Select Committee on Monetary Policy Committee of the Bank of England Report


The division of responsibility between the MPC and the Government

2.1  As noted earlier, the MPC has been given the task of operating monetary policy, while the Government has retained fiscal policy: the MPC is encouraged by section 11(b) of the Act to support the Government's wider economic policies, but this falls far short of their being licensed to shape them. The interaction of monetary and fiscal policy will be dealt with in a later chapter, and at this point we shall examine the division of responsibilities between the Chancellor and the MPC in respect of monetary policy only.

2.2  In granting independence to the Bank of England, the Chancellor has retained certain responsibilities. This is normal for a central bank, all of which are answerable to their country's political system, although the degree of independence varies. In the Act accountability to Parliament is stated explicitly. This involves the Commons Treasury Select Committee. Your Lordships are also involved. This report is an example of the part the House of Lords may play in the accountability process.

2.3  In addition, the Chancellor has reserved two substantial powers in respect of monetary policy: the power to specify objectives and the power of appointment. Of course, in that regard he too is accountable to parliament.

2.4  The first of these is codified in section 12 of the Act, which states in its first subsection that:

"The Treasury may by notice in writing to the Bank specify for the purposes of section 11:

2.5  The Treasury is obliged to issue such a notice at least once a year. It should be noted here that the formulation of this subsection allows considerable flexibility: it commits the MPC to neither the 2.5 per cent inflation target nor for that matter to an inflation target per se. So the Chancellor can, if he chooses, set a different target (say, 3.5 per cent), a different measure (say, the Harmonised Index of Consumer Prices, which will be discussed in Chapter 3) or a different inflation regime (say, exchange rate targeting). The Act itself uses the expression "price stability" which, as we have said in Chapter 1, is subject to interpretation. Clearly, common sense must prevail. While price stability does not have to mean zero inflation, it is impossible to see high single figure, let alone double digit, inflation as meeting the requirements of the legislation.

2.6  The second power is set out in section 13. This stipulates the membership in strict terms: the MPC is to consist of the Governor; his two Deputy Governors; two members appointed by the Governor after consultation with the Chancellor, one of whom is to be a person who has executive responsibility within the Bank for monetary policy analysis, and the other of whom is to be a person who has executive responsibility within the Bank for monetary policy operations; and four members appointed by the Chancellor. (The Governor and his two Deputy Governors are appointed by Her Majesty.) The Act also commits the Chancellor only to appoint a person to the MPC "if he is satisfied that the person has knowledge or experience which is likely to be relevant to the Committee's functions."[13] We have received evidence, not least from the Governor and the Chancellor as to what this means. They have taken a rather narrow interpretation in the sense of emphasising knowledge of monetary economics and monetary policy. The Act is sufficiently vague to allow such an interpretation, but its vagueness also allows for the appointment of people with a broader range of experience if the Chancellor thought that would be desirable.

The choice of members of the MPC

2.7  All of the members of the MPC are intended therefore to be knowledgeable in ways relevant to the formulation of monetary policy, either because of their experience at the Bank or because of the Chancellor's section 13(4) duty as described above. So far, the MPC has had five members appointed in the latter way as "external members": Willem Buiter, Professor of International Macroeconomics at the University of Cambridge; Charles Goodhart, Professor of Banking and Finance and Deputy Director of the Financial Markets Group at the London School of Economics; Sir Alan Budd, formerly Chief Economic Adviser at the Treasury (in which capacity he initially joined the MPC as Treasury observer, subsequently joining as an external member upon his retirement from the Treasury); Dr DeAnne Julius, formerly chief economist of British Airways; and, upon the recent retirement of Sir Alan Budd from the MPC, Dr Sushil Wadwhani, previously partner of the Tudor Group, an American hedge fund.

