Is the Bank of England Independent?
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- Bank of England
The Bank of England was originally established as a privately-owned institution in 1694 to promote the public good and benefit of the people of the United Kingdom by maintaining the monetary and financial stability. Post Second World War the Bank of England was nationalised on 1946. Till the 18th century the Bank of England has been regularly acting as the Government’s banker by raising funds to support the government activities. Since the early 19th century the bank has become the banker to the banking system as well.
In 1997, the parliament voted to give the Bank operational or instrumental independence. The Bank now operates under the Act 1998 that sets out the current governance and accountability framework. The Monetary Policy Committee (MPC) has been established under the same Act. Instrument or operational independence alludes to the central bank's ability to freely adjust its policy tools in pursuit of the goals of monetary policy as set by the government (Walsh, C 2005).
However, the independence of the Bank of England have been controversial and an issue of debate which is also mainly discussed in this paper.
Government sets out the target for the Bank of England’s Monetary Policy Committee. Governments have recognised four major macro-economic goals which are to be achieved as follows:
- Price Stability (low and stable inflation)
- High and stable real growth
- Low unemployment
- Balance of payment stability
- The Monetary Policy Committee (MPC)
The operation of MPC has been set out under the Act 1998 which authorises the Bank to set the interest rates freely to meet the Government’s inflation target. There are nine members in the committee; the Governor, the three Deputy Governors, the Bank's Chief Economist, the Executive Director for Markets and four external members appointed directly by the Chancellor.
They are all independent members. During the process of setting interest rate they vote individually to the level of interest rate which they believe would meet the inflation target. In all MPC meeting there is one representative from the Treasury to discuss policy issues.
The goal of MPC cannot be totally independent from the government as the Bank works to achieve the target set out by the government and its economic policy. Therefore, the objectives of MPC are closely tied up with the government’s macro-economic goals which are as follows:
- low and stable inflation;
- high and stable real growth, together with low unemployment;
- stable financial markets and institutions;
- stable interest rates;
- stable exchange rates.
- Central Bank Independence in General
Independence has two aspects: firstly, independent central banks can be free to set their own budgets, while if politicians controlled their funding, their decisions would be influenced by politics; secondly, independence means central banks are protected from their decisions being reversed by ‘outside’ bodies. However, there has always been a controversy about the independence of central bank and the question has arisen “Is the Central Bank Independent?”
The emergence of this question is a relatively recent development: originally, central banks were often set up as a function of the government or as the government’s bank with a variety of different objectives.
Types of independence of central banks:
- Instrument independence refers to the central bank’s ability to use the full range of monetary policy instruments without restrictions from the core executive (Alesina & Summers, 1993). A central bank should have sufficient authority to determine the adjustment of its monetary policy instruments within the constraints stipulated by its objectives and the autonomy delegated to it.
- Goal independence provides the central bank with the power to determine its own goal(s) independently. A single or, at least, clearly defined primary goal of the central bank provides more weighty grounds for holding the latter accountable. It is argued that multiple objectives, in contrast, can impede central bank effectiveness, reduce accountability, and complicate the coordination of economic policies with the government (Lybek, 2004).
It is considered particularly important that monetary policy decisions are free from political interference: successful stable monetary policy requires a long-term perspective, and many decisions can take several years to produce results. For example, the time horizon between interest rate changes and domestic inflation rates is estimated to be approximately 2 years. Politicians, on the other hand, and particularly those facing re-election, are more interested in relatively short-term goals; which may include promoting short-term prosperity over long-term stability This was often seen in the ‘stop-go’ policies of the 1970s and 1980s, when, in the run-up to an election, monetary policy was selected as a tool to boost political popularity: monetary policy was changed to increase output and employment prior to the election. Of course, the consequence of this was higher inflation later (after the election). In view of this, governments have given the responsibility for monetary policy to independent apolitical institutions, to avoid the temptation of short-term expediency.
The emergency actions required during the financial crisis, and the size of the financial support which was needed to aid the financial institutions, have led to the extent of the actual independence of the central banks being called into question. In the United States there has been a political backlash, after the large expenditure required on behalf of the government.
The main argument against the independence of central banks is that it is undemocratic: effectively, one of the most important government functions has been passed to an organisation that unelected. In an effort to reconcile this issue and create trust in the policy makers, it is the politicians who set the goals to be pursued by the central banks. Also, the central banks provide regular reports regarding the progress made in the pursuit of the goals. What is important in terms of trust in the system is how the message is communicated.
- Independence of the Bank of England
Before 1997, Bank of England was the least independent central bank among other major central banks because the Bank had no any authority to set interest rates as it was only the Chancellor of the Exchequer who had that authority. After 1997, the Bank of England was granted independence by the parliament to set its own interest rates to achieve the government’s inflation target. However, in extreme circumstances government can over-rule the decision of the Bank of England for a limited time.
The Bank of England is accountable to the parliament, especially, the House of Commons Treasury Committee. MPC is required to explain the inflation target report and any actions regularly to the Treasury Committee.
- Is the Bank of England Genuinely Independent?
In my opinion, from the above discussion, the Bank of England is not totally independent. However, it was given the power by the parliament for the instrumental independence, the parliament still retains the power to over-rule the decision made by the Bank of England temporarily in an extreme circumstances. As said earlier, the main argument against the independence of central banks is that it is undemocratic: effectively, one of the most important government functions has been passed to an organisation that unelected.
According to S. Richards, an economist (2012), “Even the strongest defender of the Bank of England would find it hard to argue that there are any signs of independence here. After all these are exactly the sort of policies that would make virtually any UK government smile! Interest rates slashed and their debt being supported by Bank of England purchases under Quantitative Easing would surely be on the vast majority of political Christmas wish-lists”.
Bank of England was founded in 1964 to maintain the monetary and financial stability of the United Kingdom and to support government activities by raising funds acting as a government’s banker. In 1997, the parliament voted to grant the instrumental independence to the Bank of England. The Monetary policy committee was established under the Act 1998 and given the authority to determine the interest rate which possibly the best and could achieve the government inflation target. The Monetary Policy committee objectives are very closely tied with the goals of the government. The Monetary Policy Committee is accountable to report to the government, particularly the Treasury Committee about its actions and the inflation target report.
Though, the Bank of England has been given the instrumental independence by the parliament, there has always been a controversy regarding the Bank’s independence.
- References and Bibliographies
Walsh, C. "Central Bank Independence" Prepared for The New Palgrave Dictionary December 2005 RBNZ Website: http://www.rbnz.govt.nz/keygraphs/Fig1.html Lybek, T (2004). “Central Bank Autonomy, Accountability, and Governance: Conceptual Framework”, Paper presented at the 2002 IMF Seminar on Current Developments in Monetary and Financial Law, Washington, D.C.,
Alesina, A. and Summers, L. (1993), “Central bank independence and macroeconomic performance: some comparative evidence”, Journal of Money, Credit, and Banking, 25, 151 -162
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