Written by Sir John Redwood
Sir John Redwood has given us his kind permission to re-publish this article (in three parts). It was published in his Diaries but he also asked us to credit CapX and the Centre for Policy Studies. Read Part 1 here.
The doctrine of central bank infallibility
The idea of independence is based on the common fallacy that rule by technocrats is preferable to rule by elected politicians because they know the answers to how their areas should be run. Why not leave running banks, money and credit to bankers? And leave running health policy to medics, the criminal justice system to lawyers and the education system to teachers? After all, they are qualified, know what they are doing, and will not “play politics” with the great services they are involved with. The rule of the technocrat is particularly favoured in the EU, where the demands for evidence based policy produced by specialists is often most developed.
There are several main problems with this viewpoint. The first is the assumption that all bankers will decide on the same answer for any given banking problem, or all lawyers will have just one view of what the law is , or that all medics will agree on what is the correct treatment for difficult diseases. The professions have as many arguments about what is the right course of action as politicians have. There has to be some way of concluding these rows to turn opinions into policy.
The second is the assumption that experts will always be better at making right decisions than generalists charged with making decisions in the public interest. The elected Ministers have the advantage that they can call on any expertise they wish without themselves usually having any commitment to one professional faction or view over another. They can also make decisions which balance the best technical answers with the wider impact these may have on society, and can see the interplay between narrow professional fields and the wider public interest. There may be a conflict of professional advice. In the current crisis the best remedies proposed by economists for prosperity may be very different from the answers favoured by health experts to deal with the virus.
The third is that so called experts have a right to be exempt from tough cross examination by journalists and politicians seeking the truth or trying to force a change of policy. It means technocratic government escapes the challenge and the need to think things through and defend them that Ministers are used to. It makes mistakes more likely.
The fourth is the assumption that because people are experts everyone else will accept what they say. The danger is if a group of experts of one way of thinking hijack policy in a particular area, they build resentment not just against their policy but against the whole system, as those suffering from it cannot see an easy way of changing it.
The major decisions have to be taken by elected officials who can weigh the conflicting claims, decide what the state can afford and draw on the best professional advice in the relevant fields.
The Bank of England’s experts have been more often wrong than right for the last 50 years
It is time to review the record of the Bank in its roles as setter of interest rates and regulator of the banking system over the last half century. The period began with the secondary banking and property crash which compounded the damage of the international oil price explosion in the period 1972-5. It led on to the 1989-92 Exchange Rate Mechanism disaster. It was followed by the big boom and bust culminating in the great banking crash of 2007-9.
More recently we witnessed the Bank get its forecasts hopelessly wrong over the likely impact of Brexit, only to pursue an inconsistent and damaging monetary policy from 2016 to 2019. In each case the Bank made wrong forecasts and took bad decisions about the permissible levels of credit in the banking system. These were followed by over reaction to create a recession which then did damage to the economy.
The Exchange Rate Mechanism was the most perfect example of rule by the technocrats which went badly stray. The member states of the EU in the 1980s had widely divergent economies. The differing levels of inflation, debt and productivity caused considerable fluctuations in exchange rates. The countries with too much debt and inflation tended to devalue and the countries with strong balance of payments positions and low inflation tended to have strong currencies, led by Germany.
The advocates of European monetary union combined with the technocratic tendency to require the states to lock their currencies one to another within tightly proscribed fluctuation bands, with a view to reducing and finally eliminating currency variations. This they thought would move all the countries onto something like the German pattern with low inflation and reasonable growth. The UK was told by advocates of the ERM we would enjoy a “golden scenario of low inflation and good growth”. If only.
I argued that the ERM would instead prove destabilising, leading either to an inflationary increase where markets thought a currency was too cheap and should go up more than the bands allowed, or to a recession where markets thought a currency too dear and it should fall below the floor price allowed.
In my 1989 pamphlet for the CPS on this I said:
“The idea of the EMS (ERM) is theoretically flawed. The history of the pound against the DM over the last year illustrates why this is so. Despite government efforts to get the pound to shadow the DM and to hold it around 3DM, there have been periods of intense pressure leading to substantial fluctuations around that level. The main method for trying to keep the currencies in line is the sale or purchase of large quantities of the given currency by European Central Banks, acting in concert or individually. …………This action is intrinsically destabilising. If the Bank of England sells a large amount of sterling…. It then has a monetary problem. If it simply creates the pounds it has sold it adds directly to the money supply. Foreign banks and other buyers have more pounds at their disposal . If they go into the banking system they become high powered money, enabling a commercial bank to lend this money several times over expanding the amount of sterling credit in circulation. This produces upwards pressure on the British price level, causing inflationary worries and forcing a further rise in interest rates.….leading to a further demand for pounds requiring more pounds to be made and sold by the Bank of England.”
Once the inflation is well set the reverse sets in. Foreigners sell the pound, the UK has to buy up pounds. This contracts the money supply and brings on recession, aided by the need for even higher interest rates to defend the pound.
This was all obvious to a few when I published in April 1989. I lost the argument in government and we entered the ERM. It duly unfolded in a predictable way. The pound wanted to go up. Money growth and inflation accelerated. The pound then wanted to go down,. Rates rose too high, credit contracted and we entered a recession. The technocrats had proved to be sadly so wrong. This scheme was heavily backed by the Treasury and Bank of England, and supported by the leading opposition parties. When it failed many of its supporters claimed it had been badly executed or had been done at the wrong exchange rate. That was strange, as when we entered they did not complain about the rate which had been carefully calculated by the Bank and Treasury on the basis of past currency movements. The experts had their way and got it wrong. The price of their mistake was many bankruptcies and lost jobs.
(to be continued …)