Sunday, 3 June 2012

How Independent is the Bank of England?

As the debate leading up to the referendum begins to heat up, one of the most important issues will be the currency an "independent" Scotland decides to use. Since John Swinney announced that the SNP would keep sterling as the currency, there has been a series of statements from the SNP leadership, mainly Alex Salmond and Nicola Sturgeon, some of which have been condemned by the Unionist opposition, as "gaffes". The most recent from Ms Sturgeon, came in a televised debate in which she claimed an independent Scotland "would have a seat on the Monetary Policy Committee" (of the Bank of England). The first Minister reiterated the claim during First Minister's Question Time in the Scottish Parliament the following day and, despite serious pressure on both Ms Sturgeon and Alex Salmond, to provide proof that this would be so, none was forthcoming.

I have an obvious interest to declare here as I have been banging on about the SNP's policy on the currency, not just for the months since John Swinney's statement, but for the years since the SNP decided it would join the euro. I have been attacked and ridiculed for my efforts by the usual SNP supporters, but not once has there been any attempt to address the issue of what a monetary union means and how it would effect an "independent" Scotland. Now that the SNP's policy on the euro is dead in the water, although as I pointed out in the most recent blog on the subject, the leadership were still supporting it a couple of months ago, attention has now switched to the use of sterling and how an "independent" Scotland would have a say in devising monetary policy, the current responsibility of the Bank of England. As recently as yesterday several SNP Tweeters insisted the Bank of England is independent and, that meant that it would determine monetary policy for the UK "as a whole" including the part that was now an "independent" Scotland. That suggested of course, that the Westminster government would have little or no say and, with a seat on the MPC of the "independent" Bank of England, something we do not have at the moment, Scotland would be in a stronger position than we are now.

Perhaps my usual critics could address the issue for once (I do not expect the attacks and ridicule to stop as that would render most of them speechless) but if they are so sure the SNP is right, that their arguments are valid, it should be very simple to destroy my arguments and therefore my case, thereby reinforcing the arguments put forward by the SNP and improve the liklihood of  a "Yes" vote in the referendum. It is certainly true that the SNP is in the strongest position, in terms of money, supporters and organisation, to win a "Yes" vote, to say nothing of the personal profiles of Alex Salmond and his ministers, particularly Nicola Sturgeon. By the same token, they have the greatest potential to provoke a "No" vote, if they continue with the nonsense claims they have been making, and not just on the currency. I need no persuasion to vote "Yes" but there is something like 30% of the Scottish electorate, including many who voted for the SNP last time around, who do need to be persuaded and won't be, if all they hear from the SNP are personal attacks on anyone who criticises them, together with ludicrous asserttions that can be kicked into touch by the first lad you meet in the pub. I intend to address the issue of an independent Scotland having its own currency in the next blog but for now, the following is an examination of just how independent the Bank of England is and, what that will mean if Scotland keeps using sterling.

When Gordon Brown became Chancellor in 1997, he changed the responsibilities of the Bank of England in two major respects, the first removed its function as overseer of the financial services industry, including the major banks, the second, gave it the responsibility, and alleged freedom to act independently, in setting interest rates. The Bank of England Act of 1998 set out the parameters of the Bank's responsibilities thus,

1) "maintain price stability and, subject to that,
 2) to support the economic policy of HM Government, including its objectives for growth and employment"

The Chancellor instructed the Bank to create a committee, the Monetary Policy Committee, which would set interest rates, bearing in mind the responsibilities which it had been given. The MPC has nine members, five from the Bank of England and four "external" members appointed by the Chancellor. The Governor chairs the MPC meetings, which take place once a month and the other Bank members include two Deputy Governors, chief economist, Director of operations and Committee chief economist. A Treasury representative attends every MPC meeting but does not vote. The purpose is to ensure the MPC is appraised of the government's fiscal policy and any changes that may be intended, as well as the Chancellor being kept informed of the views being expressed by the MPC. One of the major criticisms that has been made of the MPC, is that it is composed of Bank "insiders" and academics, with little or no business experience. In other words the Government gave the Bank of England operational independence - to set interest rates.

