The new move to “forward guidance” signals the next step in the process of demystifying and ‘technocratising’ monetary policy. It has moved much further than other areas of policy, notes Jill Rutter.
Very few people now write formal letters to each other. But recent delicately choreographed exchanges (“Dear Chancellor, Dear Mark”) signal the next stage in opening out monetary policy. For those interested in alternative ways of making policy, the changes in UK monetary policy illustrate how far it is possible to move issues from high politics to deep technocracy.
Once, not too long ago, interest rates were regarded as high politics by the Treasury and No.10. Nigel Lawson’s mammoth tome, “The View from No.11”, even entitles a chapter “Politics and Interest Rates, 1986” and describes how he made a decision on interest rates as the economy deteriorated that year. He was returning from the Conservative Party Conference in Bournemouth, where he had ‘dealt with the tricky issues of interest rates and the pound by ignoring them’.
He wrote: “As soon as I got back to London…I called a markets meeting with Robin [Leigh-Pemberton, then Governor] and the customary cast and decided without too much difficulty to raise interest rates by one per cent….Margaret [Thatcher, Prime Minister] was sufficiently relieved I had not gone for a two-point rise to agree to it with relatively little resistance. For myself, I disliked going up by more than one point at a time partly because it looked like panic and partly because I wanted to educate markets this was the norm.”
Ken and Eddie
Those who wanted to understand the Chancellor’s thinking on interest rates in October 1986 had to wait until he shared it in his book published six years later. Things began to change with the setting of clear inflation targets as part of the post-Exchange Rate Mechanism exit regime established by the Treasury in 1992. But the real opening up came a year later when the new Chancellor, Ken Clarke, decided to publish the minutes of his monthly interest rate setting meetings (planned in advance – no ad hoc phone scrambles on the way back from Bournemouth) with then Governor Eddie George – with a six week lag. Those minutes were labelled the ‘Ken and Eddie show’. It still did not stop Chancellors overruling Bank Governors, as Ken Clarke did on a number of occasions, but it meant that their track record could then be judged. The mere fact of retrospective publication was designed to provide the markets with reassurance that rate decisions were a balance between the Bank technocrats and political Chancellors.
The next big step forward was Gordon Brown’s dramatic announcement in the first week of the new government that he was handing the power to set interest rates, guided by an inflation target set by government, to the Bank of England’s newly constituted Monetary Policy Committee (MPC), making his first interest rate decision in May 1997 also his last. The Bank of England Act, which came a year later, requires the Bank to publish MPC minutes within the same six week period that the government used to observe. But in October that year, the Bank itself decided to come clean a month earlier – and instituted the regime of publishing with a mere two week delay.
But those minutes still set out why the MPC had made a decision, not how it would make future ones. That was left to the interpretation of comments by individual MPC members, a judgement of the relative balance of power between ‘hawks’ and ‘doves’ and the implications of the Bank’s forward-looking inflation report.
We are all much clearer now about how the Bank will approach future interest rate decisions both with some decision review points – 7% unemployment – and ‘knockouts’ on price and financial stability, which would trigger a reconsideration even if the unemployment threshold had not been met. What was once deemed to be the stuff of high politics, a decision to be made in secret and the subject of tense exchanges between Nos. 10 and 11 Downing Street, is now in the hands of technocrats who not only show their workings, but also share with us how they will approach future decisions.
The evolutionary path of monetary policy, which affects every household and business in the land, shows how much government can change the way it makes decisions. This year’s LSE Growth Commission report argued there were other areas: infrastructure, education and private investment, where outcomes could be improved if we could ‘break the familiar cycle of institutional churn and political procrastination to find ways of ensuring that difficult and contentious long-term decisions are based on the best available independent expertise’.
This article was originally published on the Institute for Government blog.
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Jill Rutter is Programme Director at the Institute for Government. Jill joined the Institute as a Whitehall secondee in September 2009. Before joining the Institute for Government, Jill was Director of Strategy and Sustainable Development at Defra.