Outlook: King manages to be both wrong and right on interest rates

The Chancellor will have to make his mind up shortly on who he's going to have as the next Governor of the Bank of England. Sir Edward George is not due to retire until June, but the general assumption is that the markets will be given quite a bit of time to get used to the idea of whoever his successor might be. That would indicate a decision shortly after Christmas.

The three front runners for the job – Sir Howard Davies, chairman of the Financial Services Authority, Andrew Crockett, outgoing general manager of the Bank for International Settlements, and Mervyn King, the present deputy governor – have already been much analysed and commented on, but only the last of these candidates has a track record in the administration of British monetary policy by which he can be judged. The other two men have had spells at the Bank (Sir Howard actually voted at the first two Monetary Policy Committee meetings) but neither of them have been MPC time servers.

Does Mr King's record count for or against him? The fashionable view is that making the Bank of England's Monetary Policy Committee responsible for interest rates was one of the best things New Labour has done in its five years of power. In marked contrast to both the European Central Bank and the US Federal Reserve, the Bank's handling of monetary policy has been masterful. Inflation has been kept low while aggregate growth, though plainly not as good as the US, has easily outstripped other major economies. In Europe policy has been too tight, in the US it's been too loose, but in Britain it has been just right.

Scratch the surface, however, and the MPC's record doesn't look as good as it is often portrayed. Ever since August 1998, inflation has either been at or quite significantly below the mid point of the Government's target range. On a number of occasions it has come perilously close to breaking through the bottom limit of the range altogether, a point at which the Governor is required to write formally to the Chancellor explaining why the Bank has messed up so badly.

The implication is that monetary policy has been too tight through most of the MPC's reign. Growth could have been higher than it was without significantly adding to inflation. On one or two occasions, such as the run up to the Russian debt default in the autumn of 1998, the MPC was demonstrably at fault in maintaining rates at too high a level.

What of Mr King's individual record? It scarcely needs saying that Mr King is a hawk, but boy what a hawk he has turned out to be. The MPC has met 65 times since its inception. Generally speaking, Mr King has voted with the majority and much of the time the vote has been unanimous. But where the MPC has been split, there's not much doubt about where Mr King stands. On no fewer than nine occasions Mr King led the minority in voting for a rise, and on two of those occasions he was on his tod in thinking higher rates appropriate. On two occasions he was in the minority in opposing a cut and on 13 occasions he was with the majority in opposing it. On 10 occasions he was with the majority in voting for a cut but there was a minority that wanted an even bigger one. Finally, he was with the majority in voting for a rise on four occasions.

In only three instances where there has been a split on the MPC has there also been anyone in a more hawkish position than Mr King, and on two of those occasions it was the maverick Willem Buiter, who has since left the Bank. Given his position and standing, it is only reasonable to conclude that Mr King has at all times exerted an unduly hawkish influence on the committee. Had Mr King on all occasions got his own way, the Governor would by now have penned his letter, and possibly his resignation too. There's no point in beating about the bush. On the hard evidence, Mr King has been wrong, and furthermore he's been more consistently wrong than anybody else.

That in any case is the message being whispered in some parts of Whitehall. There are excuses. The earnings data was at fault in the early years, suggesting as it did a faster rate of growth than was actually occurring. Interest rate policy is an inexact science, the MPC was feeling its way, and there was every reason for thinking, given Britain's inflationary past, that if you were going to get it wrong, it was much better to get it wrong on the downside than the upside. Taking risks with inflation just wasn't part of the script.

To the extent that the Bank did get it wrong, it was because Mr King and others refused to believe that the labour market could be as tight as it was for as long as it has been without triggering inflation. Shushil Wadhwani and DeAnne Julius, both now departed from the MPC, were too much in a minority in recognising the structural changes that had allowed this happy state of affairs to take root. Most others shared Mr King's scepticism about the wonders of the New Economy.

But perhaps the most powerful argument in Mr King's defence is that although monetary policy has been too tight on a strict interpretation of the Government's brief, it may have been basically sound once other factors are taken into account. If interest rates had been lower, the asset price bubble, first in the stock market and now in the housing market, would undoubtedly have been more severe. Central bankers used to insist that it is not part of their job to arrest or puncture asset price bubbles, except in so far as they think the bubble will cause wider inflationary pressures.

Alan Greenspan, chairman of the Federal Reserve, still seems to hold that view but he is part of a diminishing minority. The aftermath of a bubble is one thing central bankers have to watch out for. A bubble left unchecked can eventually have extreme economic consequences, as we are being only too painfully reminded. The socially divisive nature of a bubble, which widens the gulf between the haves and the have-nots, must also be taken into account, and if very low interest rates are causing anomalies in the accumulation of wealth, then it is obviously something that needs to be addressed. You won't read about this sort of thing in the MPC minutes, and it is not clear that it is ever discussed, but it will throughout have been at the back of Mr King's consciousness. Asset bubbles are unhealthy things, both economically and socially. The MPC is walking a perilous line in using the housing market to support the economy. If policy were easier still, imagine the consequences. Gordon Brown, the Chancellor, already has, making it clear in interviews that he would not be opposed to interest rate rises intended to take the steam out of the housing market.

Mr King cannot therefore be regarded as definitively wrong, and as his supporters point out, the other two contenders have yet to have their judgement tested at the coal face. Even so, if the Chancellor is looking for reasons to bring in someone new, he has plenty of ammunition here. Mr King has been consistent in his view. He's not chopped and changed it, as he was once accused of doing, to pander to whatever the latest political thinking might be.

In another case of being apparently wrong, he voted twice this summer for a rise in interest rates, despite the slower than anticipated recovery in the world economy and the severe conditions in equity markets. If Mr Brown is looking for consistency, he'll choose Mr King. But if he wants to continue with the consensual tradition established by Sir Edward, he'll go for one of the other two.

jeremy.warner@independent.co.uk