House of Commons
Wednesday 11 June 1997
The House met at half-past Nine o'clock
PRAYERS
[Madam Speaker in the Chair]
Bank of England
Motion made, and Question proposed, That this House do now adjourn.--[Mr. Robert Ainsworth.]
9.34 am
Ms Diane Abbott (Hackney, North and Stoke Newington): The announcement by my right hon. Friend the Chancellor of the Exchequer about the independence of the Bank of England on interest rates had such a rapturous welcome that it is with some diffidence that I rise to attempt to put a reasoned case against that independence.
The universal acclaim from pundits, commentators and the rest of the chattering classes with which independence for the Bank was greeted reminded me of nothing so much as the universal acclaim that greeted our entry into the exchange rate mechanism some years ago--and we all know what happened to that.
I must begin by saying that, of course, everybody on both sides of in the House is in favour of the lowest possible inflation. There can be no dispute about that. Yet I shall argue against independence, for the following reasons.
First, we cannot decouple economic management from politics. Secondly, the academic arguments for an independent central bank are built on sand, intellectually. Thirdly, the idea is fundamentally undemocratic. Finally, it would mean taking risks with growth and jobs. I represent one of the poorest constituencies in the country, with one of the highest levels of unemployment, so the House will understand that, ultimately, my concern is about growth and jobs.
There can be no doubt that independent central banks are the fashionable thing, not only with British commentators and pundits but internationally. Since the late 1980s, more than 25 countries, from France to Kazakhstan and from New Zealand to Pakistan, have opted for independent central banks, so there is no doubt that the Chancellor is in the vanguard of fashion.
However, with some reluctance, I must tell the House that there is a gaping chasm between what economic theory suggests central bank independence might do and what the empirical evidence shows it can do. Despite the universal assumption among journalists and some of my hon. Friends that an independent central bank necessarily leads to low inflation, the academic research suggests that, although there may be a statistical relationship between central bank independence and low inflation, no causal relationship can be established.
That point is so important that the House will forgive me if I linger for a few minutes on the academic arguments. In 1993, the Treasury Select Committee conducted a major inquiry into the idea of independence for the Bank of England. Our report records that our then specialist adviser, Andrew Wood, reviewing the academic literature, concluded:
Mr. Giles Radice (North Durham):
My hon. Friend has mentioned the Select Committee report. Would it not be fair to point out that the Committee came out in favour of the model proposed by the Chancellor? There was a Conservative majority on the Committee, but all Labour members--with the exception of my hon. Friend--also voted in favour.
Ms Abbott:
I am grateful to my hon. Friend--with whom I have served with pleasure on the Select Committee for years--for reminding the House that my opposition to bank independence is not short term, but a long-standing position.
Let us look briefly at some of the academic evidence, at the risk of wearying some hon. Members. A major study--which is always quoted by the proponents of independence--was carried out in 1996 by Sylvester Eijffinger and Jacob de Haan, who looked at 20 different studies of bank independence. Out of 20, 18 showed a link between independence and low inflation. There is no doubt that some of my hon. Friends will call this in aid, as always.
Furthermore, another major study in 1991 by Grilli, Macciandaro and Tabellini showed that the three most independent central banks had the lowest inflation. But that is not the sum total of academic work, although one might believe it is from listening to some of the Eddie George groupies in the House.
There is other and more recent academic work on the subject. I draw the House's attention to the studies of Adam Posen, an economist from the New York Federal Reserve, who said that central bank independence was a consequence of pressure from the financial sector. He said:
The first point I am anxious to make is that, just because central bank independence is associated with low inflation--I do not deny that--does not mean that it causes low inflation. That is the weakness of the argument used by my hon. Friends who are in favour of independence. I maintain something different--that, contrary to popular belief, an independent central bank does not create a culture of low inflation, but is a reflection of a culture of low inflation. The distinction may seem pedantic or trifling to some of my hon. Friends, but it is the key distinction.
When people come to argue for an independent central bank, they always pray in aid the Bundesbank and Germany's economic record, and there is no doubt that the Bundesbank is the Arnold Schwarzenegger of monetarism. The Bundesbank has practised a form of macro-monetarism for longer than any of us here can remember. The classic statement of the Bundesbank's position was given by Karl Blessing, its president, in 1966, when he said:
I remind the House that, twice in a generation, Germany experienced hyper-inflation--in 1923 and again after the war. In 1922, inflation in Germany was running at 1,300 per cent. No other G7 country has had that experience this century. The mark ended up in 1923 at one trillionth of its 1913 level. It is at the height of this hyper-inflation that we see historically the Nazis' rise to power.
