Could the current crisis challenge the independence of the central bank?
What kind of legacy the coronavirus pandemic bestows on the UK has already been the subject of much analysis in the media. Amongst other things, it has been suggested the current crisis could reshape our working lives, reinvigorate a sense of community, or lead to the emergence of a new type of state. With the UK economy heading for its biggest downturn in three hundred years, what might be the consequence for relations between the government and the Bank of England? Could the current crisis challenge the idea of central bank independence (CBI)? Understandably, such a question is unlikely to be prominent in the minds of the public, yet any undermining of the Bank of England’s (BoE) autonomy would be a significant development in UK political economy.
At first glance, any suggestion that BoE independence is under threat seems implausible. In its first ten years of operation, the Bank presided over a superior record of price stability and was widely praised. After the credit crunch in 2008, it was the Bank that was given the job of returning the economy to its pre-growth trend, while the Treasury set about reducing the government deficit. In this task, it deployed of a range of ‘unconventional’ monetary policy instruments. In 2009, it slashed interest rates to 0.5 per cent and has kept them close to zero ever since. It unleashed Quantitative Easing (QE): a programme to boost liquidity in the economy through the purchase of government bonds in exchange for reserves. At this time, the BoE enjoyed heightened status: it was ‘the only game in town’.
Recently, commentators have started to question the effectiveness of this monetary stimulus and, indirectly, the reputation of the BoE. QE has been criticised for boosting the wealth of the richest in society and exacerbating economic inequality. Indeed, some have started to query the relevance of monetary policy in a world where short-term interest rates have remained close, inflation is low, employment is at record highs, yet growth consistently underperforms. If politicians want to see their economies return to the sort of growth trajectories they enjoyed before 2007 (so the argument runs), monetary policy (and central banks) need to step aside. Fiscal policy and supply-side reform (both government responsibilities) need to take centre stage.
The Covid-19 crisis has reinforced this argument. Public spending is now to the fore, with the Treasury lavishing money on a range of policies designed to keep the economy afloat. It now heavily subsidies the wages of millions of workers through its Job Retention Scheme; has funded a number of state aid packages; and guarantees a number of business loan programmes conceived to keep finance flowing to companies that need it. At the same time, the BoE has slashed interest rates to 0.1 per cent, as well purchasing an extra £200bn of government bonds (taking the total amount of government debt on its balance sheet to £635bn). Most controversially, the Bank has announced it will directly finance additional government spending by expanding the government’s overdraft limit on its account at Threadneedle Street (known as the Ways and Means facility). This extension is unlimited and will allow the Treasury to bypass the bond market. This co-operation between the Treasury and the Bank has been widely praised, in contrast to the media’s more critical reaction to the government’s handling of the Covid-19 pandemic.
Despite these plaudits, one worry for the BoE is these developments appear to challenge the distinction between fiscal and monetary policy and, with that, pose a threat to the Bank’s identity. With the relevance of monetary policy already being questioned, the current crisis suggests that the BoE’s role is simply to finance whatever spending and debt politicians deem necessary. A particular concern has been raised about the overdraft extension on the Ways and Means facility. It is ministers who will take the initiative when drawing down and repaying this overdraft, raising the spectre of the Bank submitting to an inflationary public spending splurge of the type witnessed in the first half of the 1970s. The BoE’s reputation (and independence) would be undermined in such a scenario.
The BoE is not ignorant of this risk and rejects any suggestion that it could lose control of monetary policy. As the new governor Andrew Bailey has made clear, ‘institutional safeguards’ rule out such a possibility. The Bank is legally required to deliver price stability and, under QE, it is the MPC that decides when and how much government debt to purchase. It is true that ministers enjoy discretion concerning how they use the Ways and Means facility, but the Debt Management Office has accepted the government will only operate its overdraft as a temporary and short-term cash-flow management tool. The Bank has also been keen to stress that a similar extension to the Ways and Means account was allowed in 2008, with the Treasury paying back the money within four months.
Persuasive as this riposte may be, there is a sense in which it highlights the precariousness of the BoE’s position. Falling back on arguments about institutional safeguards merely reminds us that the government is the author of these institutions and can alter them if necessary. Ultimately, when the UK emerges ‘from the other side’ of the crisis, the BoE may find that ministers are reluctant to return to the past, preferring to continue with, perhaps intensifying, present cooperative relations. They may start to lobby the Bank to consider writing off some or all of the government debt it has accumulated on its balance sheet – a proposal which would further cast doubt on Threadneedle Street’s independence. While technically straightforward, it must be said that, politically speaking, such a move appears some way off at present. However, faced with the backdrop of deep economic ‘scarring’, bankruptcies, rapidly mounting unemployment (not to mention the prospect of having to raise taxes significantly to start repairing the public finances) the idea of debt forgiveness may begin to look appealing to the Johnson Government.