Can Labour Resist The Economic Orthodoxy of the Bank of England?
by Adam Blanden (@Adam_Blanden) on September 14, 2019



Labour Shadow Chancellor John McDonnell provoked predictable outrage in the tabloid press and among bankers when he recently suggested he would install a Bank of England governor ‘in tune’ with his own economic ideas. In response, Labour moved quickly to reiterate its commitment to maintain the Bank of England’s much-vaunted ‘independence’ from politics. The party has been formulating radical economic policy at a rate of knots in recent years, from advocating new models of democratic ownership to mandating worker ownership funds in large firms. However, it has not always been clear how the Party intends to deal with state institutions which may in effect become barriers to its plans.

Few British state institutions wield as much power over the direction of the economy as the Bank of England because of its distinctive, independent role in targeting inflation rates and ensuring the stability of the UK’s large financial sector. Yet, the Bank is shielded from democratic control by its independent mandate and, as will be shown below, has played an important role in the development of financialised capitalism. McDonnell has suggested some measures to reform the Bank, including the idea of changing the Bank’s Treasury authorised mandate to help tackle the climate crisis and to target productivity alongside its traditional inflation target. These moves may simply expand the Bank’s influence to new areas of the economy without challenging its deeper ideology though. The Bank’s commitment to keep inflation low and ensure a strong pound could help scupper Labour’s more radical plans, especially if the Bank is allowed to remain democratically unaccountable. If Labour is to really overturn the prevailing orthodoxy of the Bank of England, it may have to take bolder action to end the Bank’s independence.

The ‘Bank of Banks’

First of all, why is the Bank of England so important for the functioning of the economy as a whole? A central bank can be thought of as the linchpin of an advanced financial system – in economist Costas Lapavitsas’s words it is the ‘bank of banks’. Commercial banks hold reserve accounts (which can be thought of as current accounts) with the central bank. These reserve accounts are the ultimate means of settling payments between banks: to cover transactions in the wider economy, funds are frequently transferred between reserve accounts held at the central bank by commercial banks. Without these reserve accounts lending between commercial banks could not continue without sudden interruptions due to funding imbalances between banks. In developed economies with advanced financial systems the central bank takes responsibility for ensuring the stability of the financial system by ensuring ‘low and stable’ inflation via the setting of interest rates.

The Bank of England uses a range of tools, such as its power to buy or sell previously issued assets to or from commercial banks, to control short-term interest rates. Through its structural power over interest rates, the central bank can target a specific inflation rate (normally around two percent) for the domestic economy as a whole. If inflation is set to rise rapidly (due to exchange rate movements or increasing domestic demand), the bank will increase interest rates to constrain domestic economic activity or stabilise the performance of the currency on foreign exchange markets. When forecasted inflation is below its target rate, the bank can spur economic activity by lowering the interest rate. So, at least, goes the theory: as the 2008 financial crash showed, using monetary policy alone to boost growth is hardly reliable, while destructively high interest rates in the early 1980s helped crush inflation, but at the cost of wages and employment more generally.

This structural power makes a central bank a very peculiar institution within any given state system: it is at once an integral component of financial markets and an external regulator of those markets. A central bank resembles in many ways a private financial firm, with a balance sheet of assets (such as government debt, private sector securities and foreign exchange reserves) and liabilities (such as commercial bank reserves and domestic currency). Unlike banks in the private sector, however, a central bank is not subject to strict capital requirements, which means it can absorb large amounts of assets in order to supply liquidity to the financial system. It pursues its policy goals through operations that are integral to the financial system. While it answers to the government, it is also a leading player in financial markets. Its centrality is unusually exaggerated in the British case, where the extremely powerful financial interests of the City of London play a significant role in shaping the direction of government policy. Since as early as the 1950s, when markets for overseas dollar-denominated transactions first emerged, the UK has been at the centre of financial capitalist development. In all capitalist economies, the financial system is vital to ensuring smooth circulation and therefore accumulation of capital. But in financialised economies, financial activity (including the trade in assets, speculative investments in financial securities, and high speed currency trading) influences every area of economic life. Consumption is increasingly funded by household debt; rising property prices are fuelled by the easy availability of credit; and a vast ‘shadow’ banking sector specialises in the trade in complex asset-backed securities.