Outside of having the responsibility of setting interest rates, "free" of direct political interference, it is difficult to see how the Bank can be considered "independent"  in any other meaning of the term, bearing in mind its main responsibilities. To emphasise just how much the Bank is a creature of government, under the provisions of the Act of 1998, the Chancellor must write to the Governor of the Bank at least once every 12 months, laying down the Government's inflation target for the coming year and reminding the MPC of its remit under the Act. The letter is couched in the following terms,

"The MPC is accountable to the Government for the remit set out in this letter. Any changes to the remit will be set out in the Budget"

The target for inflation in respect of the Consumer Price Index (CPI) is currently 2% and has been at that level since 2003, when the target was changed from the previous Retail Price Index (RPI) to CPI, more of which below. In the event that the target is missed - either 1% above inflation or 1% below - the Governor of the Bank is obliged to write to the Chancellor with an explanation of why the target has been missed. To date, the Governer has written such a letter to the Chancellor on twelve occasions. The change from RPI to CPI was introduced in 2003 and was criticised as motivated by politics, to bring the UK more into line with the EU, which uses the CPI. One of the criticisms is the way in which the measurement of inflation differs between the CPI and RPI and the Royal Statistical Society has "called for a comprehensive review of the issues relating to the measurement of inflation." Another criticism is that the CPI shows smaller changes and therefore disguises inflationary pressure.

The Office For Budget Responsibility (OBR) has forecast the inflation for RPI and CPI as follows:-

Forecast       2010/11    2011/12    2012/13    2013/14    2014/15

CPI%               2.8            2.6             1.9             2.0           2.0

RPI%               4.2             3.4            3.0             3.2            3.4

OBR questions the assumptions on which inflation is calculated and predicts the gap between CPI and RPI will widen to as much as 1.8% by 2016. The CPI excludes the following goods and services from the measurement of inflation, which are included by RPI, Vehicle and TV licences, mortgage interest payments, household insurances and council tax. Perhaps the most important difference is the exclusion of mortgage interest payments, which are of far greater importance in the UK than they are in the EU because of the differences in the methods of mortgage lending. To exclude mortgage payments from the measurement of inflation seems ludicrous particularly when it is known that between 1997 and 2003, the average interest rate in the UK was 4% while in the eurozone it was 2%, although the UK has had the benefit of interest rates of 0.5% for the past three years, which has had an effect on mortgages rates. The Bank of England had no say in whether or not that change to the measurement of inflation should go ahead despite having the responsibility for setting interest rates, which can be instrumental in causing inflation.

In November last year, a report called "Independence and Accountability - A New Mandate For the Bank of England" was published by the Centre for Economic Policy Research, although it did not reflect that organisation's views. The report was the work of a panel chaired by Lord Roll of Ipsden and which included a group of academics and people from the finance industry. The main concusion of the panel was that the Bank of England should be "completely independent of the Treasury and have as its sole aim, the maintainance of price stability" or setting of interest rates. The view of the panel is that the Bank is not independent in areas where it needs to be. There is no doubt that any organisation which is set up by Government, has its targets set by Government, must answer to Government and which must support Government policy as set out in its remit, and relies on Government for the composition of its most important committee, and can have its functions changed at the whim of Government as was done with the governance of the financial services industry, is hardly independent.

SNP supporters who insist the Bank of England is "independent" must now say in what way it is independent. I appreciate that the SNP currently has problems defining what independence is going to mean for Scotland, but if the party's supporters continue to insist the Bank is independent, they have an obligation to say what that means. They must also say how the "independence" which they insist the Bank has, will be of benefit to an "independent" Scotland. What is it the bank will be able to give to an "independent" Scotland, it is not providing now? What is it that SNP supporters expect of the Bank of England in respect of Scotland? The SNP leadership has claimed it is only reasonable that if Scotland decides to retain Sterling, that Scotland should have a place on the MPC. The party has been told by several authorities, including past Chancellors, it will not be entitled to a seat, nor will it be given a seat, on the MPC. A seat on the MPC is not within the gift of the Bank of England and, bearing in mind that the second main remit of the Bank is "to support the economic policies of HM Government, including its policies for growth and employment." is the SNP really asking for a seat on a committee which is obliged to support the policies of a "foreign" government?

The history of interest rates in the UK is one where the interests of Scotland have rarely been considered and not considered at all, if they ran counter to the interests of the South East of England. Despite that, SNP supporters on here, have argued that maintaining sterling would be OK for an independent Scotland because the "economic policies of the Bank of England are unlikely to be much different from those an independent Scotland would have in any case." That argument is for the next blog. meantime, let us hear the SNP case for the independence of the Bank of England and how that independence will benefit Scotland.

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