Government Response to the Committee's
First Report: 27 July 1999, Paper 96, Session 199899
The Government welcomes the Committee's conclusion
that "The Government was right to give operational independence
for monetary policy to the Bank of England, and to place it on
a statutory basis".
The Government's response focuses on those specific
recommendations that concern the overall monetary policy framework,
for which the Government remains accountable. The Bank will respond
separately on those matters that concern the implementation of
the Government's policy, which is now the responsibility of the
Monetary Policy Committee (MPC). A copy of the Treasury Paper
"The New Monetary Policy Framework", released on 19
October, is attached. [not printed]
The Government's response to the Committee's specific
recommendations is set out below.
1. The Government
was right to give operational independence for monetary policy
to the Bank of England, and to place it on a statutory basis (paragraph
· The Government
welcomes the Committee's support for its decision to give the
Bank of England operational independence to set interest rates.
As noted in a paper published on 19 October by the Treasury, this
has increased the credibility of monetary policy and should help
ensure that the inflation target continues to be achieved. Low
inflation is an essential precondition for delivering the Government's
central economic objective of achieving high levels of growth
2. The Treasury
and the Bank of England have a duty to monitor in detail the performance
of the Monetary Policy Committee, and to publish their assessment
of it (paragraph 7.2).
· The Government
monitors carefully the MPC's performance. A recent paper by the
Treasury sets out the Government's assessment of the performance
of the MPC, and the framework more generally, over the first 2½
years of its existence. The paper concludes that the MPC have
been very successful in maintaining price stability while avoiding
a return to the boom and bust cycles seen so often in Britain's
· The new framework
is characterised by a clear separation of roles and responsibilities.
The MPC has a clear remit to achieve a symmetric inflation
target and thus support the Government's economic objectives for
growth and employment. Economic commentators continually assess
the MPC's performance. This Lords Committee report and the Commons'
Treasury Select Committee report add to this high level scrutiny.
3. We agree that an inflation target of 2.5
per cent is appropriate at this time (paragraph 7.6).
· The Government
welcomes the Committee's support for its inflation target. As
the Chancellor has stated on numerous occasions, it is important
to have a record of sticking to the target set.
· The Committee
also suggests that the open letter system needs explaining because
inflation 1 percentage point above or below target "does
not necessarily imply serious policy error". As discussed
in the Treasury's 19 October paper, the open letter should not
necessarily indicate failure. Rather, it provides an immediate
opportunity for the MPC to explain why the divergence has occurred;
the policy action being taken to deal with it; the period within
which inflation is expected to return to the target; and how this
approach meets the Government's objectives for growth and employment.
4. There is a need for further clarification
by the Treasury on the "subject to that" part of section
11 of the Act (paragraph 7.7).
· The Chancellor
sent the Committee a Memorandum (p387 of the Committee's evidence)
which set out clearly how section 11 of the Bank of England Act
is to be interpreted. This interpretation is accepted by the Bank.
5. We are less
than clear whether the decision procedure of the Monetary Policy
Committee is more an art than a science. They must make their
procedure clearer so as to aid public scrutiny, and re-examine
this procedure in order to remove any possible bias (paragraphs
7.9 and 7.11).
· This is a matter
for the Bank of England. However, the Government believes the
minutes of the MPC meetings provide a very open and transparent
account of the factors that underpin the MPC's interest rate decisions.
of independent members of the Monetary Policy Committee must be
made in a more open fashion. Such appointments should be for five
years and normally non-renewable (paragraphs 7.13 and 7.14).
· The Nolan procedures
formally cover the Court of the Bank and the MPC. However, given
the highly market sensitive nature of the MPC appointments there
is a need for a particularly high degree of confidentiality in
to the MPC are subject to external scrutiny, ex post, by the Treasury
Select Committee. The MPC is also much more accountable than other
public bodies through statutory requirements for reporting, e.g.
disclosure of decision, publication of minutes and individual's
voting records, the quarterly Inflation Report and regular appearances
before parliamentary committees.
· As regards
the length of appointment, there is a balance to be struck. On
the one hand, terms need to be long enough for members to develop
experience and familiarity with the MPC procedures. On the other
hand, terms should not be too long so that high calibre candidates
are not deterred from applying. The Government believes it has
struck a reasonable balance.
· The Government
sees no reason why a well-performing member should not remain
on the MPC for more than one term.
7. More attention
should be paid to the reasons for interest rate differential between
our interest rate and that set by the European Central Bank (paragraph 7.10).
· The Bank of
England Act requires the MPC to set interest rates to meet the
inflation target defined by the Government. The Government's inflation
target was reaffirmed by the Chancellor in the Budget in March
of this year as a 2½ per cent annual increase in the RPIX.
The differential between UK and euro area interest rates reflects
differences in the cyclical positions of the two economies, but
has narrowed over the past 2 years.
8. The Court needs to make full use of its
power with respect to the Monetary Policy Committee and could
play a more active role (paragraph 7.16).
· This is an
issue for the Bank of England.
9. The Office for National Statistics (ONS)
needs to play a more active role in dealing with all the problems
that have emerged in connection with the measurement of inflation,
and especially the role of the harmonised index of consumer prices
(HICP) (paragraphs 7.17 and 7.20).
· The ONS plays
an active role in the statistical aspects of inflation measurement.
It is actively involved in a major research programme investigating
possible bias in the RPI and plays a major role with Eurostat
and partner Member States in the development of the HICP. It also
consults users (and price index experts) on these developments.
· The ONS provides
users with advice about the statistical attributes of its various
inflation measures. In particular, it publishes RPI and RPIX as
the main domestic measures of consumer inflation. It also promotes
the HICP for use in international comparisons and recognises the
HICP as the preferred measure of inflation in the Monetary Union
of the HICP was brought forward last year and now appears with
the RPI and RPIX in a joint First Release that includes commentary
on the relationship between the measures.