2.8  The appointments reflect the Chancellor's commitment, noted in his 6th May 1997 letter to the Governor, that the external members would be "recognised experts". That they are indeed experts in monetary policy has never been doubted, at least in the presence of our Committee. But there has been criticism of the Chancellor's insistence on experts, and in his refusal to consider appointing someone from "the coal face". Such a criticism often comes from the manufacturing sector, which has perceived the membership of the MPC to be out of touch with conditions in their sector. As put to us by Sir Brian Moffatt, Chairman of British Steel, "There is a strong case for arguing that a committee with a broader composition of members, representing a wider range of sectors and backgrounds, would have exhibited a greater sensitivity to the impending recession in manufacturing, and avoided the "overkill" apparent in the decisions made during the course of 1998." (p 285) John Monks, General Secretary of the TUC, told the Committee that in the TUC's view "we would have liked to have seen a Trades Union Congress member or someone who at least understood the labour market from a union perspective as a member of the MPC" (Q 544). Even some who, like Gerard Lyons, feel that members of the MPC "should, on the whole, be trained economists or experts" accept that "not every member need be a trained economist or monetary expert. On occasions, the MPC may benefit from a detached, but still well informed view." (p 244)

2.9  On the other side there is a general feeling that monetary policy must be conducted by experts in the field if the MPC is to achieve its objectives and maintain its credibility. The European Central Bank, for example, feels that "Expertise in monetary policy is crucial in view of the task assigned to the Eurosystem. Explicit representation of other policy areas could blur the respective assignments of policy areas, hampering the credibility of the Eurosystem." (p 187) Nor is such an opinion restricted to central bankers and economists: Sir Ronald Hampel told us that "the quality of the people on the MPC should be unquestioned and they should be people who understand the dynamics." (Q 1283) He added that "to say that it will not succeed unless you have one businessman, one academic, one economist and so on, does not convince me." (Q 1284)

2.10  That the members of the MPC must be experts need not preclude the possibility that they could come from a business or industrial background. France's monetary policy is now decided by the ECB. M. Jean-Claude Trichet, the Governor of the Banque de France, told us that previously in regard to his team of experts, "The law says that in our case they have to be professionally experienced and competent in the monetary or financial or economic field". (Q 1389) This means that "we have a professor of economics out of the six, we have a leader of the insurance industry, an insurance industry CEO, a CEO of the banking industry, we have a representative of the major union in France, we have the CEO of a small and medium sized business industry." (Q 1391)

The restrictions on choice provided by requiring no conflict of interest

2.11  The Chancellor's stipulation that there can be no conflict of interest for members of the MPC inevitably restricts his choice of appointments: in effect, an external member of the MPC must be either an academic or a retired person or, if from a business background, must resign and sever his links with his former environment. This rules out part-time members whose other job is of a commercial nature, and it is not clear whether someone could be appointed to the committee on full-time secondment with the expectation of returning to their original job. ( This is not to say that the committee believes this to be impossible.)

2.12  In addition, Schedule 3 of the Act restricts an appointment to the MPC to three years, although that term is renewable. We have had the opinion expressed to us that the basic period of appointment should be longer than that, both to allow the person to plan their career better, and to make best use of the experience they gain as a member of the MPC. It may also be stressed that up to a point the longer the period of appointment the more the person concerned can act in an independent way. We return to these matters in Chapter 7.

Method of selection

2.13  At the moment, the external members of the Committee are chosen by the Chancellor without reference in whole or in part to the so-called "Nolan rules", by which persons appointed to senior public positions are appointed in a public, objective and systematic way. If they were to be so appointed, the Chancellor would have to proceed via an open selection procedure, incorporating advertisements in the national press. (This process does not preclude the use of headhunters.) Lord Desai summarised this view when he noted that "in appointing people there ought to be some scrutiny process by a legislative Select Committee" (Q 1218). There is a sort of scrutiny process: the Treasury Select Committee has initiated "confirmation hearings" for new members. But unlike the United States Senate, the Committee cannot veto the Chancellor's appointment and it remains to be seen what would happen in the event of the Select Committee's refusal to endorse a new member. The Treasury Select Committee also seems to have limited severely the range of questions asked, certainly as compared with the typical approach of the Senate.

2.14  The Chancellor has defended his reluctance to appoint external members in that way, arguing that to do so would make the selection process open to pressure group influence. It has also been argued that Nolan in its entirety would be rather bureaucratic. (We have not on this occasion asked Lord Nolan whether he thinks his approach is fully relevant to the case in hand). Others are wary of the Chancellor's argument. Lord Desai's view was that "the latest member was sprung" (Q 1218). This is a reflection of the fact that it was not made clear that a new member of the MPC would be appointed (rather than renewing the term given to Sir Alan Budd) until the appointment of Dr Sushil Wadwhani was announced. We must remark that we have no knowledge of the field that was considered before the latest appointment was made, and we even have difficulty elucidating the procedure that was followed . We comment further in Chapter 7.

