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The only policy which has worked
Gordon Brown's only masterpiece
 Just over 300 years since it started operation, the Government granted the Bank of England operational independence in May 1997, allowing it to set domestic interest rates. The Government retains control of the final objective of monetary policy by setting the inflation target within which the Bank must operate when carrying out monetary policy decisions.
Performance by Bank good
The Bank of England's record since independence has been good with inflation remaining close to the target measure of 2.5% (plus or minus 1%). The Governor of the Bank of England has not had to write an open letter to the Chancellor explaining either an inflation over-shoot or an under-shoot.
Gordon Brown's statement
Then
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At the time, George Brown stated that,"Now is the time for long-termism. This is the time to set the British economy on a new long-term course that will deliver high levels of growth and employment through lasting stability. Price stability is, as I have said, an essential precondition for the Government’s objectives of high and sustainable levels of growth and employment. The question is how to achieve the long-term stability that we seek?"
The Monetary Policy Committee's responsibilities
The Bank of England Act 1998 sets out the role and constitution of the Monetary Policy Committee (MPC) which, in relation to monetary policy, the objectives of the Bank of England shall be to maintain price stability (ie continued low inflation), and subject to that, to support the economic policy of the Government, including its objectives for growth and employment.
The Inflation Target
Now
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The inflation target for the MPC to meet was set as a 2.5% annual increase in the retail prices index excluding mortgage interest payments (the RPI(X)). Decisions on what actions need to be taken to achieve the target are taken by the MPC, on the basis of a majority vote. The MPC's main role each month is to make decisions on the base rate of interest, the benchmark for the Central Bank's daily operational of monetary policy in the UK.
Monetary policy in the UK is now much more open and transparent than it was under previous regimes. Minutes of MPC meetings are published within 2 weeks of decisions. The Bank states its latest forecasts for inflation and provides detailed assessment of macroeconomic conditions in the UK and overseas through the publication of a Quarterly Inflation Report.
Winning over the opposition
One of the more remarkable aspects of this policy is that all of Britain's main political parties now accept that the Bank of England should remain independent. At the time of the Act feelings were very mixed. One of the important reasons for political parties accepting this move is related to lessons learned concerning political party risk1 associated with interest rate setting.
The record
The Bank of England's record since independence has been good with inflation remaining close to the target measure. However, in mid-April, 2007, Mervyn King, the Governor of the Bank of England, had to write the first ever letter2 to the Chancellor forewarning of a temporary overshoot of the agreed upper margin for inflation; even perfection has blemishes!
The benefits
The Bank of England's record since independence has been good with inflation remaining close to the target measure. However, the overall good performance has been, in part, due to the sustained strength of the sterling exchange rate, particularly against the Euro since it was launched as a traded currency in January 1999. The Bank of England has also been helped by a very benign global inflation environment. Consumer price inflation in the G7 and OECD countries has been falling over the last ten years. But the overall perception is that the Monetary Policy Committee has demonstrated an ability to agree their decisions free from political influence and in spite of pressure from lobby groups, trade unions and the media prior to each MPC meeting.
Broadly speaking this change in policy has been the only decision by the Labour Government which has proven to be completely successful and this is because it is run in an independent fashion.
Updated 3rd July 2007:
1 with respect to political party risk factors - The Conservative party underwent the experience of the expulsion of the pound from the ERM in 1992, an interest rate rise which resulted in the repossession of some 1 million homes and there was a significant and unnecessary loss in reserves as a result of inappropriate Treasury tactics. These were a significant factors in the Conservatives losing the 1997 election. Amongst others, the essential lesson learned was that there was a significant political risk to political parties remaining in power if there were associated with significant under- or over-shoots in interest rates. Reference: "The Briton's Quest for Freedom", pp. 137-140, HPC, July 2007;
2 with respect to letter from Mervyn King to Gordon Brown, reference: "The Briton's Quest for Freedom", pp. 141, HPC, July 2007.
This article was originally posted in June 2004.
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