As the UK financial sector has grown and developed, the central bank has become responsible for maintaining its stability (and by extension the stability of the increasingly financialised economy more broadly). The representatives of finance are keen to identify the sector’s interests with the economy as a whole: ‘The Bank of England’s mission is to promote the good of the people of the United Kingdom by maintaining monetary and financial stability,’ the Bank declares in official publications. However, finance should not be seen simply as a ‘rentier’ fraction of the capitalist class (as in stereotypes of the ‘moneyed capitalist’), but as a central component of advanced capitalist accumulation that nevertheless requires state-backed coordination and representation through the central bank. The Bank of England is not the instrument of financial capital, but rather a leading actor and component in the system of financialised capitalism, capable of regulating the system as a whole in the name of stability. This does not, however, mean challenging the status quo that ultimately maintains the power of finance over the British economy.

Politics and ‘Independence’ at the Bank of England

The decisions to make the Bank of England independent from government control and to lend it greater powers to stabilise the financial sector have allowed it to increase its influence within the British state. Some writers point to then-Chancellor Gordon Brown’s 1997 decision to give ‘operational independence’ over interest rate setting and inflation targeting to the Bank of England as a major change in UK economic policy making. Indeed, in speeches Brown was keen to associate the Bank’s newly-declared independence with a consistent commitment to price stability. This wasframed explicitly by Brown in terms of learning the lessons of the high inflation 1970s and incorporating into social democracy the prudential approach of some monetarist thinkers, albeit without the obsession with explicit money supply targets. Others have convincingly described the rapid expansion of the Bank’s powers since the financial crash of 2008 as a crucial turning point. Just when you might expect the influence of finance over the economy to have dwindled in the wake of the crash, the Bank actually successfully won an expansion of its powers to regulate the financial system as a whole and to reduce ‘systemic risk‘ in the economy.

This was in part because the Conservative-Liberal Democrat coalition embarked on austerity and entrenched the neoliberal belief that fiscal policy (public spending) should be institutionally constrained. In such an environment, monetary policy was the obvious alternative to fiscal policy. The tendency to prioritise monetary policy over traditional public spending peaked with the policy of Quantitative Easing, launched by the Bank of England in the wake of the financial crisis to inject liquidity into the financial sector (by buying up vast amounts of assets in exchange for cash) in the hope of spurring private sector activity. But central banks increasingly prefer to escape narrow ‘rules’ (which inevitably have to be broken) in favour of more flexible ‘constrained discretion’. In other words, the Bank wants to be free to make whatever decisions have to be made to prop up the financial system, while avoiding too much public objection to its pronounced role in macroeconomic policy making.

The Bank’s governors have not entirely avoided controversy in this regard. In 2010 the Financial Times reported that the then-Governor Mervyn King supported the Cameron government’s austerity programme. Current governor Mark Carney has drawn the ire of much of the tabloid press for his various pessimistic Brexit forecasts. However, these relatively infrequent forays into day-to-day politics matter less than the political interests and assumptions that are baked into the Bank’s underlying ideology. Orthodox economists have long held that democratically elected politicians are unreliable stewards of monetary policy because they have a short-term electoral motivation to increase inflation by driving up wages and economic growth. This has led to efforts to ‘depoliticise’ monetary policy by removing it from democratic oversight and placing it into the hands of a small, unelected expert policy committee. At the Bank’s celebration of twenty years of operational independence in 2017, Carney reaffirmed the view that politicians would always be tempted by a ‘dash for growth’ and would betray their promises of prudence. Price stability was, he said, monetary policy’s contribution to the ‘public good’. Central banks have pursued price stability to the exclusion of all else, while central government has become overly reliant on monetary policy to solve all economic ills.

