In his March budget, the United Kingdom’s chancellor of the exchequer, Rishi Sunak, enlarged the mandate of the Bank of England (BoE) to include supporting the government’s target of achieving net-zero greenhouse gas emissions by 2050. But in a June 8 letter to the Financial Times, Mervyn King, a former BoE governor, was sharply critical of the move. King warned that “an expansion of central bank mandates into political areas, such as climate change […] threaten[s] to weaken de facto central bank independence, leading to a slow response to signs of higher inflation.” So, what is going on?
A little history may help. By the 1980s, a consensus had emerged among policymakers that the main macroeconomic problem was inflation. Governments’ “Keynesian” efforts to push unemployment below its “natural rate” made them unreliable guardians of the value of money.
Governments therefore outsourced inflation control to “non-political” central bankers. In 1997, the UK’s new Labour government, acutely aware of the party’s reputation for profligate spending, gave the BoE a mandate to meet an inflation target of 2.5% (later lowered to 2%). The power to set the official interest rate (Bank Rate) was transferred from the Treasury to the BoE’s Monetary Policy Committee.
The expectation was that the newly empowered BOE would raise its interest rate when inflation was trending above 2%, and lower it when inflation (or the price level) fell. Moreover, the medium-term nature of the inflation target gave the BoE some wiggle room to adjust interest-rate policy to reflect economic activity. This monetary regime, adopted by most rich-country central banks, was credited with maintaining price stability during the so-called “Great Moderation” that lasted until 2008. But low commodity prices, conservative fiscal policy, and China’s integration into the global economy were almost certainly more important factors than the technocratic calibrations of independent central bankers.
In the 2008 global financial crisis, however, central banks went beyond their traditional role as lender of last resort and bailed out bankrupt commercial banks deemed to be “too big to fail.” As the banking crisis turned into a severe economic downturn, and official interest rates fell to near-zero, fulfilling the inflation mandate was thought to require additional monetary-policy tools. Enter quantitative easing (QE), or “unconventional monetary policy”, which meant flooding the economy with money to offset the effects of business contraction.
Central banks tasked with controlling inflation were thus now using monetary policy to stave off economic collapse – something for which they had no mandate. Amid the ensuing confusion about the nature of their role, monetary policymakers claimed that their massive purchases of government debt – amounting to hundreds of billions of dollars, euros and pounds between 2009 and 2016 – were intended to “raise the inflation rate to target”. But everyone knew that inflation was the last thing they had in mind as their economies plunged.
Had central banks openly proclaimed their role as rescuers of last resort, most people would have said that this was the government’s responsibility, and with good reason. As John Maynard Keynes had pointed out 80 years earlier, it is the spending, not the printing, of central bank money that is crucial for economic activity.
Central banks never satisfactorily answered the question of how their massive monetary injections were supposed to increase real economic activity, or raise prices for that matter. As economies continued to stagnate, the best they could do was to argue that things would have been worse without QE.
Then, with recovery from the 2008-2009 financial shock far from complete, the Covid-19 pandemic struck. This time, it was governments that (rightly) started spending on a huge scale to sustain societies’ purchasing power in the face of mass lockdowns. Central banks, still ostensibly pursuing their inflation targets, now financed whatever scale of public spending governments chose, without anyone bothering to change their mandate. A few intrepid spirits asked how financing an ever-growing government deficit could be consistent with hitting a 2% inflation target. But posing this question was considered bad form, since it “undermined the credibility” of the central bank’s anti-inflationary mandate.
Sunak’s new climate-change mandate, which at least has the virtue of being transparent, thus comes at a time when the waters of monetary policy are already muddied and the meaning of central-bank independence blurred. Establishing greater clarity on such questions was one of the main purposes of the recent UK House of Lords Economic Affairs Committee inquiry into monetary policy.
The committee’s report, Quantitative Easing: A Dangerous Addiction?, charts with meticulous detail the progressive deterioration in the coherence of the BoE’s mandate. It recognizes that preventing catastrophic climate change should be a central preoccupation of public policy. The issue is simply the extent to which the central bank could be drawn into political matters without undermining the credibility conferred by its independence from politics. The committee’s report concludes gingerly that because of the chancellor’s enlargement of the BoE’s mandate, “the bank risks being forced into the political arena”.
But the important question is not the extent to which the BoE’s expanded mandate undermines its anti-inflationary credentials, but rather the degree to which it blurs the responsibilities of the government and the central bank for the conduct of economic policy. The current regime assumes that central bankers should control the quantity of money, while allocation of money (or capital) through the budget would remain in the hands of democratically elected governments.
But involving central banks in allocating money to firms or sectors on the basis of their “greening” potential – by buying the debt of hydroelectric power companies but not that of petroleum firms, for example – forces them to make political decisions for which government should be held accountable through the tax system. The UK government’s readiness to exploit the QE tool to outsource capital allocation to a nonaccountable body is thus a further step in its abdication of responsibility for ensuring a healthy, sustainable economy.
Robert Skidelsky, a member of the British House of Lords, is a professor of political economy at Warwick University.
Copyright: Project Syndicate