Bank of England reaches limits of independence

November 8, 2011

By Peter Thal Larsen. The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The Bank of England is under the microscope. A UK parliamentary committee has called for the central bank to be better governed and more accountable. It’s important to keep the government at arm’s length. But the new post-crisis powers vested in the Threadneedle Street institution make greater political scrutiny inevitable.

In the decade that followed the Labour government’s decision to give the Bank of England freedom to set interest rates, the move was seen as an unqualified success. The financial crisis and subsequent economic slump fractured the consensus. However, Britain responded by giving its central bank new powers to maintain financial stability and supervise banks.

This concentration of power has prompted questions. Politicians wonder whether the newly formed Financial Policy Committee should have the capacity to impose limits on sensitive areas such as mortgage lending. While bank regulation needs an overhaul, the Bank of England’s handling of the crisis was hardly flawless. The bank’s recent failures to keep inflation in check only add to the unease. Meanwhile its performance has not been subject to public examination — unlike the Financial Services Authority, which has engaged in far-reaching self-criticism.

The Treasury Committee’s report makes some sensible suggestions. It wants the Bank of England’s Court to become more like a supervisory board, holding executives to account. It wants a clearer definition of financial stability. And it wants the bank to be more open about decision-making.

However, these proposals do not deal with the central conundrum, which is that the bank is owned and controlled by the government, but is also supposed to be independent of political influence. In an environment where economic growth is sluggish and credit is scarce, it is increasingly difficult to square this circle.

This does not mean that politicians should regain the power to set interest rates or influence bank lending. However, its new powers and recent track record also make it hard for the Bank of England to insist that its decisions are best made by technocrats with weak accountability and supervision. Whether the central bank likes it or not, greater political scrutiny is unavoidable.

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Excessively loose monetary policy appears to have been the order of the day ever since the BoE was granted independence. To my mind, that is not a great result, although it will always make the BoE popular with banks and those with large mortgage debt.

Let’s hope that greater supervision is beneficial, but given the political pressure on the BoE recently to print more money, I suspect it’s unlikely to make much difference.

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