Select Committee on Treasury Twelfth Report

Conclusions and recommendations

Reform of the monetary framework

1.  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. (Paragraph 7)

The economic context

2.  While it is difficult to quantify the contribution made by the Monetary Policy Committee to maintaining a low inflation rate over the last decade as distinct from the effects of wider changes in the global economy, the Monetary Policy Committee deserves a significant amount of credit for ensuring that inflation over the last decade has been both lower, and less volatile, than in preceding decades. (Paragraph 14)

3.  Several issues, such as the recent rise in asset prices, the potential end of the tailwinds of an increasing effective labour supply and globalisation which have tended to reduce inflationary pressures in recent years, and the risk of a disorderly unwinding of global imbalances have been drawn to our attention as factors suggesting the possibility that the economic climate over the next ten years may not be as benign as that seen over the last decade. While we are sure that the Monetary Policy Committee are aware of this risk, it is important that the public are also prepared for the possibility of less benign conditions ahead. Later in this Report we examine actions that may be necessary to educate the public about monetary policy in more uncertain times. (Paragraph 18)

4.  The recent period of low interest rates has seen a rise in asset prices. One possible response by the Monetary Policy Committee would be to target such rising asset prices by 'leaning against the wind'—raising interest rates to deflate the bubble in those prices. However, such a move would presuppose the successful identification of such a bubble. On the evidence we have received, this is not possible with certainty. Furthermore, the only instrument available to the MPC is moving the interest rate, and increasing interest rates to counter a rise in certain asset prices could hamper economic growth across the economy, not just in the markets with rising prices. For such a policy to be worthwhile, therefore, the risk to the economy of a rapid fall in asset prices would have to exceed the actual cost of raising interest rates to counter the rising asset prices. (Paragraph 22)

5.  The weight of evidence we have received suggests that the rise in household debt is not on such a large scale as to exert significant influence on monetary policy. However, the risk remains that future interest rate rises will see larger numbers of households in financial difficulties than anticipated. (Paragraph 31)

6.  We have received differing evidence about the importance that should be attached to the rise in the money supply. While we acknowledge that it is difficult to assess what information such strong growth in the money supply might provide for future movements in the inflation rate, there is a possibility that, in the medium term, the current rise in the money supply might presage a higher path for inflation. (Paragraph 33)

7.  The anchoring of inflation expectations has had an important role in ensuring that inflation has varied by less than might have been expected given the external shocks faced by the economy in recent times. However, we remain concerned that, while inflation expectations appear anchored in financial markets, the general public appear to have less understanding of the monetary policy framework. (Paragraph 35)

The monetary policy framework

8.  With only a single policy instrument of interest rates available, we agree that the Bank should have as its primary objective price stability. However, subject to that, we will continue to monitor the Monetary Policy Committee's compliance with the secondary objective of meeting the Government's intention of high and stable levels of growth and employment. (Paragraph 39)

9.  It is appropriate for the inflation target to be set by the Chancellor of the Exchequer. We consider that it would be valuable to maximise certainty about the target going forward. To that end, we recommend that the Government give consideration as to how this might be achieved. (Paragraph 42)

10.  We strongly support the symmetry of the inflation target. We will remain vigilant for any signs that there appears to be either anti- or pro-inflationary bias by the Monetary Policy Committee, and should such signs appear, we will ask for an explanation during our regular hearings on Inflation Reports. (Paragraph 44)

11.  We do not believe that the move from the Retail Prices Index (excluding mortgage interest payments) to the Consumer Price Index has adversely affected the work of the Bank of England in anchoring inflation expectations. While the Retail Prices Index may be the dominant index for wage negotiation, and thus of interest to the Bank, wages are, in the main, set by market forces. (Paragraph 45)

12.  We do not, at the present time, recommend changing the Consumer Prices Index to reflect housing costs, before a pan-European consensus has been achieved. However, we recommend that the Government and the Office for National Statistics (with assistance from the Bank of England if required) work with their European partners in bringing about such consensus as quickly as possible. (Paragraph 49)

13.  We see no merit in the case for the Bank of England being given control of any elements of fiscal policy, which should properly remain the province of elected politicians accountable to the House of Commons. (Paragraph 56)

