Two Reforms to Improve the Bank of England

How can the Bank of England up its game? That was the subject of a report released last week by the House of Lords Economic Affairs Committee. Their Lordships certainly did not hold back in their criticism of the Bank’s performance in recent years and set out a number of recommendations for improving its performance. There are too many to discuss in this article, but let’s look at two of them.

One such recommendation was to review hiring practices, especially for members of the Monetary Policy Committee (MPC). The report raises concerns that there is a lack of diversity of thought and background when it comes to appointments to the MPC. This is a fair criticism given that the vast majority of people who have served on the MPC have also at some point worked for HM Treasury. What is more, MPC members – if they haven’t worked at the Treasury –  tend to either have worked for the Bank of England, an investment bank, or in academia. 

This obviously does tend to lead to a form of group think. However, the report really isn’t clear on how this could change. The main criteria for a role on the MPC must surely be an expertise in economics and an understanding of the financial system. As such, there is a limited pool from which to choose from. 

Rather than obsessing over the background of the MPC members, it would probably make more sense to ensure that the MPC creates an environment for healthy debate and disagreement.  Under the current model five of the MPC members work for the Bank of England while four are external members. Given that one member is the Governor and the other four are technically his employees, this does risk a potential conflict of interest as it can be awkward to disagree publicly with one’s boss. We could end this by expanding the size of the MPC by increasing the number of external members. Doing so would ensure that there is more debate and where conventional and institutional wisdom is challenged and so improve decision making.

The Committee also raised concerns over what it saw as the Bank’s expanding remit. While it was right to suggest that the main focus of the Bank should be monetary policy, it missed a trick by not recommending a more radical reform of its remit. 

The current remit of the Bank of England is to maintain inflation at two per cent. Recent history notwithstanding, the Bank has done a good job at meeting its remit over the past 25 years. However, such a strict target is incredibly tricky for central bankers to meet given the blunt tools of monetary policy at their disposal. We are now seeing inflation slowly return to target due to the Bank’s restrictive monetary policy but this has come at great expense. Hiking interest rates has suppressed demand and made things harder for firms. This has tamed inflation but it has restricted economic growth and will likely lead to a recession at some point in the near future.

Rather than a narrow focus on inflation, the Bank's remit should change. Inflation targeting should be replaced by nominal GDP targeting. This would mean that the MPC stops targeting price rises and instead focuses on the amount of nominal spending in the economy. Such an approach would be a radical change but would provide greater stability and help to create sustainable economic growth. 

The work of the Bank of England is important as its decisions impact us all. As such, the House of Lords is right to raise concerns and make suggestions on how to improve things. The most effective way to do this will be to increase the number of outside and independent decision makers on the MPC and introduce nominal GDP targeting.

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Ben