Take it from the Lords Economic Affairs Committee: All is not well at the Bank of England

The Bank of England
The Bank of England

Inflation is, thankfully, down from its 40-year high. But why did it rise so high in the first place? Did the Bank of England make errors? If so, what were they – and what lessons can be learnt? Simple questions, and ones that matter to us all. An inquiry by the House of Lords Economic Affairs Committee sought to answer these questions, putting the events of the last few years in the context of the Bank’s 25 years of independence.

Independence, we concluded, should be preserved. Taking control of monetary policy out of politicians’ hands has contributed to the low inflation we saw up until the end of 2021. But that does not mean all is well.

First and foremost, the Bank of England – like many other central banks – erroneously forecast that, when inflation rose above target in 2021, the rise would be as transitory. Why? Thanks in part to a lack of diversity of views – not just in the Bank, but in central banks around the world: witnesses spoke of years of low inflation breeding a collective, misplaced confidence about the inflation outlook. Linked to that was, we were told, an insufficient attention to money supply. And alongside this was an over-reliance on inadequate forecasting models, which seldom predict anything other than a return to the inflation target over their forecast horizon.

Next, the Bank’s remit has grown. Each year, the Chancellor writes to the Governor, setting out the Bank’s remit. Successive Chancellors have asked the Bank to “have regard to” or to “consider” a growing number of issues to support the Government’s economic policy. Andrew Bailey told us the addition of numerous “have regards” to the Bank’s remits “certainly creates more work … it makes policy-making more complicated”.

George Osborne felt that the Chancellor’s remit letters should not be turned into “Christmas trees where you put all your baubles on them”. Our conclusion was that the growth in the Bank’s remit risks jeopardising its ability to prioritise its primary objectives; drawing the Bank into the Government’s wider policy agenda; and risks conflict between various objectives. Meanwhile, thanks to years of quantitative easing, the Bank’s balance sheet has grown – peaking at an estimated 50 per cent of GDP – which has blurred the lines between fiscal and monetary policy, and has implications for debt management.

Third, Parliament has processes to hold the Bank to account and uses them well. But these processes have not grown commensurate to the Bank’s remit, creating a democratic deficit. Just last week, the Autumn Statement bumph contained the Chancellor’s remit letters for the Bank. Given the criticism that the Bank has faced over its handling of inflation, you might have thought that these letters would have generated considerable debate. But no. There was barely a whisper.

Put all that together, and there is a series of steps that need to be taken to improve the Bank’s performance and strengthen accountability. It must do more to foster a diversity of views and strengthen a culture that encourages challenge: it should look at its governance, hiring practices and appointments. The Treasury should get out the shears and prune the Bank’s remit, to ensure that it is focused on its primary objectives of tackling inflation and ensuring financial stability. The Bank and the Treasury should clarify how monetary policy and debt management operate. Finally, and critically, Parliament should conduct an overarching review of the Bank’s remit and operations every five years, enhancing Parliament’s ability to hold the Bank to account, and express its views on the Bank’s performance and leadership. This final point merits emphasising: independence and accountability must go together, hand in hand.

Reforms such as these may not set the pulse racing. But the Bank, alongside the Treasury, takes decisions which have an impact on the entire economy, and every household. Unlike the Treasury, those decisions are taken by unelected officials. Getting the framework for independence right is therefore critical. For the last few years, that framework has been tested. It’s now time to make the Bank of England work better.

Lord Bridges of Headley is chair of the Lords Economic Affairs Committee

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