History won’t be kind to Gordon Brown either as chancellor or prime minister. He presided over a massive expansion of public spending, without having the courage to raise the taxes to pay for it all. He allowed a reckless expansion of credit and the financial system. He plotted ceaselessly against his colleagues, yet when he finally secured the top job he turned out to be hopeless at it.
Still, everyone seems agreed on one thing. He made a brave decision in giving an independent Bank of England (BoE) the power to set interest rates. It has, so the consensus runs, been a huge improvement over the bad old days when the chancellor set the rate charged for money. But is that really true?
When Brown transferred control of interest rates to the Bank’s Monetary Policy Committee (MPC) in 1997 it was the culmination of a long period of debate – and it followed the example of economies that were, on the whole, more successful than ours. Ken Clarke had started involving the Bank more and more in his decisions. The Bundesbank in Germany and the Federal Reserve had long been independent of political interference, and both America and Germany seemed to be better at keeping inflation under control and promoting growth than we were. The argument was simple to follow. Chancellors were constantly manipulating interest rates for their own wicked ends. They’d put them up after an election then cut them as the ballot box loomed on the horizon. A bad by-election result and there was suddenly a quarter-point off everyone’s mortgage. Monetary policy was dictated by the electoral rather than the economic agenda.
An independent Bank, so we were told, would be above such sordid considerations. It would set rates for the long term. Inflation would be anchored and, in time, the Bank would be trusted absolutely, the same way the Bundesbank was in Germany.
Most people would probably now concede that the experiment is having a few teething problems, to say the least. In retrospect, monetary policy was too relaxed in the run up to the financial crash. In the past 12 months, the MPC seems to have forgotten completely about its inflation mandate. Interest rates have been held at a three-century low, even as inflation climbs beyond 4%. Nobody at the Bank seems aware that credibility is the main tool for keeping prices under control – and once you’ve lost that you are about as well equipped as an artillery battalion without any shells.
Still, the consensus is that it’s better for Osborne to have the MPC in charge of monetary policy. He can sidestep the flak for inflation. And interest rates remain low, preventing a return to recession that would land his government in big trouble. Bad as things might be, they’d be even worse with the chancellor in charge of monetary policy. But is that really right? Try a short experiment. Imagine the Bank had never been made independent and in May last year Osborne had been put in charge of interest rates. He would be in charge of a coalition with a secure majority and with no plans to hold an election until 2015. He’d know he had to cut the deficit on a huge scale. He’d know, as well, that there was an inflation problem bubbling up. Whatever else you may think of him, Osborne is clearly a smart guy. So what would be the smart thing to do?
Put up interest rates gently, probably in November or December. Four quarter point steps might do the trick, spread out over a year. That should be enough at least to stop inflation rising – and with any luck get it back onto its 2% target. There would, of course, be a price to pay. It might well create a double-dip recession. There would be two, perhaps three quarters of falling output as both monetary and fiscal policy put the squeeze on spending. There would be howls of protest from the retailers. Unemployment would rise. The coalition would take a hammering in the polls.
But think of the upside. Once you’d got the pain out of the way, it would all be plain sailing. By 2013, the economy would be through the worst and would have started growing again. The deficit should be down to manageable levels. You could start cutting taxes. And, importantly, with inflation nipped in the bud, you could cut interest rates as well. Through 2014 people would be paying less tax and their mortgage would be lower as well. The feel-good factor would be back – just in time, surprise, surprise, for the election. It would be cynical, and political, no question about that. But, and here’s the thing, it would also be the responsible course to take for the economy as well.
The one thing we know for sure about inflation is that it is like a disease. The earlier you treat it the better. The Bank is leaving raising rates far too late. It will probably have to raise them sharply in 2013 or 2014 – and that will be the worst possible timing for the government. Indeed, the longer and harder you look at the evidence, and think about the alternatives, the harder it is to conclude that handing over control of monetary policy to the BoE has been any kind of improvement at all. We’d have been better off leaving interest rates under the control of the chancellor.