Select Committee on Treasury Twelfth Report


2  Reform of the monetary policy framework

Recent history

3. On 16 September 1992, the United Kingdom exited the European Exchange Rate Mechanism. In October 1992, the United Kingdom adopted a new monetary policy framework with an inflation targeting regime. In this system, the Governor of the Bank of England and the Chancellor of the Exchequer met monthly to discuss monetary policy, but actual responsibility for setting short-term interest rates lay with the Chancellor of the Exchequer alone. The inflation target was a range between 1% and 4% on the RPIX inflation measure, with an aim by the end of that Parliament of having inflation in the lower end of that range.[9] In 1995, the inflation target was revised so that the inflation rate was to be 2.5% or lower on the RPIX measure of inflation.[10]

4. In May 1997, this framework changed. Under the new system, the inflation target was to be set by the Government, and the MPC of the Bank of England was created with operational independence to set the level of short-term interest rates to achieve that target. At the time of its institution, the inflation target was set at 2.5% on the RPIX measure of inflation. The MPC has nine members, and operates on a one person, one vote system, designed to promote both transparency and independence. This contrasted with the circumstances we found on our visit to Canada and the USA. In Canada, decision making is based on a consensus format. In the United Kingdom, the Governor of the Bank of England has been outvoted twice in close decisions.[11]

5. When we asked Lord George, who was Governor of the Bank of England in 1997, how important the changes at that time were, he told us that they were a culmination of a set of changes, both in policy and thinking. An inflation target had been adopted five years earlier. The role of fiscal policy moved to being seen as useful in the medium and longer term. Monetary policy's role was not seen as maximising a trade off between inflation and growth but keeping aggregate demand growing in line with the growth in the supply capacity of the economy. As Lord George put it, there was a broad political consensus that it had become "a technical job to manage monetary policy to keep demand growing in line with supply".[12]

The need for further legislative reform

6. The Bank of England Act 1998 is the legislative centrepiece of the new monetary policy framework. During our inquiry, we have discussed with witnesses possible reforms which would require amendment of the Bank of England Act 1998. Examples of issues considered below which could be included in this category include changes to the frequency of meetings held by the MPC, the frequency of changes to the monetary policy remit, and the length of the terms of office for 'external' members of the MPC.

7. While much evidence concerned specific proposals for legislative change, several witnesses argued against legislative change at a general level. Ms Kate Barker, an 'external' member of the MPC, told us that while "tweaks" could be made, "Frankly, I am not sure that there is anything that I would change about the framework of the Act".[13] The Governor of the Bank of England agreed with this view, stating "I do not see a strong case for making changes in the legislative framework, but that is not to say that we cannot learn from other central banks about how they carry out their research or how to think about certain questions that come up".[14] The then Chancellor of the Exchequer told us that the "test of this framework is its success", but that "we shall look at any reports that your Committee brings to us about possible changes that you wish to recommend".[15] The monetary policy framework of the last decade has been broadly successful. At least some of that success can be attributed to the Bank of England Act 1998. Continuity is an important part of this framework, allowing market participants to have faith in the stability of the system. In view of the broad level of success of the framework and of the legislation, we do not see any reason why legislation to amend the Bank of England Act 1998 ought to be accorded high priority within the Government's legislative programme. Thus, while some of our recommendations might require legislative change, we accept that the opportunity for such change may not occur in the near future.


9   'The Inflation-targeting framework from an historical perspective' by Luca Benati, Bank of England Quarterly Bulletin, 2005 Back

10   Bank of England Website, http://www.bankofengland.co.uk/monetarypolicy/history.htm Back

11   Bank of England Website, http://www.bankofengland.co.uk/monetarypolicy/mpcvoting.xls Back

12   Q 98 Back

13   Q 238 Back

14   Q 260 Back

15   Q 409 Back


 
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