Back before he was Labour’s shadow chancellor, John McDonnell liked to say that if Labour got into power the first thing it would do is to strip the Bank of England of its power to set interest rates.
It is quite something, then, that today Mr McDonnell committed himself to reforms which will make the independent Bank even more powerful.
While most economists and analysts have fixated on Labour’s plans to move the Bank to Birmingham and to introduce a new 3% productivity target – both indeed significant shifts, they have missed an even more important point.
Under the plans laid out by Labour’s economic advisors GFC, the new remit for the Bank would dismantle one of the key principles which has, for decades, prevented the institution from becoming too powerful – the ban on its involvement in fiscal policy.
Even as he made the Bank independent back in 1997, Gordon Brown jealously guarded the Government’s ability to tax and spend.
The Government would leave the Bank to decide on interest rates and, in return, it expected that the Bank would not intervene in its tax and spend decisions. This firewall has remained in place ever since, but Labour is now proposing to dismantle it.
Every time there is a Budget, the Bank will be duty bound to write a letter to the Government explaining how its tax and spend plans will or won’t boost productivity. This is a crucial step shift – and an unexpected one.
Far from diminishing the Bank’s power, these Labour reforms would establish it as the key arbiter on the country’s macroeconomic performance.
Here is the relevant paragraph from the Labour report today: “the Bank of England Governor – after discussion with the Monetary Policy Committee and Financial Policy Committee members – will respond to each Budget in writing to the Chancellor. The letter should describe how the Government’s fiscal position (including tax and spend policies) announced in the Budget is expected to impact on the 3% productivity growth target, as well as explaining any policy reactions required by the Bank. The Governor will take electoral commitments made by the governing party (in the manifesto) as given, commenting on the general economic outlook and productivity-promoting investment, including research & development.”
This is a big deal. Once upon a time, the Treasury had the power to 1. forecast the UK economy, 2. set interest rates and 3. decide tax and spending. It has already ceded control of 1. to the Office for Budget Responsibility, 2. to the Bank of England and now Labour proposes that the Bank should effectively cast judgment on 3. as well.
In other words, for all that many people expected Labour to water down the Bank’s powers or even cancel its independence, it has instead backed proposals turning it into the most powerful central bank in the world. They may well have to move to Birmingham, but the Bank’s unelected experts will also get an unprecedented suite of tools to control and influence the economy – as well as keeping the government in check.
This, it strikes me, is perhaps even more important than the proposal of a 3% productivity target.
Like other commentators, I’m a little sceptical about whether this target will work. It’s questionable that the Bank could directly influence it in the same way as it can influence inflation. It may be less effective than alternative remit ideas like price level targeting, in which one compensates for years of below or above target inflation in future years.
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There are legitimate concerns about moving the Bank’s domestic functions out of London, where the City of London plays such a crucial role in the UK’s monetary transmission mechanism.
But even as many in the City worry that the Bank has become too powerful, Labour have just promised to beef it up even further.