Immediately after the war--and in the ruins of a defeated Germany--the country once again experienced hyper-inflation. Otmar Issing, chief economist of the Bundesbank, has said:
One of the problems is that central banks have a history of being deflationary. I shall quote from Labour's 1945 manifesto. I do not want to embarrass colleagues who believe that the party has no history, but the 1945 manifesto reflected this country's experiences of the 1930s. In the 1930s, we had an independent central bank, and its name was Montagu Norman. I sometimes think that my colleagues who favour an independent central bank should get T-shirts saying, "Come back, Montagu Norman--all is forgiven."
In the 1945 manifesto, Labour said about the 1930s:
In looking at the tendency of central bankers to be deflationary and to overestimate the dangers of inflation, we do not have to look in a crystal ball. I was in the City, talking to some economists with a Japanese bank. They reminded me of the joke that the governor of the Japanese central bank between 1989 and 1995, Mr. Mieno, was voted central bank governor of the year by the Americans for ruining the Japanese economy. He jacked up interest rates relentlessly, and did not reverse the policy quickly enough in a recession. Ultimately, the Japanese Ministry of Finance had to step in in 1992. I hope that it does not come to that in this country.
I do not need to talk about 1945 or about the Japanese in making my case. Sadly, because I am a tremendous admirer of Eddie George--a great and distinguished public servant--I need only talk about the recent history of monetary policy in this country.
In May 1995, the Governor of the Bank of England, Eddie George, recommended that interest rates be raised by 0.5 per cent. to meet the inflation target. This view was based in part on the Bank's notorious inflation forecasts, which Mervyn King--who is in charge of these matters--admitted to the Committee had a poor track record, producing overly pessimistic forecasts of inflation. The then Chancellor refused to accept the Governor's advice, because, in his judgment, the economy was slowing sufficiently for the inflation target to be met.
Two years later, we know that the former Chancellor's judgment was correct. I am well aware that he needs no endorsement from me. Whatever we think of the contestants for the Conservative party leadership, he consistently called the economy right more times than Eddie George.
I do not want Eddie George to be hurt by these remarks. There is nothing wrong with central bankers having a deflationary bias--that is what they are for; it is the culture in which they are bred--but history teaches us that they should be under democratic control.
The downside of a central bank is that it is hard to achieve co-ordination of policy, and there are risks to jobs and to growth and the danger of an overvalued pound. It is also almost irreversible. Of the 20 frequently cited studies on central bank independence, only one associates it with growth. Guy Debelle and Stanley Fischer said:
"Some general conclusions can be drawn from this review of the literature:--there is a statistical relationship showing that on average countries with independent central banks achieve lower inflation than countries with dependent central banks. There is no conclusive statistical evidence of a causal relationship between the status of the central bank and the inflation performance".
Yet--
"Central Bank independence arises from the desires of an interest group--
the financial sector--
"that is more committed to price stability than the average voter."
Michael Jenkins of Hull university said in his research on the subject that, if one factors out other structural factors tending to low inflation--for instance, the corporatist wage bargaining of West Germany--there is no statistically significant relationship between higher central bank independence and low inflation. Gerard Lyons, chief economist of the Japanese bank DKB, has said that the evidence that bank independence guarantees low inflation is slim. In 1993, Blake and Westway said that a central bank pursuing its own goals with no regard for the social welfare function is frequently harmful.
"There can be no hard currency without hard measures."
Let us linger on the German case, which proponents of independence always cite. The belief that the fact that Germany has an independent central bank and also has low inflation is an argument for independent central banks elsewhere is a simple case of reverse causality. I put to the House the following proposition--the reasons for Germany having low inflation are much more fundamental, and partly rooted in its history.
"It is no coincidence that it is the Germans with their experience of two hyperinflations in the 20th century who have opted for an independent central bank which is committed to price stability."
There are other structural reasons why Germany has low inflation, one of which is the underlying strength of the German economy this century. Germany has had a strong manufacturing sector, a high savings ratio and strong export performance. That is the real economy of Germany, not some short-term monetary fix leading to a low-inflation environment. I would argue that the academic evidence for an independent central bank is simply not soundly based, and I urge my hon. Friends to go back and review the academic evidence.
"Great economic blizzards swept the world in these years. The great inter-war slumps were not acts of God or of blind forces. They were the sure and certain result of the concentration of too much economic power in the hands of too few men. These men had only learned how to act in the interest of their own bureaucratically-run private monopolies which may be likened to totalitarian oligarchies within our democratic state. They had and they felt no responsibility to the nation."
Some of my hon. Friends may say, "That was 1945. We are new Labour. What possible relevance does this have to us today?" I would argue that the issue of political accountability and responsibility to the nation is as relevant to the Labour party now as it was in 1945.
"Since 1962, countries with independent central banks have suffered deeper recessions on average than those without."
Mark Hutchison and Carl Walsh found the same in a study of New Zealand. Robert Chote, economics editor of the Financial Times, writing in a personal capacity, said:
"People may lose their jobs unnecessarily because Mr. Brown is abdicating responsibility for achieving his inflation to the Bank."
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