Previous SectionIndexHome Page

8.38 pm

Mr. Nick Gibb (Bognor Regis and Littlehampton): I begin by congratulating the hon. Member for Batley and Spen (Mr. Wood) on an excellent maiden speech. I hope that we shall hear more from him in future.

I shall keep my remarks brief, as I am keen to hear the debate among Labour Members on a matter that obviously divides them deeply.

The Chancellor's decision to give the Bank of England independence over interest rates will prove to be the Government's first major policy error, and it occurred within four days of the new Labour Government coming to office. It has resulted in the abandonment of a monetary and economic policy that has yielded the best inflationary record for 50 years, low and falling unemployment, and steady growth. It has removed from direct control and accountability a principal lever of economic policy. As Robert Chote--who has been quoted many times tonight--the economics editor of the Financial Times, wrote in his excellent paper for the Social Market Foundation, an independent Bank of England

Monetary policy, and the conduct of monetary policy, has such a fundamental effect on people's lives and is so fundamental a part of economic policy that it has to be in the hands of those elected to office.

The Bill will divorce monetary policy making from fiscal policy making. It will result in higher than necessary interest rates, with all the consequences for mortgages, for the competitiveness of British business and for higher unemployment.

By giving the Bank of England independence on interest rates, the Government are signing up to the latest fashionable, quick-fix panacea. All the panaceas that Governments have adopted over many decades--the gold standard in the 1920s and 1930s, the parity with the dollar in the 1940s, the Bretton Woods arrangement and, most recently, the exchange rate mechanism--have ended in failure. There is no short cut to the successful management of the economy, which is difficult and sometimes requires unpopular policies.

Mr. Nigel Beard (Bexleyheath and Crayford): The United States and all the other nations in the European Union have separated fiscal control from their

11 Nov 1997 : Column 787

Governments for some years. Why have all those countries performed better than we have in the past 18 years?

Mr. Gibb: I shall come back to that point in a minute, but France and Germany currently have levels of unemployment that are twice as high as ours. The Conservative Government, by adopting a balance between sensible monetary and fiscal policies, achieved a steady and stable economy. Any number of trendy panaceas proposed and adopted by the present Government will not change that truth.

I acknowledge that the immediate effect of giving the Bank of England control over interest rates was to reduce the premium between short-term and long-term interest rates. However, that premium had built up since the war because Britain has been plagued by periods of high inflation, mostly brought on by previous Labour Governments. The Government faced a choice between a quick-fix panacea, which would reduce the premium in the short term but at a cost to growth and employment, and a long-term commitment to conducting monetary and fiscal policy in such a way as to demonstrate that Britain has at last become a stable, low-inflation economy. They have gone for the quick fix. The previous Conservative Government opted for, and delivered, long-term stability.

The various studies that have been trumpeted by the very few supporters of the Bill who have spoken today show that countries with an independent central bank have lower average inflation rates than countries that do not. I acknowledge that. The Harvard Institute of Economic Research showed, for example, that countries with central banks with the most independence--Switzerland, Germany and the USA--had an average inflation rate of less than 4 per cent. between 1951 and 1988. Those countries with central banks with the least independence--Spain, Australia and the United Kingdom--had average inflation rates of 7 per cent. during that time.

However, as the hon. Member for Hackney, North and Stoke Newington (Ms Abbott) said, when she opposed the Government's policy in an Adjournment debate:

She repeated that comment today. That view is backed up by Michael Jenkins of Hull university, who has commented that there is no statistically significant relationship between high central bank independence and low inflation.

I come to the cost of the policy. It is not the lack of a causal link that prompts my opposition to the Bill. Those countries with independent central banks have experienced much deeper recessions than those without, as the hon. Member for Great Grimsby (Mr. Mitchell) pointed out. He quoted the academics Sylvester Eijffinger and Jakob de Haan, who have studied the point in great detail. They cite five studies of central banks, four of which show that, for any given reduction in inflationary pressure, the deflationary cost is higher in those countries with independent central banks than in those without.

Another academic study in 1994 by Guy Debelle and Stanley Fischer showed that since 1962 those countries with independent central banks have suffered deeper recessions, on average, than those without. The countries

11 Nov 1997 : Column 788

with independent central banks did not enjoy higher growth levels, despite the high social costs of the recessions, so there was no compensatory rise in growth in the long term.

