The policy of openness opens up new problems Problems abound for the new monetary mechanism

'It is hard to imagine the present set-up, in which the Governor of the Bank of England is in open disagreement with the Chancellor about the setting of monetary policy, being tenable for very long under different incumbents'
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The Chancellor has decided that henceforward he will publish the conclusions of the International Monetary Fund mission to the UK each year, claiming that this will increase "openness and transparency in relations between the IMF and its member countries". Mr Clarke should get some credit for this decision, though it is as nothing compared to his previous spasm of glasnost fever - the publication of the minutes of the monthly monetary meeting between himself and the Governor of the Bank of England.

This, perhaps the most significant single move towards transparency in Britain's history, was a very strange animal to emerge from a Chancellor who frequently tells his staff that he does not believe in open government. Not only is it the only meeting in Whitehall which is subject to public scrutiny within six weeks of it happening, but it is also the only one in which civil servants are permitted to disagree with their minister, on the record and in front of outsiders. Admittedly, the points made by Treasury officials are not attributed to anyone by name, but they nevertheless appear in cold print for the world to scrutinise.

It is a remarkable and attractive characteristic of the Chancellor's that he does not seem to mind this public show of disunity from his officials. Observers say that such freedom of expression is not encouraged on the Bank side, and indeed it is unlikely that it would be countenanced by many Chancellors other than Ken Clarke. In fact, it is hard to imagine the present set-up, in which the Governor of the Bank of England is in open disagreement with the Chancellor about the setting of monetary policy, being tenable for very long under different incumbents.

I have always thought that the present arrangements represent an unstable half-way house between the old secretive UK arrangements and full operational independence for the central bank. Unstable because the new system inevitably results in dramatised conflicts between the Chancellor and the Governor, where one side or the other is inevitably deemed by the press to be the "winner". This seems unlikely to lead over time to calm deliberation about monetary policy.

Furthermore, the incentive to tweak the mechanism so that the real decisions are taken in unrecorded private meetings, and then rubber-stamped by the official monthly jamboree, is very great. I heard recently that the Chancellor and the Governor routinely meet every month for lunch, outside the framework of the official meetings. What do they talk about? And why are these meetings not minuted? These are the kind of "thin end of the wedge" questions which are inevitably raised when our closed system of government allows the outside world to peek under its skirt.

Of course, the irony is that when the new system was first introduced, virtually everyone believed that it would greatly strengthen the Bank's position at the expense of the Treasury's. If that had happened, the politicians might already have decided that the constraints and burdens of the new mechanism were intolerable. Yet, through some odd quirks of history, the opposite result seems to have occurred. The fact that the Chancellor has been seen to over-rule the Bank, and apparently to pay no penalty for so doing, has robbed the Bank of its former mystique. Under the old system, it was never clear how much influence the Bank was having. Now it is clear that it is having virtually none.

The latest problem for the Governor has been to figure out how to proceed when his advice on interest rates is not heeded by the Chancellor for several months in a row. Here is the dilemma. In June, when Mr Clarke reduced base rates from 6 per cent to 5.75 per cent, the Bank unambiguously advised him to leave monetary policy unchanged. The question for the Bank, going into the next meeting on 30 July, was whether to accept the previous month's cut, or to reiterate its opposition to it. If it did the latter, then it would in effect be arguing for an increase in base rates this month, however skillfully the Governor chose to word his advice. It will be interesting to see whether this is what happened when the minutes are published in September.

If it is indeed what happened, which is probable, then there is obviously a danger that the Bank's advice may over time drift apart from the actual setting of interest rate policy chosen and implemented by the Chancellor. This could lead to all sorts of new misunderstandings and dilemmas as two separate time series - the Bank's recommended level of base rates and the Chancellor's chosen level - potentially drift apart from each other.

Of course, none of these problems means that the old system of setting interest rates - when sudden changes were imposed for political reasons, often under the orders of the Prime Minister rather than the Chancellor - was superior to the present one. It would be hard to argue that. But they do mean that we may not yet have alighted upon a robust alternative which will truly survive the test of time. Sooner or later, an accident may happen which could force further changes to the system. Since there are good reasons for believing that the Bank will generally want to set tighter policy than the Chancellor of the day, this accident is most likely to be one of four types which are described in the accompanying matrix. Essentially, the cells are divided as follows - either the Bank's tough advice is proved right or wrong; and the Chancellor either follows the Bank's advice, or he does not. The outcomes are very different in these four cases.

The one we have seen so far is the bottom right, where the Chancellor rejects the Bank's tough advice, and is proved to be right. In this case, the system survives intact, but the Bank limps along with a discredited reputation. Worse happens in the top right quadrant, where the Bank is again wrong, but the Chancellor reluctantly decides to follow its advice. Here we have a recession, since monetary policy is too tight, and the Bank gets the blame. Under such circumstances, it becomes possible to imagine that the Chancellor might go back to the old system, in which the Bank's advice is not published at all.

Now consider the alternatives in which the Bank's tough advice proves to be right. If the Chancellor follows this advice, again reluctantly, then policy is tightened in time to avoid a rise in inflation. The Bank gets the main part of the credit, but the Chancellor is praised for having the sense to follow its advice. The system probably survives intact, though the Bank could win operational independence in this case. Only in the final case, the bottom left, would the clamour for Bank independence become overwhelming. In this instance, the Bank's advice proves right, but the Chancellor fails to follow it. Inflation rises, the markets lose confidence in the Chancellor, and he is forced to concede that the Bank should set interest rates in future.

Only one of these four alternatives results unequivocally in independence for the Bank - and sadly it is one which requires a policy disaster to intervene first.

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