John Redwood: The real role of the Bank of England in economic policy demands a lot

Sir John Redwood MP for Wokingham, and former Secretary of State for Wales.

I have two main frustrations with hearing so many MPs and agencies stat about inflation. They tell me that the Bank of England is independent, when the Bank says it is not on many important matters.

They refuse to engage in any conversation that could criticize the bank for inflation exceeding five times the inflation target even though they feel the bank is responsible for delivering the two percent target.

The Bank of England is 100 percent state owned. Its governor is elected by the government and he answers to the chancellor, both personally and in parliament, in public, for his conduct and policies.

George Osborne, as chancellor, chose a governor who supported his economic and political strategy. Backing the partisan position of Osborne and some other ministers, the bank became staunchly Remain when the country was deciding whether to Remain or Leave.

The governor took the bank to green policy without changing the banking law, again a reflection of the government’s will.

Gordon Brown, as Chancellor, gave the Bank the sole power to set the Bank Rate, and called it Bank Independent. At the same time, he took away important powers to regulate commercial banks and influence government lending. Arguably the bank was less independent overall after his change.

The Great Banking Crash of 2009 led to banks creating more money and seeking to conduct monetary policy by buying government debt to lower long-term interest rates, as well as simply lowering bank rates.

However, it decided that it did not want to be independent when doing so and agreed that all such activities required the Chancellor’s express written consent. The bank has insisted on a government guarantee against any losses on the ownership and sale of the bonds and said it acts as the agent of the Treasury when dealing with the bond portfolio.

Since money creation and bond purchases became the main tools of monetary policy, it is wrong to say that the Bank followed an independent monetary policy after 2009.

Treasury/bank-friendly policy added £895bn of assets to the latter’s balance sheet and set taxpayers up for potentially big losses as interest rates rise; When rates rise, bond prices fall.

Of course the government and parliament need to be the final arbiter of the £895bn bond purchase; These sums dwarf the extras spent in the chancellor’s annual budget. Now the bank is sitting on unrealized losses that far exceed its stated capital, but is happy to do so, because taxpayers will pay it back as the losses go along.

All this makes it all the more perplexing as to why there is such deafening silence among political parties about the estimated £100 billion or so expected loss over the next five years and how the Bank has allowed double inflation.

Banks, governments and most politicians say that banks are solely responsible for inflation because they alone have the power to set bank rates. It can use it to create a boom or bust, high inflation or low inflation. It is now a wealth boom, and high inflation, driven by a desperate bid to get inflation down is lurch from recession.

Those of us who warned that the last £150bn of money creation in 2021 could prove inflationary were never given a proper answer as to why the Bank thought we were wrong.

The bank largely blames the Ukraine invasion and disruption of energy markets, ignoring the fact that inflation has been very low despite the need to import huge amounts of expensive energy from China, Japan and Switzerland. It also has to explain why UK inflation was 5.5 per cent, 175 per cent above target, before the attack.

Britain deserves an honest debate on how to take off inflation. There needs to be more openness to the idea that monetary policy allows too much money behind too few assets, first creating a bubble in bonds and property, then more general inflation as more money washes out of asset markets.

I’m not proposing to take power away from the Bank of England, but would like some broader understanding of how the Bank fits into Treasury policies so we can try to avoid boom/bust mistakes in the future.

For now, my suggestion for both is that they have done enough to bring down inflation and no further rate hikes are needed. The bank should reduce its bond holdings as they are repaid, but should not accelerate the process by selling them in the market.

A bloated bill does not need to be accepted to cover losses from treasury market sales. The new government has made its biggest ever financial pledge through parliament to pay £11 billion to banks for losses by March! Their taxpayers should agree to stop this drain.

Meanwhile, the government needs a budget for growth. The UK lacks many types of capacity: from water to energy, from food to steel. Long-term inflation control will be greatly helped if we have a budget for growth that helps us keep all the excess capacity we need.

As the world turns to protectionism and domestic manufacturing, the UK needs to provide tax incentives and sensible regulation to attract and retain big investment in making and growing the things we need.