Bank of England (Economic Affairs Committee Report)

Lord Turnbull Excerpts

Thursday 2nd May 2024 Lords Chamber

[Lord Turnbull (CB)]

My Lords, I thank the noble Lord, Lord Bridges, for his skilful chairmanship of the committee and the support we had from the start. I congratulate the noble Lord, Lord Moynihan, on shoehorning so many interesting insights into the conventional constraints of a maiden speech.

In many ways, this was a difficult investigation. Serious criticism was made of the Bank’s performance by many serious people, particularly for the period 2020 to 2022. The focus of concern was that inflation, which had been kept close to 2% for over 20 years, suddenly took off and the Bank appeared to have lost control. By contrast, virtually no one advocated withdrawing operational independence or dropping or even recalibrating the inflation target. At least for now, the priority for the Bank was seen to be to rebuild its credibility by getting inflation back to 2% before looking at anything else.

What concerned the EAC was that we were repeatedly told by people in the Bank that there was always robust debate in the MPC, and alternative views were expressed. In March 2020, the Bank rate was reduced to 0.1% and no change was made to interest rates for 18 months, until December 2021, and at that time all votes were unanimous. During this period, inflation rose from 1.5% to around 5%, on its way to a peak of 11%, before the Bank reacted, and even then it reacted only cautiously. Where was the robust debate? In economics there is the concept of revealed preference: look at what people do rather than what they say.

The dominant narrative was that, after Covid, the economy was teetering on the verge of recession and inflation was likely to stay low. The forces that had pushed prices up were labelled as transitory: once the initial hit had ended, inflation would return naturally to its previous level. What this narrative missed was that there was a different story to be told: the sharp rise in inflation reduced the incomes of families and companies, and they would be anxious to try to recoup these losses, although in doing so they would perpetuate inflation. Also, during the Covid lockdown, people’s and companies’ bank balances—that is, broad money—increased substantially, so as soon as they were released to do so, households and companies started to spend again and had the money to do so. This was before supply chains could be fully restored. The result was a sharp rise in inflation which is taking time to be brought under control.

What we have seen would be regarded as groupthink. Was there enough diversity within the MPC to explore different scenarios, raising questions about the process by which members are selected? They say nostalgia is not what it used to be, but has the inaugural MPC appointed in 1997 ever been bettered for its range of experience?

In his memoirs, the late lamented Lord Lawson regretted the fact that, in 1988, he had underestimated the strength of the recovery and the upward pressure on prices. He particularly regretted the use of the word “blip”. Did the present Governor of the Bank of England make the same mistake with his use of the word “transitory”? How was it that there was so much focus on the narrative that interest rates needed to be kept low and so little attention to an alternative scenario in which, with supply lines disrupted, this sharp increase in spending would lead to a sharp increase in inflation?

The answer may be found in the report the Bank commissioned from Dr Bernanke on its forecasting. In it he drew attention to the excessive focus on a central forecast and the lack of investigation of alternative narratives. We should bear in mind the maxim of George Eliot: prophecy is the most gratuitous form of error. Dr Bernanke’s recipe for this was that alternative scenarios should be looked at more, as the Bank had failed to realise that we were in a different world and that it was not in Kansas any more.

In mitigation, the Bank has claimed that it did no worse than other central banks. This may tell us that there was groupthink within not only the Bank of England but the community of central banks, all of which bought in heavily to the idea of a transitory inflation increase, while their economies were teetering on the edge of recession.

One of the issues addressed in the EAC report was the way the remit letters of the MPC, FPC and PRC expanded, with a proliferation of secondary objectives to be taken into account and have regard to. The danger of this was that the focus on the primary objective—containing inflation—would be diminished, and management of resources would be spread more thinly. We therefore recommended that these remit letters should be pruned—in particular, that the references to the Government’s objective of net zero should be taken out. A number of our witnesses argued that the Bank had no instruments that could be brought to bear on the net-zero objectives, and that this should be left to the Government. In response to our report, the Chancellor agreed with this recommendation, although this has brought howls of protest from environmental interests—more of which we heard only two or three minutes ago. In our session with the Chancellor, we urged him to go beyond a light trim of the remit letters, and to see whether more radical pruning could be undertaken.

One of the trickiest issues we encountered, and to which we were unable to develop a conclusive response, was the relationship between fiscal and monetary policy. In 1997, it all looked remarkably simple; the Treasury was responsible for fiscal policy, and as a result took over responsibility for debt management, and the Bank was responsible for the operation of monetary policy and decisions on interest rates. In retrospect, this clear separation was an oversimplification. As the noble Lord, Lord Blackwell, has pointed out, monetary policy has effects on the economy similar to fiscal policy, and vice versa.

The use of QE has muddied the waters further. Although decisions on the quantum of QE were ostensibly taken by the Bank as extensions of its responsibility for monetary policy, this has had a major impact on the distribution of income and wealth in society, normally regarded as concerns of fiscal policy. QE raised the value of assets for those who possessed them, and increased the cost of acquiring assets for those who did not have them, such as first-time buyers. QE has had major effects on the structure of UK debt, making it much more vulnerable to movements in short-term interest rates. The long length of UK maturities had always been regarded as a major advantage of UK debt management. As QE is unwound, there will be major losses, the cost of which will fall to the Government. We need better information on what those costs are.

I was surprised that both the Treasury and the Bank clung so vehemently to the doctrine that fiscal policy was the Treasury’s domain and monetary policy was the Bank’s domain, despite the fact that the policy of each had implications for the other party. Looking again in history, I am reminded that in 1993 the then Chancellor, now the noble Lord, Lord Lamont, consciously undertook an exercise of rebalancing, because it was felt that our membership of the ERM had forced us to hold interest rates higher than the economy required, and that at the same time fiscal policy was too loose. There was a conscious effort to ease monetary policy while tightening fiscal policy.

The process of looking to find the optimum balance of policies will be more difficult to achieve if each party sticks rigidly to its own domain. Maybe what is happening is that the Chancellor wants to avoid any possible submission that he is leaning on the Bank to keep interest rates low in order to reduce the Government’s own debt servicing costs. But this pursuit of value has the disadvantage that collaboration between the two institutions is made more difficult. As I said, the committee was unable to resolve this conundrum, so it remains in the to-do box of both institutions.