The role of internal and external members

2.15  Not everyone who serves on the MPC serves on the Committee on a full-time basis. Nonetheless, as far as the work of the MPC is concerned, all members are equal. All of the five internal members have other responsibilities in the Bank. The Governor is, of course, at the head of the whole of the Bank's operations. The other Bank members are Mervyn King, Deputy Governor for Monetary Stability; David Clementi, Deputy Governor for Financial Stability; Ian Plenderleith, Executive Director of Financial Market Operations; and John Vickers, Executive Director of Monetary Analysis and Statistics. In addition, it should be noted that of the five external members who have served, two (Sir Alan Budd and Professor Goodhart) have been employed on a part-time basis and are paid pro-rata.

2.16  It is not assumed that the full-time external members of the MPC must devote all of their time to the strict job of analysing monetary policy: Professor Goodhart is employed at the Bank for only two days per week, so that can be assumed to be the minimum amount of time reckoned to be required for the main work of the MPC. We were told in evidence, by way of example that Dr Julius (QQ 313-317) spends much of her time travelling throughout the United Kingdom meeting businessmen and others. In addition, members of the MPC are allowed to engage, with the Chancellor's approval, in other activities which do not give rise to a conflict of interest. Dr Julius, for example, is a member of the Government's Skills Task Force.

The role of the Court (and the provision of information to the MPC)

2.17  The Bank of England Act did not restrict itself to the formation of the new structure for independent monetary policy: inter alia, it also reformed the Court of Directors of the Bank. The Court, which consists of the Governor, his two Deputy Governors and 16 other Directors appointed by Her Majesty, is in the Act given the task of managing the Bank's affairs, other than the formation of monetary policy (section 2(1)). However, section 16 of the Act stipulates that:

In particular, the Court's function under subsection (1) shall include determining whether the Committee has collected the regional, sectoral and other information necessary for the purposes of formulating monetary policy.

2.18  The members of the Court are appointed in a way that is different to that followed by the Chancellor in nominating members of the MPC. They are appointed according to the Nolan rules and, unlike the MPC members, they are allowed outside interests. A majority of them are business people. They are chosen to represent, in the Chancellor's words "the whole of the United Kingdom and to take account of the full range of Britain's industrial and business sectors".[14]

2.19  Their responsibilities in respect of the MPC are designed to ensure that the MPC is as well equipped with information as is possible to conduct monetary policy. This does not mean, as noted by one member, Dame Sheila Masters, that they need to second-guess the MPC's judgments (Q 712); she sees the Court's task as "to look at procedures to ensure that the right sort of information is flowing to the MPC" (Q 711). As put by another member, Professor Christopher Allsopp, "our job is monitoring the process of information gathering to make sure that it is there, and then it is up to the MPC as to what they do with it." (Q 733).

2.20  We do not have any doubts on the scale of information available to the MPC. There is no shortage of statistics. When we visited the Bank in January, we were provided with copies of the huge bundle of tables and statistics which the MPC are given prior to each monthly meeting. These cover all conceivable aspects of monetary conditions, demand and output, labour conditions, prices and financial market intelligence. There is plenty of information. But what matters also is quality. The MPC has been criticized by some witnesses for a failure here. There has been particular criticism of the June 1998 decision to raise interest rates to 7.5 per cent. According to Sir Ronald Hampel, the recently-retired Chairman of ICI, "the one occasion the MPC surprised us all was when it put up interest rates last summer and it seemed to us it was putting up its interest rates on the basis of the wrong data" (Q 1239). This episode is now well charted: the faulty information was in respect of earnings figures from the Office for National Statistics, and in the aftermath the series was suspended and there was an enquiry into the figures. Damage was done by the episode: according the Sir Brian Moffatt, "the whole question of the intelligence system on which decisions are made really is worthy of a lot of investigation" (Q 1298).

2.21  The Court's duty to ensure that the MPC has sufficient regional and sectoral data is in part carried out through the operations of the Bank's regional agents, all of whom feed back information to the Committee each month. The agents seem to be particularly appreciated: for example, Andrew Kent, Chief Executive of the Port of Southampton, was very enthusiastic about his local agent (Q 522). But their profile is not high: another witness, James Dyson, was unfamiliar with his agent. But their reports are seen as important: for Sir Ronald Hampel, "it is worth looking very hard at whether they can get the real data by the correct thing being placed in front of them rather than by having a representative there."

