Andrew Bailey has overseen the Bank of England’s descent into a second-rate, politicised failure
Let’s hope he’s right this time. If Andrew Bailey and pals at the Bank of England are wrong about inflation again, we’ll need higher interest rates and a deeper recession to drive it out of the system. That’s the trouble with losing credibility. Once you’ve lost it, you need to work harder and harder to get it back.
The Bank this week released a dire new set of growth and inflation forecasts. A long, hard recession is coming and inflation is meant to peak at 13 per cent this autumn and then head conveniently back to the target of 2 per cent in early 2024. Of course, in May, the Bank thought inflation would peak around 9 per cent. In December last year, the Bank said that inflation was due to “transitory” factors and would peak at 4.5 per cent earlier this year. It’s not hard to spot the pattern.
As Mr Bailey argues, it’s not the Bank of England’s fault if Vladimir Putin has decided to cut off the gas. The governor’s imperative, naturally, is to defend his own and his institution’s reputation. Unfortunately for him, this politicises an already uncomfortably political position. Both Tory leadership candidates argue that domestic policy has a major role in controlling inflation. Rishi Sunak talks up the importance of fiscal policy. Liz Truss points the finger at the Bank. Both are right to some degree. The Bank cannot control gas prices, but it did create an economy primed for inflation by printing so much money during the lockdowns (when supply, not demand, was being constrained) and then failing to wind up the stimulus and raise rates when the warning signs appeared.
The whole thing carries eerie echoes of the 1970s. The first inflation spike of 9 per cent, in 1971, was brought on by then-chancellor Anthony Barber’s over-stimulation of the economy. The second, 24 per cent in 1975, was sent into the stratosphere by the Arab oil embargo. The third, 18 per cent in 1980, helped bring on Geoffrey Howe’s recessionary “sound money” budget, which finally pulled the country out of the perpetual swamp of inflation.
The difference this time is that setting monetary policy is now nominally an independent process. No one can tell Mr Bailey what to do. And yet, somehow, markets have developed the funny idea that the Bank is not truly independent, but is being driven by political imperatives. This is not just because its mandate is being successively diluted – first, with the requirement to consider the UK’S “competitiveness” in regulating banks and second, with a vague demand that it use markets to help achieve net zero. It is also not just because of the Bank’s enthusiastic participation in woke fads, like membership of Stonewall’s “diversity champions” scheme.
More fundamental than any of these distractions is the suspicion that the Bank has been openly used to finance record deficit spending during the pandemic by printing money, and that its reluctance to wind up quantitative easing and raise rates is related to fears for the public finances. The Office for Budget Responsibility has estimated that for every 1 percentage point rise in market interest rates, government borrowing costs rise by £20 billion. And when the Bank starts selling all the gilts it bought, as it has now promised to do in September, who is going to buy them – and at what sort of discount? Is this the real underlying reason for Rishi Sunak’s extreme caution on fiscal policy?
It is officially not the Bank’s job to worry about this. Its legal mandate is only to worry about inflation: it had one job and has failed at it. So the question is how the Bank found itself in this position. It is unlikely there was some sort of conspiratorial decision to finance the Covid spending boom. Instead, what appears to have happened is that the Bank has been in decay for some time, has filled its ranks with sub-par economists and extreasury officials, and therefore became incapable of intellectually rigorous, dispassionate and confident stewardship of the economy. Although one cannot call this a conspiracy, it cannot have been entirely displeasing to the Treasury to get the Bank back in its orbit. The Treasury never liked the idea of an independent, uncontrollable Bank in the first place.
The rot began with Mark Carney. Senior economists are divided on whether Mr Carney was simply a PR man or a great brain, but they all agree that, unlike his predecessors, he was a man determined to go places. Previous governors and their deputies tended to be owlish academic economists content to live out their post-bank days in book-lined studies, digging into obscure databanks and writing long, turgid books. This was often true even before Bank independence. Their sense of worth came from their intellectual work and the esteem of other economists. Not so Mr Carney.
He was already a Davos man and he seemingly wanted to be prime minister of Canada, or else some sort of celebrity, or, failing that, a paid-up member of the save-the-world, UN climate crew (the role he’s doing now). George Osborne, a fellow worshipper of Davos celebrity, was naturally wowed by the fellow. Anyway, the perception was that monetary policy had been solved.
Inflation had been controlled by cheap, globalised production in China. It wasn’t rocket science.
What followed was a steady shift in the Bank’s culture. As it took over some of the old Financial Services Authority’s functions, it gained an influx of staff used to an entirely different culture (Mr Bailey himself spent some time at the FSA). The Bank never managed to make them its own. Instead, turnover increased and quality declined. The new chiefs no longer paid the usual respects to their bespectacled predecessors and forged their own path.
Today’s monetary policy committee, although it has some clever thinkers on it, like Michael Saunders (soon to leave) and Catherine Mann, cannot really boast a single world-leading economist, of the kind young economists aspire to become. While you might expect to have a bit of Treasury experience among them, it is striking that all three deputy governors are former Treasury officials and two of them spent most of their careers there. Most astonishingly, the incoming member of the committee, Swati Dhingra, is not even a full professor of economics, but a relatively junior “associate” professor at the LSE. Her list of published journal articles does not fill one page. She may be a talented and impressive economist. She is not, however, a senior figure in her field.
All of this would be mere trivia if it were not for the fact that the Bank has failed in its duty so badly. Setting interest rates is inherently a political act, but it was able to masquerade successfully as a boring technocratic function for a long time because the people doing it were, in their hearts, data geeks and not political servants. That is no longer true. The result is a Bank buffeted around by the prevailing political winds. We are all the poorer for it – and getting poorer.
Buffeted by the political winds, and stacked full of extreasury officials, the institution has got its one real job badly wrong