In these times of crisis, is Bank of England's MPC up to the job?

Published on 06/10/2008 21:35

ONE of the surprises in Gordon Brown's reshuffle was the creation of the National Economic Council (NEC) to provide a new approach to co-ordinating economic policy.

It includes 12 Cabinet ministers whose portfolios touch on economic issues. It will meet twice a week and has been likened to Cobra, the Cabinet committee to deal with civil emergencies. Economic policymaking isn't usually a twice-a-week business.

Its creation signals two things: that the economic situation is so bad the government is effectively going on to a war footing, and that existing arrangements for economic policy are incapable of meeting the challenges the British economy now faces.

On the first point, there can be little argument. Crisis in the financial sector, plummeting house prices, falling retail sales and rising unemployment present as gloomy a picture of the British economy as has been seen for decades. Like the panic over subprime mortgages, the gloom has spread contagiously.

Alistair Darling, the Chancellor, will admit tomorrow that government borrowing is spiralling upwards and the self-imposed "golden rule" will have to be abandoned. Next financial year, the government will not borrow solely for investment, but also to inject demand into the economy to prevent the recession worsening. The death of Keynesianism has been much exaggerated.

The second point, that the creation of the NEC is an implicit criticism of current policy- making arrangements, cannot have been welcome for the Treasury or Bank of England. Sharing economic policy with ministers who deal with energy, housing and education cuts against the grain of Treasury culture.

There must be increasing anxiety at the Bank that its monetary policy committee will be perceived as fiddling while Rome burns. MPC member Kate Barker said business sentiment in some areas was "cautiously optimistic". Andrew Sentence, another member, said the state of the economy was "very different to major recessions we have previously seen… (when] economic activity fell sharply for one to two years … in my view, the current outlook is for a much milder period of weak economic activity". If so, what is the point of the NEC?

Until now, the majority MPC view seems to have been that in, the medium term, inflation will still be a serious problem. This is starting to look dangerously complacent. Commodity prices, including oil, are heading south. Lack of demand, partly driven by falling house prices, is precipitating price cuts across the retail sector. Wage inflation didn't accelerate in the past ten years when the economy was booming; it is novel to imagine it will increase now. The view that interest rates should be cut on Thursday is supported by employers' organisations, unions and the press. It is certainly supported by homeowners, whose increased mortgage payments have been one of the principal causes of falling demand.

The Chancellor said in times of crisis the Bank should not focus on inflation to the exclusion of all else, but consider the government's "wider economic objectives". Perhaps the MPC does not view the present circumstances as a crisis and should continue to soldier on in "business as usual" mode. The remit of the Bank cautions against keeping inflation at the target rate if external events cause "undesirable volatility in output". There's no indication from MPC minutes that the majority view is we are anywhere near this situation – but we are.

If the MPC is unwilling to act, the Treasury can legally direct the Bank to take monetary policy actions "if they are satisfied that the directions are required in the public interest and by extreme economic circumstances".

With the creation of the NEC, the government is signalling it seeks a more co-ordinated approach. It may not be coincidence that the NEC has been created just as the MPC's stock appears to be on the wane. The MPC's independence may be assured for the time being, but this may be conditional on it taking a broader view of its remit.