2.22  Having remarked in Chapter 1 on the data looked at by the MPC, which despite some quality deficiences which are easily rectified, is not lacking in quantity, we have to say we are less well informed about the economic analysis carried out for the MPC. There is extremely valuable material in the Inflation Report and the Quarterly Report. There are also the Bank's excellent research papers. In addition the Bank has now published its model, but not in a form which would enable other economists to run it and test it with any ease. What we have not examined, but would wish to do in the future, is any further analysis provided to the MPC by other experts both internal or external. Also given the presence of serious economists on the MPC we would be interested in due course to see whether they have presented specific pieces of analysis to the committee.

The accountability of the MPC: its desirability and the ways it is achieved

2.23  The Chancellor defined the MPC's accountability in his remit for the Committee, which was set out in a letter to the Governor on the coming into force of the Act, as follows:

(We note there is no mention of their Lordships here! We assume the omission was because this Committee not being in existence at the time. As this Report demonstrates the House of Lords takes its role in the accountability process very seriously.)

2.24  All central banks are accountable in some way to their national parliaments, and the obligation to give evidence before parliamentary committees is similar to the requirements made of the Governor of the Banque de France and of the Chairman of the Fed, the latter of which is required to give a assessment of the current situation to Congress at the twice-yearly Humphrey-Hawkins hearings. The ECB, while not technically a national central bank, is also accountable, in this case to the European Parliament, where the President has to present an annual report which is then debated by the Parliament. He must also attend hearings there every quarter. As central banks go, the Bank of England is seen to be at the more accountable end of the scale. As viewed by Gerard Lyons, it is less accountable than the Fed, but more accountable than the ECB and considerably more accountable than the Bundesbank (Q 1122). We ourselves do not think the actual and optimal degree of accountability is fully decidable at this stage, but there can be no doubt whatsoever that the Bank of England today is very accountable and more so than it has ever been in the past.

The openness and transparency of the deliberations of the MPC and its decisions

2.25  The MPC is required by section 15 of the Act to publish minutes of its meeting within six weeks, and as a matter of course it now fulfils this obligation within two weeks. The Act also requires the Committee to record the voting record of the individual members. In addition, section 18 of the Act requires the Bank to prepare every three months a report (known as the Inflation Report) which reviews its recent monetary policy decisions, assesses United Kingdom inflation developments and indicates its expected approach to meeting its section 11 obligations.

2.26  According to Lloyds TSB, "The United Kingdom now has the most transparent system of monetary policy of any major nation." (p 203). As put by Sir Brian Pitman, their Chairman, "I do not see how they could go much further." (Q 936) And Professor Tim Congdon added his voice to the chorus of approval when he told us that "the combination of inflation reports and the publication of minutes is a very transparent system." (Q 1155)

2.27  Gerard Lyons is of the opinion that the MPC's openness and accountability could be improved by the publication of a detailed economic forecast, in addition to that already contained in the Inflation Report (p 245). There is also a minority view that there should be more of an effort to indicate in the minutes the individual opinions of the members of the MPC. But for most people, the recording of their votes is sufficient. With the present degree of accountability it is difficult if not impossible to relate the decision actually taken to particular economic arguments, data, or forecasts. Without knowing who said what and why it cannot be concluded what in the end determined the decision that was actually taken. To be set against this we agree that anonymity is helpful to independence, and protects individual members of the MPC from external pressures.

The voting arrangements

2.28  At the end of the meeting of the MPC, the Governor invites the Committee to vote on his proposal for the interest rate. The minutes record whether the Committee agrees with him, and, if there is any dissent, which members voted with him and which against him. They also record the individual preferences of the members of the Committee in respect of the amount by which they wish to change the interest rate, if at all. This feature is almost unique: of the G7 nations, only Japan follows such a practice. We assume each member gives his or her vote publicly in the committee. We regret to say we did not take evidence on the order of voting, or on whether the individual vote is inevitably regarded as final. We are aware of the existence of a large, chiefly mathematical, literature on voting procedures. Problems of bias and illogicality can arise from seemingly innocuous methods. There can be no doubt that it is not trivial who puts the proposition that is voted on or the form in which it is set out. We have a little more to say on this in Chapter 7.

