You can’t reform a central bank by changing the faces of its management
SIR Mervyn King’s replacement as Bank of England governor has finally been announced. But we shouldn’t let our excitement at the appointment of Mark Carney distract us from the severe structural issues that persist beneath the surface.
The Bank has recently come under strong scrutiny for the way it handled the financial crisis. Its economic forecasts have been criticised by David Stockton (former chief economist of the US Federal Reserve), who pointed out that the Bank routinely overestimates growth and underestimates inflation. In addition, Andrew Tyrie MP, chairman of the Treasury Select Committee, has criticised the scale and scope of the Bank’s assessment of its own actions during the crisis, claiming that a comprehensive review still needs to be made.
For many economists, this isn’t surprising. The Bank of England is a state institution that attempts to manipulate the demand for and supply of money. Prior to the crisis, its intention was to fix interest rates at a particular level. Now, it also sets target quantities. If you believe that the central planning of the milk industry would cause shortages and gluts, then it’s not unreasonable to apply the same logic to the market for money. And even though the Bank of England has operational independence, its targets and tools are set by politicians. It is fundamentally an instrument of the state.
It is widely accepted that the Bank of England had a role in contributing to the financial crisis by keeping interest rates artificially low, stoking a housing bubble, and encouraging excessive leverage and debt. It is somewhat arrogant to believe that this was a failure of individuals. This implies that, if only we had different economists in charge, everything would be ok. In fact, we put an unfair burden on central bankers. It is next to impossible for them to achieve what we ask. Monetary policy mistakes are a nearly inevitable consequence of monetary policy.
This leaves free market critics of the current system two options. Many would argue that, for better or worse, we are stuck with the central bank in its current form. Therefore it’s worth trying to reduce the harm that it causes by taking an active advisory role in an attempt to improve policy decisions.
Others would say, however, that since the Bank’s decisions are destined to fail, efforts to improve them are foolish. The only solution is an event so catastrophic that radical reforms can be made.
This is part of a broader concern about how we should deal with the state. Some want to get involved with policymaking in order to alleviate any harm caused. But in doing so they end up endorsing the very system they so heavily criticise. Others simply stand back, hope that something snaps, and stand ready to pick up the pieces when it does.
How much economic damage must policymakers cause before the public cottons on? Too much, it seems.
Anthony J Evans is associate professor of economics at ESCP Europe Business School. Web: www.anthonyjevans.com, Twitter: @anthonyjevans.