10. Response to
observation that "ONS should undertake or commission research
to determine (a) whether there are significant regional differences
in inflation rates, and (b) how important in quantitative terms
normally is the distinction between domestically caused inflation
and imported inflation".
· ONS are aware
that there is a growing demand for regional data in general. ONS
will continue to consult with users about their needs and evaluate
these relative to other priorities in the context of its annual
planning round. The development of regional inflation measures
would require a major development programme to resolve a number
of technical matters. Also there would be a need to expand significantly
the Family Expenditure Survey to provide regional consumption
patterns. This would involve significant additional expenditure
involving millions of pounds rather than thousands.
· The ONS does
not explicitly produce measures of domestically generated inflation.
There are certain conceptual differences in decomposing inflation
between domestic and imported sources. These are discussed in
the August 1998 Bank of England Inflation Report (page 39). Nevertheless,
a range of measures of domestically generated inflation can be
derived from existing ONS inflation indices such as RPI, import
prices and the GDP deflator.
is required of the part that the external value of sterling plays
in the transmission mechanism of monetary policy to the real economy
· The Bank of
England published a paper "The transmission mechanism of
monetary policy" in its May 1999 Quarterly Bulletin, which
set out the role the exchange rate plays in the monetary transmission
19 October 1999
LETTER FROM THE GOVERNOR OF THE BANK OF
ENGLAND TO THE CHAIRMAN OF THE COMMITTEE
I understand that the House of Lords will be debating
your Report on the Monetary Policy Committee next Tuesday. The
MPC and the Court of the Bank have considered your recommendations
and the Court have prepared a written response to recommendation
8, which I enclose. The MPC have noted the other recommendations
and will be happy to give further evidence if required.
28 October 1999
RESPONSE BY THE COURT OF THE BANK OF ENGLAND
The Committee recommended "The Court needs to
make full use of its powers with respect to the Monetary Policy
Committee, and could play a more active role".
In the body of the report it said, "The 16 outside
members of the Court are all part-time. Our interpretation of
the Act is that they are involved with the accountability process.
We are concerned with the way in which they have undertaken this
task so far. On the face of it, they have an important role in
setting the parameters under which the Bank itself and the MPC
operate. It was also our impression that they would play a central
part in the preparation of the Annual Report, and in assessing
the work of the MPC. While accepting on this as on everything
that these are early days, we are surprised at the reluctance
shown by the Court in exercising their functions in relation to
the MPC. We would expect their role to be stronger in future,
not least in connection with the quality of data made available
to the MPC".
Court as a whole is responsible for the management
of the Bank, apart from the formulation of monetary policy. The
non-executive Directors on Court have been delegated a range of
particular functions, including reviewing the Bank's performance
in relation to its objectives and strategy (which are set by Court),
monitoring financial management, reviewing internal financial
controls and setting remuneration. They are also required to review
the procedures of the MPC, and in particular, determine whether
the Committee has collected the regional, sectoral and other information
necessary for formulating monetary policy. Non-executive Directors
must contribute a section to the Bank's annual report on the discharge
of their functions, and this report is sent to the Chancellor
and laid before Parliament.
Court plays a very active role in managing the Bank
as a whole, taking responsibility for the same high level management,
investment and financial control issues as the board of a public
company, and preparing and publishing audited accounts each year
in accordance with Companies Act requirements. Court also has
an Audit and Remuneration Committee, in line with private sector
In relation to the MPC, Court made full use of its
powers, to review the procedures of the MPC, and examine the collection
of information. These powers are delegated to the non-executive
Directors, who commissioned and considered in Court, and in meetings
of their own sub-committee between October 1998 and April 1999,
eight papers on the work of the MPC. In particular, there were
lengthy and detailed discussions of the quality of data made available
to the MPC. Non-executive Directors reviewed the difficulties
experienced with the earnings figures at the earliest possible
opportunity after the problem came to light. Proposals for improvements,
based on a service level agreement with the Office for National
Statistics, were put to Court and endorsed by the non-executive
External members of the MPC were invited to many
of the discussions on MPC procedures. The non-executive Directors
also discussed the work of the Agents in Court with a number of
the Agents and made a series of visits to Agencies to see at first
hand how the Bank gathers regional intelligence. Most of the non-executive
directors also attended one or more of the pre-MPC meetings with
Bank economists, which take place the Friday before the decision-making
meeting, to see for themselves how the process works. The non-executive
Directors discussed peer group reviews of the MPC procedures,
including the views of other visitors to the pre-MPC meeting.
In particular, they interviewed a team from the International
Monetary Fund which reviewed the British monetary policy process
as part of the Article IV consultations with the British Government.
Finally, the non-executive Directors were closely
involved in the preparation of the annual report of the Bank,
and contributed their own section to it. As described in this
year's annual report, the non-executive Directors decided that
they would, as far as practicable, rely on processes established
for and work done for or in Court. Certain of the work required
to fulfil their delegated functions was already carried out by
the Audit and Remuneration Committees of Court. The work of these
Committees is considered in Court. The terms of reference of these
Committees were modified where necessary in order to align them
with the Act and to facilitate the discharge of the non-executive
Directors' responsibilities. The result was that a substantial
amount of the work for which the non-executive Directors are responsible
was in practice done in Court- 16 of whose 19 members are non-executive
or in committees of Court, which are entirely comprised
of non-executive Directors. Therefore, to avoid duplication of
work described in other sections of the report, the non-executive
Directors kept their sections short, by referring wherever possible
to other sections of the Annual Report, for which they, as members
of Court, are also responsible. The non-executive Directors met
regularly during the year to satisfy themselves that their delegated
functions were being satisfactorily discharged.