2.29  The voting procedure is second only to the overall decision of the MPC as a whole in terms of the interest generated by the Committee, and as the MPC has matured so there has been considerable scrutiny of the records of the individual members of the Committee. The Financial Times has even instituted its own indices: the Aviary Index, which marks an individual member's tendency to flee the nest by dissenting from the majority opinion; and the Activism Index, which measures their tendency to vote for larger moves in rates than the majority.

2.30  Such scrutiny of individual voting patterns is treated with caution by the ECB, who have their own reasons for not disclosing votes. They feel that if the votes were disclosed, the national bank members would feel pressured to vote according to their own country's interest and not that of Europe as a whole. Added to this, we were told by Dr Duisenberg that he thought "it is undeniable that revealing the individual positions of votes of the members of the Monetary Policy Committee itself has an impact on markets or market expectations which I regard as undesirable." (Q 869) We must say that the purpose of our visit to the ECB was to do with placing our own arrangements in an appropriate context. It was not to examine the ECB itself. We were impressed with the general point that, while totally favouring transparency, they were sensitive to the need to protect the relevant decision makers from undue external pressure. We agree, but subject to that, favour maximum transparency for all public institutions in the economic and financial area. Lloyds TSB see as the main problem of the MPC's transparency, that "it encourages an industry to spring up centred on analysing the voting behaviour of individual MPC members, with too much media attention focused on this and too little on the economic fundamentals that drive MPC decisions." (p 203) We recognise what has been said, but do not regard the problem as major or insurmountable.

2.31  It is not appropriate to delve too far into the voting patterns of individual members, but one or two aspects are worth noting. First, the Governor has so far always voted with the majority, and he has always voted to reduce or raise interest rates by the amount that has been agreed by the majority. Secondly, he is not alone in this: of the four other internal members, one has never voted in a different manner to the majority, another has voted in a different manner on only one occasion, and another has voted in a different manner on only two occasions; only Mervyn King has regularly voted against the majority. This may or may not be coincidence, but on the face of it most of the five internal members seem to vote together, almost as a bloc. It is also worth noting that the revelation of votes has focused great attention on those individual members who vote in distinct patterns: in particular, on Dr Julius and Professor Buiter. This reinforces our view, expressed fully in Chapter 7, on the need for research and deep scrutiny of the voting behaviour of the MPC.

Communications between the MPC and the Government

2.32  The MPC and the Government communicate in several ways. Aside from the most formal sense in that the Chancellor communicates the specific objectives to be pursued, there are regular meetings between the Chancellor and the Governor and between Bank and Treasury officials. The Treasury keeps the Committee informed of policy developments and briefs them before the Budget. Most importantly, the Treasury has a representative at each meeting of the MPC, who participates in the meeting but does not vote. We have not seen any minutes of these meetings or asked about them. We have also not so far pursued the question of whether and how the Governor reports back to the Bank and the MPC.

How effective are the Inflation Report and the Minutes?

2.33  It has been argued to us that the transparency and openness embodied in the Inflation Report and the Minutes will help industry and the City by making it easier to predict future trends not only in interest rates and inflation but also in the wider economy. We have received evidence that there has sprung up a minor industry attempting to predict the MPC's decisions, and individual firms employ economists to do this for them, as far as it is possible. As put by Sir Brian Pitman, "it reduces the uncertainty all the time" (Q 936). His view is echoed by Professor Patrick Minford, who said that "If, in fact, there is this continuous dialogue of conveying of information about what people are minded to do, that reduces uncertainty in so far as it can be reduced." (Q 1157) A more detailed welcoming of the transparency comes from Lloyds TSB:

2.34  Not everyone fully agrees. Roger Bootle, for example, claims that "the markets believe that the Inflation Report's inflation forecast is in some sense a "fix"". (p 256) We are not convinced he is correct, but we repeat our earlier comment that it is not easy for outsiders to trace the connection between the forecast (or general economic outlook) and the ultimate committee decision.

2.35  The Minutes focus largely on the prospects for inflation, and contain little information on the reasons for the choice of interest rate. Nor do the Minutes suggest that the MPC discusses the appropriateness of previous decisions. Since the interest rate decision is an aspect where transparency is vital, there should be greater clarity about the choice.

Section 13(4). Back

14   6 May 1997 statement. Back

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