targets, when previously stable relationships break down and the aggregates run out of control, can have disastrous consequences. Because the previous government repeatedly staked its credentials on following monetary and exchange rate rules, it - and the economy - was faced more than once with a heavy price for breaking them, both in lost output and jobs and in lost credibility.
The modern route to credibility, in the face of volatile and unpredictable financial flows, is, instead, clear long-term policy objectives, well understood procedural rules for monetary and fiscal policy that keep markets and the public properly informed and ensure that both objectives and decisions are seen to be credible. Transparency about objectives and the reasons why decisions are taken, and checks on the ability of government to manipulate the flow of information, make it less likely that investors will be suspicious of government intentions. They also allow greater flexibility of policy to react to real crises and make it easier to build a consensus for difficult decisions.
Which is why a commitment to transparency and clear procedural rules lies at the heart of the UK's new fiscal and monetary framework. Fiscal policy is now set to achieve clear, prudent and unambiguous rules: the golden rule - to balance the current budget on average over the economic cycle - and to stabilise the ratio of debt to GDP at a prudent level over the economic cycle. The Code for Fiscal Stability enshrines much greater openness and transparency in legislation.
So in monetary policy, clear procedural rules and accountability have been augmented by a new commitment to openness in place of the Treasury secrecy of the past. MPC minutes are published with details of votes cast. The quarterly Inflation Report explains how the Bank is setting policy to meet its objectives. The Forward Book of foreign exchange transactions is published with a lag. There is now far more open discussion of the optimal balance of monetary and fiscal policy than there ever was pre- independence.
But more importantly, this openness is designed to preserve constrained discretion. Policy is set to achieve an inflation of 2.5 per cent. But if the actual inflation rate were to go more than one percentage point either side of the target then the Governor will write an Open Letter to the Chancellor explaining why this has occurred, how long it is expected to persist, the action the MPC is taking to get inflation back to target and how this is consistent with its objectives.
The importance of openness and transparency is increasingly accepted internationally, as the decision to ask the IMF to draft codes of conduct for transparency in fiscal, monetary and financial policy demonstrates. But it is particularly important for a new institution with new responsibilities such as the reformed Bank of England or the European Central Bank - institutions which cannot rely on immediate financial market credibility or public understanding or support.
The Maastricht Treaty, as the table on the left shows, is surprisingly undemanding on transparency and accountability grounds. Nor does it rule it out. The ECB could set a clear inflation target, endorsed by Ecofin, which could reinforce political support for the ECB's interest rate decisions to meet that target. Publishing minutes regularly alongside an inflation forecast could help build not only market but also public understanding and tolerance, especially when times are hard and difficult decisions must be made. Publishing votes of all board members could both dampen destabilising speculation and guarantee proper accountability for national, as well as the European, parliaments.
Which is why Europe, and the EMU countries, would be wise to embrace this transparency approach. Some say a six-week delay between monetary meetings and the publication of minutes may be too long for the Bank of England. But 16 years looks much too long for the ECB.
Edward Balls is the Chancellor's Economic Adviser.Reuse content