The reason for that phenomenon is plain. If a Government give a central bank the duty to meet an inflation target, that is what it will do. Any idiot can eliminate inflation from an economy by pushing interest rates sky high, oblivious to the consequences for growth and unemployment. A successful manager of an economy has to secure a balance between low inflation and economic growth. As Stanley Fischer has pointed out:

That over-deflationary bias has been the experience of the Bank of England since before 1 May. In November 1995, for example, the Governor proposed a 0.5 per cent. rise in interest rates to combat what the Bank saw as incipient inflationary pressure in the economy. That rise was opposed by my right hon. and learned Friend the Member for Rushcliffe (Mr. Clarke) and, 18 months later, his opposition has been proved correct.

Since the election, evidence of over-deflationary bias has been still more manifest. In six months, we have seen five interest rate rises--empirical evidence that independent central banks are more prone to set higher and excessive rates of interest than those that are not independent, because the incentives exist for them to do so. The Government acknowledged that fact soon after their announcement, on 6 May, of their decision to give the Bank independence. A few weeks later, the Chancellor revised his proposals.

Mr. Geraint Davies: The hon. Gentleman asserted that the five rises in interest rates since the election were caused by independence being given to the Bank of England. He has no counter-factual evidence to suggest that interest rates would not have been higher under political control. The shadow Chancellor has no view on that, because he and the Conservative party do not know what the rate should be. In essence, he said, "This situation is awful, but I don't know what we would do." To suggest that the rises are a function of independence is rubbish--they are a market response to the current economic conditions.

Mr. Gibb: The Government and the Chancellor say that it is the Bank's responsibility to determine interest rates, but now the hon. Gentleman is saying that the Chancellor is in favour of the five rises in interest rates since the general election.

The Chancellor revised his original proposals, announced on 6 May, a few weeks later, seemingly in response to the criticism, which was abounding, that they would lead to excessive interest rates. He relaxed his inflation target and brought in a lower parameter below which the Bank was not allowed to let inflation stray. None the less, the deflationary instinct remains, as evidenced by last Thursday's interest rate rise, which was not widely acclaimed in the City.

11 Nov 1997 : Column 789

That instinct will be institutionalised by the way in which the Bill is drafted. Clause 11 proposes:

That appears to be copying the objectives of the Bundesbank. The 1957 Bundesbank law says that the Bundesbank shall regulate the volume of money in circulation and of credit supplied to the economy with the aim of safeguarding the currency.

Section 12 of the Bundesbank law adds that the Bundesbank shall be required to support the general economic policies of the Federal Government. The same word "support" is used. That vague imperative to have regard to the general economic policy of the Government clearly has not worked well in recent years in Germany, where unemployment is more than 12 per cent., compared with 5.5 per cent. in Britain. Anatole Kaletsky argued in The Times in June that the very independence of the Bundesbank has led to the prolonged recession in Germany for the past few years.

The United States, on the other hand, has a different model. The Federal Reserve Act of 1913 provides that the Federal Reserve shall conduct its operations

In 1978, the Humphrey-Hawkings Act specifically set the Federal Reserve the dual target of full employment and price stability.

We are talking about something more fundamental than merely the structure of the objectives of an independent central bank, however. The principal reason for the success of the Federal Reserve in recent years is that the Fed is chaired by Alan Greenspan, a man who consistently gets it right. If another individual with a different view of the way in which monetary policy should be set had taken his position, the chances are that the Federal Reserve might not have been so successful. However, one cannot legislate for an Alan Greenspan. Monetary policy is not an exact science.

As my right hon. Friend the Member for Fylde (Mr. Jack) said in the Adjournment debate on the subject in June:

Even more than that, however, interest rate judgment depends on how potent an effect one believes an interest rate rise or fall will have on the economy. That is very much a political view.

Whether an independent central bank will be successful depends on the composition of the Monetary Policy Committee and on the Governor. That is fine if things go well, but what happens if they go wrong? Because one cannot pass a law to ensure that the Bank gets monetary policy right; because the mechanics of interest rate policy are still the subject of political debate; and because handing that over to an independent bank will not stop interest rate policy being the subject of political debate, it is essential that such decisions remain in the hands of those elected to office, who are accountable and can be turfed out by the electorate if they get it wrong.

11 Nov 1997 : Column 790

The key to maintaining a low-inflation economy is to have a low-inflation culture. To create that, one needs the backing of the British people. We can have any number of independent institutions which are crafted and structured in any way we wish, but if the support of the people is not there, the central bank will not succeed. As Robert Chote says:

It is important that, when people go to the polls, they understand that they need to elect politicians for whom low inflation as a principal object of economic policy.

In a free and democratic society, people must have the ability to determine the economic policy of this country, whether they are right or wrong. That is what the Government want to avoid. They realise that, given Labour's instinct for economic mismanagement, people will not vote for a Labour Government unless that Government hand over their conduct of the economy to someone else--anyone else.

Next Section

IndexHome Page