The Monetary Policy Committee as a body

14.  We support the retention of an MPC with nine members, comprised as at present of five 'internal' Bank of England staff, and four 'external' appointees. (Paragraph 58)

15.  It would be inappropriate to consider places being available for certain 'constituencies' among the 'external' membership of the MPC. For that reason, while we would welcome the appointment at some time of an 'external' member of the MPC with experience of economic modelling, we would not expect the presence of such a member to be a permanent requirement within the membership. However, certain attributes are important: a good understanding of economics, either via academic research or experience in the financial sector or business; a strong degree of personal independence and confidence; and, finally, the ability to communicate their view of the economy, both to specialist audiences and the general public. (Paragraph 64)

16.  We are mindful of the need to ensure that the MPC remains independent, and to allow a flexible system of terms and conditions that can enable recruitment from the widest base. We therefore recommend that, should the Bank of England Act 1998 be modified in the future, a new term of office for 'external' MPC appointments be instituted, based on a six-year term, with no option of reappointment, with a three-year minimum, after which continuation would take place only with the agreement of both the Non-Executive Committee of the Court of the Bank of England and the postholder. This would give the flexibility to remove those who are unfit for the job, retain flexibility for those who might wish to leave the post early, and ensure continuation was not at the discretion of the Chancellor of the Exchequer. (Paragraph 68)

17.  We find the explanations of why the full-time option was removed for all 'external' members unconvincing, especially for new members of the Monetary Policy Committee. We recommend that all working patterns be available to 'external' members of the MPC, so that they may undertake their duties as they see fit, as their career progresses. (Paragraph 70)

18.  We welcome the changes to the appointments process for 'external' members of the Monetary Policy Committee outlined by the then Chancellor of the Exchequer in evidence to us in June 2007. We welcome the fact that Government will advertise for different qualities and skills for each new 'external' member of the Monetary Policy Committee. We hope that they will lead to timely appointments of experts suited to the role of Monetary Policy Committee member. We note that there is no current proposal for a confidential pool created of experts who could be nominated to the Monetary Policy Committee where posts need to be filled at short notice. We therefore recommend that the Government consider adding a note to candidates as part of the appointments process asking them if they would be willing to form part of such a pool if not selected for the current vacancy. (Paragraph 79)

19.  We welcome the Government's commitment to enable appointment hearings by this Committee for nominees for the post of 'external' member of the MPC to take place prior to formal appointment. We note that the Government considers such hearings would be "non-binding". We consider it important that such hearings can be scheduled sufficiently far in advance of the date of the formal appointment to enable the Chancellor of the Exchequer to be able to give proper consideration to any view expressed by the Treasury Committee without there being a danger of the MPC membership being temporarily reduced as a result of reconsideration of a nominee. We recommend accordingly that nominations be announced at least three months prior to the date on which the vacancy falls to be filled. We also consider that, if the Treasury Committee were to reach an adverse opinion on a nominee, which would only be after careful and considered reflection, the Committee ought to have the power to require a debate in the House of Commons on the nomination. (Paragraph 82)

20.  We believe that the positions of the Governor and the two Deputy Governors should be recruited by open advertisement as well as confidential search. (Paragraph 84)

21.  We have heard differing views on the need for monthly meetings of the Monetary Policy Committee. With hindsight, it would have been better if the Bank of England Act 1998 had not mandated monthly meetings, but had left the number of meetings each year to be determined by the Court of the Bank of England on the recommendation of the Governor, but subject to the following conditions: that there were to be a minimum of eight annual meetings, that Monetary Policy Committee meetings were to be evenly spaced across the year, and that MPC meetings were to be pre-announced with a year's notice, except in 'emergency' cases. We therefore recommend that, should changes to the Bank of England Act 1998 be required for any other purpose, these changes be made at that time. (Paragraph 86)

22.  We believe that the present Court of the Bank of England is too large and should be reduced in size. We note the role played by the Court in the accountability process of the Monetary Policy Committee. We will continue to monitor the decisions of the Court, and at times may request additional information from it relating to the Monetary Policy Committee to ensure that it is undertaking its proper functions as related to the Monetary Policy Committee. (Paragraph 91)

23.  We note with concern the questions raised by the Bank of England's Chief Economist about the ability of the Bank of England to retain its analytical staff, and we will continue to monitor this situation. (Paragraph 93)

