Peter Jones: Who should wield most power over your pound?

Published on 20/02/2011 17:40

The time is fast approaching when we must decide if central bankers should pursue their policies free from, or under, political control

TOP politicians have been bickering over Mervyn King, governor of the Bank of England. The shadow chancellor, Ed Balls, has criticised Mr King for tying himself too closely to the coalition government's plans for cutting public spending, and George Osborne, the Chancellor, has predictably responded by declaring his complete confidence in Mr King. This, I think, is more than a little political spat; it is one of many signs that the role of central Banker is becoming heavily politicised.

At the heart of the row is a big question: who now wields more power over the economy - George Osborne or Mervyn King? The Chancellor, with the power to raise or cut taxes and public spending, with all that implies for jobs and the pounds in everyone's pockets, surely does. But then, the Bank's governor and his power to raise or lower interest rates, or to create billions of pounds out of thin air, also affects jobs and the pounds everyone has to spend.

Just last week, Mr King explained the Bank's latest thinking on inflation. His remarks were widely seen to mean that interest rates will rise, probably in May. Mortgage lenders immediately hardened prices of their loans, and companies are probably experiencing the same effect. That means a rise in household and business costs, affecting consumer spending power and business profitability, with knock-on effects on the economic recovery. If that isn't power, I don't know what is.

Mr King would, I think, have two objections to this analysis. First, that his power over interest rates is actually limited. Rates are decided by the Bank's monetary policy committee, which can out-vote the governor. Nonetheless, the events of last week also showed that Mr King, even though he denied this was his intention, has gone a long way towards nudging forward the likelihood of a vote for a rates rise.

A second objection would be that his policy tool kit is extremely limited compared to that of the Treasury. Viewed simplistically, this is true; the Bank's main policy aim is to keep inflation under control and it has only one tool - interest rates - to achieve that. But the financial crisis has brought an old implement out of the cupboard - loosening controls on the money supply. This has been used in support of what has now become a policy aim which is more important than controlling inflation - keeping the economy moving forward.

This re-discovered tool, known as quantitative easing, has pumped money into the economy by buying government bonds from Banks and pension funds, giving them cash which Banks can use to increase mortgage and business lending and pension funds to buy company shares.In Britain, the policy aim is to make sure business has the finance it needs to expand and keep the economy growing. In Europe, the aim has been to restore faith in weak economies, such as Greece, and stop weak government's bonds from rocketing in price. Over in America, Ben Bernanke, the US Federal Reserve chairman, has said the aim is to keep share prices rising, thus making consumers feel confident and still spending money, keeping the US economy going.

The differing means to the same end tells you a basic truth about quantitative easing: while its practitioners say it ought to have positive economic effects, nobody knows for sure how it will work or what the effects will be, including on inflation. Theory says that inflation will rise, but the current increase seems to have more to do with rising food and fuel prices, both of which should be unaffected by quantitative easing.

Into this highly uncertain central Banking arena is being added the return of Banking supervision from the Financial Services Authority (FSA) to Mr King's remit. Although the government has announced the formation of a joint Bank/FSA committee, with some independent members to oversee a year-long transition to the new regime, how the Bank will operate these functions is also uncertain.

If the Bank decides, for example, that it is prudent for the long-term stability of the financial system to increase the amount of core capital that commercial Banks must hold, will it be able to do that independently, or must it seek political approval? The question matters politically, for the consequence of such a decision would be to reduce Banks' capacity to lend which will raise inevitable howls of protest and the bending of political ears.

Thus it seems inevitable that the Bank's governor will become seen as a highly political person. You can already see the effects of this at the European Central Bank (ECB). Axel Weber announced he would quit as president of Germany's central Bank, so ruling himself out as the next president of the ECB, a post for which he was seen as a near-certain shoo-in.

Why? Because he was opposed to the ECB's eurozone bond-buying programme, seeing it as too much interference in fiscal policies which should, he thinks, be dealt with by governments. His argument, presumably, is that the ECB allowed governments off the tax-raising and spending-cutting hook on which they should be impaled, prolonging resolution of the eurozone's sovereign debt problems.

All this implies, at the very least, a messy blurring of the lines which emerged in the late 1990s, to general approval, that politicians should stay out of monetary policy in order to ensure central Banks were unhampered by political interference in their job of keeping inflation low and the currency stable.One rationalisation of these developments is that a division of responsibility is emerging - central Banks are best suited to ensuring long-term economic and monetary stability, while politicians, whose time scales are shortened by elections, can look after the short term.

But that won't prevent conflict between central Bankers and politicians, especially when long- and short-term goals and policies do not match. The only thing that can be said with any certainty is that central bankers now occupy a more important role in shaping the course of the developed world's economy than perhaps has ever been the case. The question that now needs answering is whether they should do that free from, or under, political control.