In his first speech as Labour’s shadow chancellor, John McDonnell has stated that the Bank of England should remain independent but that a debate on the Bank’s mandate is necessary. The new shadow chancellor also indirectly suggested that QE for the People should only be used to boost economic activity when aggregate demand is low.
Central Bank Independence
In his speech the new shadow chancellor said that operations of the Bank of England requires democratic scrutiny but that he now fully endorses an independent central bank:
“I want us to stand back and review the major institutions that are charged with managing our economy to check that they are fit for purpose and how they can be made more effective.
“I will also be setting up a review of the Bank of England.
“Let me be clear that we will guarantee the independence of the Bank of England.”
This represents a significant turn around in the new shadow chancellor’s policy position. Roughly three years ago John McDonnell had suggested that he would
“in the first week of a Labour government…[end] the bank’s control over interest rates”
Similarly, just before the previous election he wrote that he was in favour of re-asserting ‘democratic control’ over interest rate setting – implying (correctly) that interest rate setting had served the interests of the banking sector.
Positive Money welcomes a democratic initiative at ensuring the Bank of England is fit for purpose. But we’d also welcome the shadow chancellor’s intent to keep the central bank independent. Some advisors to the ‘Corbyn Camp’ have argued that central bank independence is profoundly anti-democratic.
We disagree with this view for a number of reasons. To begin with, it is the democratically elected government who creates the mandate for the Bank of England. It effectively tells the Bank of England its objectives and what tools it can use to reach those objectives. It is then up to the Bank of England to independently decide how best to use those tools to achieve the target. As Simon Wren Lewis describes,
“In essence all the Bank of England normally does is decide how to change interest rates to hit a target decided by government.”
It is also important to understand how the nature of relationship between the Treasury and Bank of England would change if the latter weren’t independent. It is of course correct that the Bank of England and the Treasury work very closely on a day-to-day basis. However, currently the Bank of England will come up with proposals on how it wants to use the tools at its disposal, and will then get approval from the Treasury. This is a fundamental difference between the Treasury approving things put forward by the Bank of England, opposed to the Treasury telling the Bank of England what to do and how to do it.
People’s QE – Only When Aggregate Demand is Low
By ending central bank independence and previously suggesting that People’s QE could be used as a primary tool to finance infrastructure projects, it initially seemed as if the Corbyn Camp was suggesting that People’s QE could be as means to fund budget deficits when it was politically expedient to do so.
However, in stating “We’ll use active monetary policy to stimulate demand where necessary” shadow chancellor McDonnell seems to be suggesting that a People’s QE type of programme would only be used when aggregate demand is below a desired threshold. Under the Bank of England’s current mandate this implies that People’s QE would only be used when inflation levels are below (or are expected to go below) 2%.
Interestingly, the new shadow chancellor did suggest that the mandate of the Bank of England should be reviewed, so that new indicators for aggregate demand are considered. The shadow chancellor for example stated:
“We will launch a debate on expanding that mandate to include new objectives for its Monetary Policy Committee including growth, employment and earnings.”
This is also a sensible move. There are strong arguments that inflation targeting is ultimately an ineffective policy, and that it would be better to aim for another target.