24.  We welcome the assurance given to us by the Court of the Bank of England that the resources available to external members of the MPC are not under threat. We will continue to monitor both these resources and the role of the Court in such matters. (Paragraph 96)

The transparency of the Monetary Policy Committee

25.  We acknowledge the efforts the Monetary Policy Committee has made in educating the public, especially via its programmes for younger people, about its role, and the need for low inflation. However, certain of the Bank's own measures of the public's understanding remain low. We recommend that the Monetary Policy Committee and the Bank of England consider what the public need to know about the monetary policy framework, and then, with assistance from the Treasury if needed, consider a public education campaign to put across those points. It is important that if there are more uncertain times ahead, the public must understand and support the reasons behind movements in interest rates. (Paragraph 99)

26.  We are firmly of the view that the letter writing process should be regarded as part of the accountability mechanism of the framework, rather than a sanction. While the experience has been limited, at some point a Chancellor of the Exchequer and the Monetary Policy Committee may disagree about the steps to be taken to bring inflation back to target. In such a scenario, we would expect the reply from the Chancellor of the Exchequer to set out the Treasury's view of the reasons for inflation breaching the target, as well as their suggested timeframe and policy for bringing inflation back to target. This would allow both the House of Commons and the public in general to see clearly the areas of disagreement. (Paragraph 104)

27.  Whether or not the Monetary Policy Committee provides a forecast of future interest rates, there appears to us to be a need for more information to be provided by the Monetary Policy Committee to aid both financial markets and the general public. We therefore welcome the Governor's thoughts on providing more information around possible policy reactions should certain risks crystallise. However, we also recommend that the Bank undertake regular work to assess the current academic thinking on the feasibility and desirability of publishing an interest rate forecast, and keep this matter under review. (Paragraph 108)

28.  We have heard different views on the need for immediate transparency on the voting pattern of the MPC. We have concluded that the balance of arguments supports the need for immediate transparency of MPC voting, which would allow financial markets to assess the strength of the support within the MPC for any given decision. We recommend accordingly that the Bank of England publish, alongside the interest rate decision, the outcome of the vote, indicating which individual MPC members voted which way. (Paragraph 112)

29.  We were pleased to hear that the Bank is considering a structured set of discussions between professional economists and staff members of the Bank, and members of the Monetary Policy Committee. We recommend that the Bank provide to this Committee within six months an outline of a plan for such meetings, that allows for a diverse membership of participants, and allows for an open and transparent record to be kept. (Paragraph 113)

30.  We are concerned about the effects on the debate within the Monetary Policy Committee of having a paragraph assigned to each member. However, we believe greater thought should be given by the Monetary Policy Committee to ensuring that the balance of views of members is more identifiable with particular individuals, rather than just identifying how individual members voted. We therefore recommend that, whenever the minutes at the moment refer to "one member", that member be named within the text. (Paragraph 116)

31.  We have listened with care to the arguments against each member of the Monetary Policy Committee providing an annual report to this Committee. We have particularly reflected upon the concern that such reports might focus attention on a particular date. However, we are persuaded that regular reports by each member of the Monetary Policy Committee to this Committee would further enhance their individual accountability and enhance the value of our regular hearings with members of the Monetary Policy Committee about inflation reports. To overcome concerns about timing, we will request each member to prepare his or her report for a 12-month period ending with a different month. We wish to receive a report on that basis from each member of the Monetary Policy Committee which:

  • lists the work they have undertaken to promote transparency in and wider understanding of monetary policy in the preceding year;
  • assesses their own voting record in the Monetary Policy Committee over that period; and
  • sets out their thoughts on monetary prospects for the coming year. (Paragraph 119)

32.  We accept the argument presented by the Governor as to why other members of the MPC should not be present at the Inflation Report press conference. Members of the MPC who do not agree with the line taken at an Inflation Report press conference already have options at their disposal to explain their views in public. In addition, we consider that, where members of the Monetary Policy Committee do not agree with the line taken at an Inflation Report press conference, they should communicate this disagreement to us in advance of our ensuing Inflation Report hearing. (Paragraph 120)

33.  We welcome the support we have received for our hearings into Inflation Reports. However, we will seek to respond to suggestions for improvement, including through greater questioning of all members of the Monetary Policy Committee present and hearings on August Inflation Reports. (Paragraph 123)

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