Next week Andrew Bailey will walk into the Bank of England as Governor for the first time. In his office in Parlours, he will find an overflowing in-tray. Much of its contents will be problems inherited from his predecessor, such as the economic impact of Britain’s exit from the EU; fallout from the bank’s £435 billion quantitative easing (QE) programme; the need for new systems and approaches to financial regulation; and the urgent response to the economic consequences of the Coronavirus.
But there are three big problems he faces that have the capacity to extend dangerously the reach of the Bank of England and undermine its credibility as an institution in the longer term. The distributional consequences of the bank’s monetary and financial policies; Britain’s productivity puzzle; and the impact of net zero on the financial system each have the scope to shape Bailey’s legacy as the Bank’s 121st Governor.
Tempting thought it might be to extend the reach of the Bank to these key issues of economic policy, Governor Bailey should be honest and accept that the Bank has neither the tools nor the clear popular mandate to deal with them. If he does not, the Bank will find itself increasingly entering into the political arena and involved in matters that used to be the sole concern of the government. Bailey must simply concentrate on reforming the institutional capabilities of the Bank to deliver monetary and financial stability.
The bank’s monetary policy has always had distributional effects on different parts of the economy, but when interest rates went up and down regularly, this did not matter over the long run. Over the past decade though, a sustained period of low rates has disproportionally hit certain households, such as those trying to save for a house deposit (although this has been balanced by high levels of employment). It will be tempting for Bailey to try and resolve this. But the overall impact of high employment, low growth in real wages and the escalation of house prices should be a question for the Chancellor, not the Governor.
Bailey may also attempt to solve Britain’s puzzle of low productivity. But nearly every central banking handbook believes that monetary policies do not affect a country’s capacity to produce goods and services more efficiently. Even if you believe that the bank’s sustained low interest rate regime has reduced the incentives for businesses to lend to new, risky firms and the risk appetite of entrepreneurs, this does not fully explain Britain’s productivity puzzle. Bailey does not have the ability to solve Britain’s productivity problems, and should avoid trying to do so.
The two aspects of the green agenda that present a problem for the Bank of England are the extent to which demand and supply might alter as we move to net zero emissions, and whether certain financial assets are vulnerable to that change. In both cases, the Bank of England must understand that while it can strive to promote stability, it cannot and should not be expected to lead the political work that will solve these critical issues.
Rather than expanding the Bank’s responsibilities, the government needs to build better institutions after Brexit to support, for example, bodies such as the national infrastructure commission and the industrial strategy council. At the same time the Bank needs to be allowed to focus on its key responsibilities and avoid mission creep.
Over the past decade or so, the bank has come up with several policy innovations to nurture our fragile economy back to normal after the financial crisis. That it succeeded in avoiding a prolonged depression is a testament to its extraordinary monetary policies. But we have as a result developed a system that has discouraged financial risk-taking. And after a decade of support on demand, the private sector seems to be unable to confront risk without asking for central bank help. It is similar to the systematic calls from British industry for state aid in the post-war period. In the long run this did not help the economy.
The more pressing issue for the bank is to help the government redefine its objectives for monetary stability. It should combine its monetary and financial policy committees, review its communication strategy and contribute to the measurement and understanding of the economy. Indeed, the Governor should perhaps even call for an external review of the Bank’s remit and objectives and use it to move away from politics, and refocus on the bread and butter of central banking.
Jagjit S. Chadha is the Director of the National Institute of Economic and Social Research.