Discuss the measures taken by the current Labour government to enhance the independence of the Bank of England and the arrange

Authors Avatar

Sarah Green A344332                Nov 2005

Discuss the measures taken by the current Labour government to enhance the independence of the Bank of England and the arrangements put in place to ensure its accountability.  Are these institutional arrangements ideal?

Throughout 1989 – 1991 New Zealand, Chile and Canada all took the initiative to increase the independence of their central banks and then in 1997 the new Labour Government followed this trend giving the Bank of England independence to set interest rates.

With effect from June 1997 the Bank formed a Monetary Policy Committee (MPC) which meets on a monthly basis to determine interest rates.  Their role is to decide on the size and direction of change of the nominal base rate needed for the Bank to hit the inflation target set by the Government, which currently stands at 2%.  The MPC comprises of the governor, deputy governor and 6 other members, 2 of which are elected by the Governor after consultations with the chancellor and the remaining four are appointed by the Chancellor himself and are considered to be experts in their respective field.  Their two main responsibilities are to maintain price stability and support the economic policy of the government through the process of setting short term interest rates to achieve an inflation target.  Under previous governments it has been the Chancellor who sets interest rates but this move has given the Bank of England instrumental independence with the ability to control monetary policy, as well as operational responsibility for setting interest rates.  However, the Government still retains control of the final objective of monetary policy in setting the inflation target, preventing the Bank from having goal independence.  It is also outlined that in extreme circumstances, if it is in the interest of the nation the Government have the authority to give instructions to the Bank on interest rates for a limited period.  This policy of partial delegation of monetary policy is supported by Lohmann (1992) who believes it to yield superior outcomes, when the government is able to override the central bank at a positive cost.  But this does limit how independent the Bank can be, if there is the possibility of government interference.  Along with the move to increase central bank independence, an additional change made by the government at this point was to transfer banking supervision to an enhanced securities and investments board.

One potential problem that could arise as a result of increased central bank independence is a lack of accountability.  If the MPC are not accountable for their decisions then they may not act in the most beneficial way for the economy.  “Accountability requires that the central bank explains and justifies its policies or actions and gives account for the decisions made in the execution of its responsibilities” (Lastra, 1997) and for this reason transparency is a very important element of accountability.  To this aim the government has put in place certain requirements from the Bank.  Firstly, the Bank has to publish its inflation report every quarter, within which justification and explanation will be given as to their analysis of the economy and how they intend to meet the inflation target, in addition the minutes of each monthly meeting are available 6 weeks after.  The Bank will also continue to be accountable to Court for its operations and finances.  The Court comprises of people to represent the whole UK and are appointed for their expertise in their relative areas.  To help enhance accountability further the governor of the Bank, as chairman of the MPC, is expected to write an open letter to the Chancellor if the inflation target is missed by over 1% either way in order to explain the situation.  These measures seem to prove that the Government is committed to making the processes of monetary policy more transparent and accountable, and, through the publication of the MPC meeting minutes and inflation report, it appears that the Bank will also be accountable to the general public.  The performance of the Bank itself will be an important factor of improving accountability in addition to regular reports, and for this the appointment of a single, clearly stated objective, such as the specific inflation rate target, is paramount. It definitely aids the monitoring process by having a clear goal as it is easy to see when this is not attained and the public will also be able to observe performance more effectively.  Accountability of the central bank in this situation is also an advantage politically as increased independence could be seen as a delegation of power to unelected officials and therefore a dilution of democracy, so to maintain a creditable monetary policy it is deemed necessary to ensure the Bank is accountable to the Government who was democratically elected.  The government is also then accountable to Parliament, as, if it does not interfere with the Bank it can be accepted that it agrees with the policies and can therefore be held responsible for them.  Therefore it can be concluded that the arrangements put in place for accountability are advantageous as it shows there to be definite consequences of failing to achieve well specified goals and is therefore an incentive for the Bank to act in the interests of the whole economy to achieve the optimal inflation rate.  However, is it possible the there can be too much accountability?  An excess of supervision could counter-act increased independence, thus undermining the reasoning for measures being taken to change the position of the Bank.  Therefore it is essential to reach an optimal balance of independence and accountability where one does not diminish the other.  

Join now!

Not all economists are in agreement that an increase in central bank independence is beneficial to the economy and there are a number of costs that can be associated with this policy.  One obvious concern is the actions of the MPC itself.  A potential issue is whether they react too quickly to short term economic indicators and forecast deviations from the inflation target, which could lead to detrimental long term effects and potentially depress economic activity unnecessarily when inflationary pressures emerge.  There needs to be confidence in the MPC that this is unlikely to occur and that they will consider ...

This is a preview of the whole essay