In a Report published by CEPR on 18 November, a high-level panel chaired by Lord Roll of Ipsden (President, S G Warburg Group plc) call for a new mandate for the Bank of England. The panel states that the Bank should set monetary policy independently of the Treasury, pursue price stability as its sole objective and report regularly to Parliament. The Esmée Fairbairn Charitable Trust commissioned CEPR to establish this Panel. The Report was launched at a London discussion meeting on 18 November, addressed by David Begg, who also acted as the panel's Rapporteur.* The views expressed in the Report are those of the panel, not of the Esmée Fairbairn Charitable Trust nor of CEPR, which takes no institutional policy positions.

Following the UK's departure from the ERM, the government sought a new anchor for its monetary policy, and by the end of 1992 it had publicly settled on the pursuit of price stability. The government announced tough targets for inflation during 1993 and offered the Bank a monitoring role through the publication of its Inflation Report. Inflation has remained low since then, despite the substantial exchange rate depreciation, since the recovery remains weak after the worst recession in post-war history. These conditions are unlikely to last, however, and a policy framework with a stronger monetary anchor will eventually be required; this should be put in place now, before inflation reappears. The best available anchor is a more independent Bank of England. Independence can never be absolute, since elected governments must retain the right to determine economic policy in a crisis of sufficient severity, so the key issue is to determine the degree of independence with which the Bank should conduct monetary policy in normal circumstances.

The panel call for legal specification of the Bank's objective in its narrowest form. It should be charged with maintaining price stability alone, since a multiplicity of objectives would obscure the monitoring and accountability of an independent central bank. Given the UK's inflationary history, this would be a grave mistake. The Bank should set and announce its medium-term inflation targets in advance, in order to promote credibility and facilitate accountability. Government participation in setting monetary policy targets could undermine the nominal anchor the UK requires through an `upward drift' of such targets. The Bank must have full control of short-term interest rates in order to achieve its monetary policy targets; while the Bank and the government will normally agree on such targets, the Bank's view should prevail in the event of any disagreement.

With international capital mobility, interest rates are the principal instrument with which the authorities can defend a fixed exchange rate or manage a floating currency. Without full control of interest rates by the Bank, any strategy to grant it independence would be a sham, but no government has ever been prepared to relinquish all control of exchange rate policy. While this conflict can never be fully resolved, the Bank should routinely inform its Parliamentary monitors of any inflationary difficulties arising from the government's choice of exchange rate regime. Foreign exchange markets will determine the exchange rate, and neither the Treasury nor the Bank can have any `exchange rate policy' distinct from that implied by the Bank's obligation to pursue price stability. Control of interest rates will then normally ensure that the Bank rather than the government maintains operational control of the exchange rate under any given regime. A government that disagreed sufficiently could override the Bank and justify its action in the ensuing public debate.

Freeing the Bank of its obligations to act as banker to the government by providing automatic overdrafts and buying government stock on its own account will both enhance its ability to conduct effective monetary policy and facilitate the monitoring of fiscal policy.
Placing an independent Bank's objectives on a statutory foundation would immediately enhance the democratic accountability of monetary policy by providing legislative standards against which subsequent policy may be judged. Accountability should go much further, however, through the establishment of routine Parliamentary review of the Bank's choice of targets and conduct of monetary policy. That review should be carried out by the Treasury and Civil Service Select Committee of the House of Commons, which already routinely conducts investigations into macroeconomic policy. Since the economy is affected by the simultaneous interaction of monetary and fiscal policy, the Bank would inevitably have to discuss how the government's fiscal choices constrained its monetary policy options. The Bank should also submit its inflation targets to Parliament regularly through the Chancellor, who would lay both the communication from the Bank and an accompanying statement from the government before the House.

The government must retain the power to take over the reins of all economic policy, including monetary policy, in a crisis, but preserving credibility in normal times requires that this override be effected through a procedure that is both discrete and highly visible. Small overrides of targets are explicitly ruled out as a recipe for `target drift'. Such overrides should therefore require Parliamentary approval and should last for a finite period of six months, renewable only with further Parliamentary approval. Such a `temporary suspension' of the Bank's objective should be provided for in the legislation that establishes the Bank's independence; this ability to override the Bank's objective suffices to preserve the doctrine of ministerial responsibility to Parliament.

Neither the German nor the New Zealand model of central bank independence is appropriate to the UK, given its parliamentary institutions and the public's attitude to inflation. Germany relies on the constitutional independence of the Bundesbank, which is free to implement its mandate without detailed constraints. The German electorate's strong attachment to price stability ensures that any government that allowed inflation to get out of control would become unpopular together with the central bank, whose `independence' is as much a symptom as a cause of widespread concern for price stability. In contrast, the UK electorate favours low inflation if it costs nothing, but at any given moment there is plenty of support for boosting demand in order to raise employment, so earning credibility is much harder. For the UK in 1993, a system that emphasizes transparency, monitoring and accountability may have important advantages over the Bundesbank model, which relies more on reputation and trust. And the UK has already begun to travel down this road, with the government announcing target ranges for inflation, whose progress the Bank monitors in its quarterly Inflation Report.

New Zealand relies on a legal framework of contracts which sets a three-year inflation target as part of the contract between the Governor of the Reserve Bank of New Zealand and the government. An independent monetary policy can probably not be achieved in the UK by any system that routinely involves ministers in setting inflation targets.

Even though the UK may at some future date have to decide whether to join a European monetary union, keeping this option open has no major implications for the desirability of this model of the Bank of England's independence today. While the Panel's proposals represent a particular institutional solution to the current set of national circumstances, the same analysis could support a solution much closer to the Bundesbank model were the UK to join such a monetary union. No insuperable constitutional, legal or even practical difficulties would be involved in embarking on one model and joining a monetary union and switching to a different one at a later date.


* Independent and Accountable: A New Mandate for the Bank of England
ISBN 1-898128-02 2. Available for £6/$9.95 from:
CEPR, 90 - 98 Goswell Road, London, EC1V 7RR

The other members of the panel comprise: Sir Brian Corby (Chairman, Prudential Corporation plc), Professor Terence Daintith (Director, Institute for Advanced Legal Studies, University of London), Dr Leonhard Gleske (former member of the Directorate, Deutsche Bundesbank), Professor Charles Goodhart (LSE), Mr Philippe Lagayette (Chief Executive, Caisse des Dépôts et Consignations, Paris, and former First Deputy Governor, Banque de France), Sir Peter Middleton (Chairman, Barclays de Zoete Wedd, and former Permanent Secretary, HM Treasury), Professor Mario Monti (Rector, Università Bocconi, Milano), Professor Richard Portes (Birkbeck College, London, and Director of CEPR), Sir David Walker (Deputy Chairman, Lloyds Bank plc) and Professor Charles Wyplosz (INSEAD).