Enshrining a commitment to low inflation in the mandate of the Bank can lead to perverse economic outcomes: low inflation benefits wealthy asset holders and ensures the burden of debts (which disproportionately affects the poorest) is not eroded over time. On the other hand, the commitment to low and stable inflation has been selective and has certainly not extended to house prices. By maintaining low interest rates during the 2000s, Bank of England monetary policy helped contribute to the growth of debt-financed consumer spending and an unsustainable housing bubble. Indeed, it is arguable that by the end of the 1980s it was not tight monetary policy, but the smashing of the trade unions and the collapse in wage growth that ended the era of high inflation. The Bank of England has, therefore, played a significant role in reproducing a system of asset price inflation, debt growth, and low wages which underpins financialised capitalism. Financialisation has, according to one study, also reduced the incentives for productive investment and curtailed productivity growth, leading to low pay and more insecure work.

A Barrier to Reform

It is easy to see how such an institution could place barriers in the way of serious economic reform. In the face of a depreciating pound, central bank orthodoxy would require a rapid rise in interest rates. During the sterling crisis of 1964 Labour Prime Minister Harold Wilson was told by the then-governor of the Bank of England Lord Cromer that he would have to backtrack on his spending plans and steady the pound. Wilson relented. A government today would not face the same immediate pressures because the pound is no longer part of a fixed exchange rate system. Nevertheless, a strong currency regime and low inflation have become a part of modern economic common sense. Higher interest rates would mean higher government borrowing costs and potential constraints on the government’s spending plans. With the right government investment and support, the depreciation of sterling could help undermine the dominance of finance and encourage the British export sector, as the economist Grace Blakeley argues. The timing of central bank interventions to support the pound as well as the scale of any interest rate rises would, therefore, have to be in keeping with the government’s priorities for the economy as a whole rather than a mandated inflation target.

A major flaw in the McDonnell team’s policy planning is the belief that they can expand the Bank’s mandate to include productive, green investment. Granting an institution that already represents the interests of the financial sector greater powers over productive investment would seem foolhardy at best. At worst it demonstrates a worrying turn towards avoiding democratic accountability over public investment decisions. Labour has already signalled its preference for a rules-based regime over discretion when it comes to fiscal policy. The party’s retreat from the tabloid outrage at a suggested change in personnel at the Bank also reinforces the impression that it may take an overly cautious approach to reforming state institutions. If a radical Labour government intends to target green, productive investment, it should do so through fiscal policy, with monetary policy subordinated to its broader goals. Rules-based regimes tend to reproduce the logic of ‘depoliticisation’, which has outsourced policy to either the private sector or to non-democratic, ‘non-majoritarian’ regulatory bodies. Previous Labour governments have arguably shown too much deference to the institutional arrangements they have inherited on coming to power (such as the refusal of the 1929 Ramsay MacDonald government to leave the Gold Standard resulting in the need for crippling spending cuts). Labour needs to do more than inherit the existing institutions of the state: it needs to democratise them in order to achieve its broader economic goals.

An alternative approach would, as Christine Berry and Joe Guinan argue, seek to marginalise the non-democratic economic orthodoxy of the Bank of England by empowering local government, introducing socialised regional investment, and driving an expansion of public ownership. But even this would leave the power of the Bank to control monetary policy unchanged. Perhaps it is time for Labour to consider ending the operational independence of the Bank of England, bringing interest-rate decisions back under the control of a reformed Treasury as part of a reorientation of the British state towards green public investment and decentralised, genuinely democratic local government. Merely tweaking the Bank of England’s mandate will do little to increase the democratic accountability of the dominant state institutions and will allow the siren voices of economic orthodoxy to reassert themselves.


author

Adam Blanden (@Adam_Blanden)

Adam Blanden lives and works in London.

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