Bank of England: how is independence working?

Looking at the last 25 years as a whole, operational independence has bolstered economic confidence and credibility in monetary policy making. While the precise contribution of independence to low inflation is difficult to quantify—with globalisation widely considered a contributing factor—the conditions established by independence have provided a strong foundation for low and stable inflation since 1997. It is our view that independence should be preserved.

Some witnesses made a case for reviewing the inflation target. While the Chancellor can change the target, the disadvantages of doing so when inflation is above target, outweigh the advantages. This is the case given the potential impact on the Bank’s credibility. When inflation is low the Bank should be cautious about the impact of a prolonged period of loose monetary policy on asset prices and financial stability.

The interaction between fiscal and monetary policy requires clear lines of responsibility and effective communication between the Bank and HM Treasury to safeguard overall economic stability. It is important, particularly given the constraints of monetary policy, that when interest rates trend towards their zero lower bound HM Treasury promotes a fiscal stance which supports the inflation target it has set the Bank. The Government’s fiscal stance and the directions given to the Bank’s Monetary Policy Committee must work together. It is the Government’s job to ensure they are consistent with each other, not the Bank’s.

Quantitative easing was a powerful tool with which to combat a monetary contraction in the aftermath of the 2008 financial crisis, but its continued deployment has blurred the lines between monetary and fiscal policy. While the quantum of quantitative easing is a monetary policy decision, decisions on debt duration have consequences for debt management. In light of the concerns raised about debt duration and the effects of quantitative easing, the Bank and the Debt Management Office (which is an agency of HM Treasury) should draw up and publish a memorandum of understanding which clarifies how the interaction between monetary policy and debt management should operate.

In addition, although there are differing views about the impact of quantitative easing, the Bank of England should give prominence to the study and reporting of the potential economic risks arising from any significant expansion in its balance sheet resulting from an extended quantitative easing policy.

We repeat the call that the Government should publish the ‘Deed of Indemnity’.

It is concerning that the Bank’s remit has expanded considerably in terms of statutory objectives, functions, regulatory principles and matters to which it should ‘have regard’ and ‘consider’, in order to support the Government‘s economic policy. This jeopardises the Bank’s ability to prioritise price and financial stability; risks drawing it into the Government’s wider policy agenda; and increases the potential for conflict between the Bank’s objectives. We recommend that the number of matters the Bank should ‘have regard to’ or ‘consider’, as set out in the policy committee remit and recommendation letters, be pruned by HM Treasury to ensure the Bank can focus on its primary objectives of maintaining price and financial stability.

The expansion of the Bank’s remit has led to a rise in the Bank’s headcount and to an expansion of its management structure, resulting in four Deputy Governors and a significant number of Executive Directors. This expansion, particularly in relation to regulation, risks downplaying the importance of monetary policy amongst the leadership and staff of the Bank. We recommend that the Bank’s management structure be reconsidered, with a focus on whether it could be made more streamlined.

If a decision is made to create a Central Bank Digital Currency, the Bank and HM Treasury will need to clarify what effect this would have on the framework for operational independence and the primary objectives of the Bank. They will also need to establish commensurate accountability mechanisms. The creation of a CBDC could raise wider public policy issues—such as breaches of privacy—which are highly political and could exacerbate risks of the Bank being distracted from its main objectives of controlling inflation and maintaining financial stability.

According to the evidence we received, there is perceived to be a lack of intellectual diversity in many central banks, including the Bank of England. Witnesses suggested that this contributed to insufficient challenge on the MPC in 2020 and 2021 which allowed a unanimity of view to prevail about the “transitory” nature of above-target inflation. While every member of the MPC must be committed to fulfilling the Committee’s objectives, it is imperative that its membership comprises people of different backgrounds and economic perspectives. The Bank must be pro-active in encouraging a diversity of views and a culture of challenge. This should be reflected in its hiring practices and its appointment procedures.

There is a notable absence of any detailed discussions about money supply in the Bank’s published Monetary Policy Reports. We recommend that the Monetary Policy Reports should include discussion of the main monetary aggregates, accompanied by an analysis of their relevance to the Bank’s inflation outlook and the various scenarios the Monetary Policy Committee considers. This would ensure adequate transparency in how the Bank approaches its monetary policy decision-making.

In 2021 the Bank of England, like many central banks, incorrectly forecast that above-target inflation would be “transitory”. This was in part thanks to a lack of challenge as regards its modelling and forecasts. We therefore welcome the Bank’s new externally-led review into its forecasting capabilities. This review should seek to explain the value of models that seldom predict anything other than a return to the two per cent target over their forecast horizon. We hope the review also considers whether appointments, both of officials of the Bank and members of the MPC, are creating sufficient diversity of thought.

Members of the Bank’s policy committees make decisions which have an immense impact on the UK economy. However, being led by HM Treasury, the process for appointing members to the Monetary Policy Committee has contributed to perceptions of both bias and a lack of diversity of thought. It is notable that three of the four current Deputy Governors have a Treasury background. While they are undoubtedly able, this does not strengthen the perception of independence. HM Treasury and the Bank’s Court of Directors should commission an independent review to address this: that review should look at how other public appointments are made, such as to the judiciary; consider best practice in other central banks; and propose measures to ensure the appointments process is transparent.

Within the boundaries of its terms of reference, the Bank’s Court of Directors plays an important role in terms of holding the Bank’s Executives to account and providing internal challenge. Its ability to commission performance reviews of the Bank’s policy committees provides a key means of doing so. However, we note that the Bank of England and Financial Services Act 2016 not only abolished the Oversight Committee but also reduced the number of non-executives on the Court. While there were mixed views from witnesses on the Court’s current composition of non-executive and executive members, the Court must be able to provide a source of effective challenge within the Bank. The Chair of the Court should consider how to enhance the role of the non-executive members so they are as effective as possible.

The independence of the Bank, and the expansion of its remit, means that significant powers are delegated to, and exercised by, a small group of appointed officials who are not part of the elected Government. To meet HM Treasury’s inflation target, the Bank may act in such a way that counteracts the economic impact of the Government’s fiscal policy. It is therefore imperative that the Bank’s activities and its remit are effectively scrutinised by, and its officials are held accountable to, Parliament. Current parliamentary arrangements should be enhanced to achieve this.

We recommend that the annual remit letters for the Monetary Policy Committee and Financial Policy Committee should be published in draft to allow sufficient scrutiny of them. The final remit letters should be laid before both Houses of Parliament and accompanied by an oral statement in each House. We believe this would enhance both parliamentary scrutiny and public debate on the remits of the Bank set by the Chancellor.

We recommend that every five years Parliament conducts an overarching review, supported by expert staff, of the Bank’s remit, operations and performance (excluding individual policy decisions). This would enhance Parliament’s ability to hold the Bank to account and express its view on the Bank’s performance and leadership.

Impartial, independent analysis of the Bank’s performance should help build confidence in the Bank and enable it to be held to account by Parliament and others. The Independent Evaluation Office’s (IEO) remit is to scrutinise the performance of the Bank and we have received evidence that the IEO is both professional and has exemplary capabilities. However, its perceived independence is undermined by the fact it is located within the Bank, its staff are drawn from the Bank, albeit with some external experience; and its work is commissioned by the Bank’s Court of Directors. This underscores the need for Parliament to conduct a review of the Bank’s performance every five years.