One of the first acts of Tony Blair’s government after the 1997 election was the announcement that in future the interest rate would be set not by the Chancellor of the Exchequer but by the Bank of England. The following extract is from Alwyn Turner’s A Classless Society: Britain in the 1990s.
The concept that the Bank of England should determine the level of interest rates, free from the dictates of the chancellor of the exchequer, had been around for some time. Tony Blair said that he had first been persuaded of the case in the mid-1980s, listening to Roy Jenkins arguing for it in the House of Commons, and within a few months of becoming Labour leader had resolved that it was the way forward. Gordon Brown had also been talking about the idea for a couple of years in private, encouraged by meetings with Alan Greenspan, the long-serving chairman of the US Federal Reserve.
It had, in fact, already been proposed in the previous government by Norman Lamont, but rejected by John Major for what seemed like impeccable reasons: ‘I disliked this proposal on democratic grounds, believing that the person responsible for monetary policy should be answerable for it in the House of Commons.’
Even before that, John Smith had come to much the same conclusion, when he was shadow chancellor: ‘Don’t think that having been elected to Parliament and given responsibility for running the economy by the prime minister, I would hand over a large chunk of my responsibilities to the Bank of England.’
New Labour had no such reservations. Four days after the election, the government announced that it was giving the Bank control of base rates.
The principal argument for such a change was that the chancellor would always be tempted by short-term political considerations to act in ways that might be against the longer-term economic interests of the country. Some, such as the campaigner for constitutional reform Anthony Barnett, saw it as a positive step, suggesting that the Bank would become ‘more accountable as sovereignty over a crucial area of decision-making, the base rate, is openly shared’. But in addition to such high-minded wishes, Blair admitted, there were also ‘very good political reasons’, since the move would be ‘the perfect riposte to those worried about the economic credentials of an incoming Labour government’.
For those with longer memories, there was the added element of one more deliberate rejection of Labour’s history. Back in 1946, one of the first acts of Clement Attlee’s chancellor, Hugh Dalton, had been to nationalise the Bank of England; now that was effectively to be reversed.
Even accepting the case for handing over monetary policy to the Bank, there were a number of details to be considered.
First, the question of disclosure. If one of the key economic levers was to be taken out of the democratic arena, it seemed reasonable to consult the electorate, particularly since the move had clearly been planned before the election. Blair, it was said, wished to make the proposal public as part of the campaign, but was talked out of it by Brown.
Instead knowledge of the move was kept within a tight group at the top of New Labour, though Brown did phone previous chancellors after the election to inform them of what he was going to do. ‘You’ll be pleased to hear that I’m introducing your policy,’ he told Norman Lamont, thus ensuring that a former Conservative politician, who had failed to be re-elected to the Commons, heard the news before the Labour Party or the electorate. When Labour MPs were told, some voiced their disapproval. ‘Who elected Eddie George?’ asked Dennis Skinner and Ken Livingstone, in reference to the Bank’s governor.
Second was the matter of who at the Bank of England should actually make the monthly decision on interest rates. Conservative cabinet minister John Patten, one of those who argued for the Bank’s independence, had suggested that to retain some form of democratic accountability, the governor and deputy governors should, when appointed, be subject to confirmation hearings in front of a Commons committee. That proposal resurfaced after Brown’s announcement, but was spurned. Instead, Brown established a monetary policy committee, comprising nine members, four of whom – all economists – were to be appointed by him, the other five coming from the Bank itself. He rejected the idea of confirmation hearings.
And third was the question of what the new committee’s frame of reference should be, the factors that they should bear in mind when setting interest rates. It was not, as it turned out, a particularly wide remit. Brown set the Bank the sole task of achieving an inflation rate of 2.5 per cent; no other considerations – unemployment, for example, or economic growth – were to be taken into account.
Again, there was little new here. In the wake of Black Wednesday, Lamont had set an inflation target of between 1 and 4 per cent, to be reduced to 2.5 per cent by the end of the parliamentary term, an ambition that had very nearly been met; inflation was running at 2.6 per cent when the Tories left office. Brown was merely continuing the established Conservative policy; New Labour had bought into monetarist doctrine and inflation took precedence over all other aspects of the economy.
But if the chancellor believed his primary responsibility to be the control of inflation, and yet had handed over that duty to an unelected body, then what, one was entitled to ask, was the point of the chancellor? Or, more pertinently still, asked Bryan Gould: ‘What is the point of democracy?’ Gould, one of the few serious commentators not to celebrate the development, argued that ‘politicians should be made to bear responsibility for the performance of the economy – something they are constantly trying to escape’.
Others were occasionally to be heard expressing their doubts in private. David Blunkett confided to his diary in September 1997, as interest rates were put up, his uncertainty that ‘the decision to give interest rates to the Bank of England and to fail to take into account the manufacturing base of the country in the Monetary Policy Committee of the Bank of England has been the right one’.
The rate rise that Blunkett questioned was not questioned by many economists. Preceding the 1997 election, Ken Clarke had refused to raise rates despite the strength of the UK economy, an example of how politicians over the preceding 30 years had allowed inflation to rob people with their savings in banks and building societies. This was essentially a class issue. The middle and working classes saved this way. The wealthy put their money in more inflation proof property and shares.
Giving the Bank of England ‘the sole task of achieving an inflation rate of 2.5 per cent; no other considerations – unemployment, for example, or economic growth – were to be taken into account’ was justified by the argument that this level of inflation was consistent with what economists define as ‘full’ employment, typically an unemployment rate of around 5%. This would not have been the case 20 years earlier when commodity price shocks had a much greater effect on retail price inflation. However, by 1997 the development of the service sector meant that such price shocks were less likely to drive up the inflation rate consistent with full employment. The nearest we have come to such a shock was the rise in inflation after sterling’s collapse in 2008. On that occasion, the Bank of England allowed inflation to rise without raising rates in the belief that the inflation rate would subside. Which it did. The Bank is clearly planning to do the same again if inflation rises post-BREXIT.
Crucial to this policy has been the continuing immigration into the UK, which has helped cap or even drive down pay rates. The consequent population growth has put great pressure son the welfare state. Essentially therefore the problem of higher inflation following a collapse in sterling has been transferred to the Chancellor of the Exchequer. A certain irony there. Continuing high levels of immigration is just one example of a phenomenon that has been a benign influence on inflation during the last 20 years and which must therefore be mentioned: globalisation. The emergence of China and other economies has driven the price of manufactured goods down.
Blunkett’s comment probably reflected an even longer term perspective: the belief that bankers wanted a strong currency and would keep interest rates higher than they need be with the consequent price being lower output and high unemployment. This was true in the days of Empire when the UK did not want doubts over sterling to undermine trade. It is clearly not true today when sterling-denominated transactions are a small percentage of business conducted in the City. In fact, the opposite is true. The bankers are desperate to keep interest rates at zero and for programmes of QE to continue, even if the levels of economic growth in recent years have argued for a rise in interest rates.