Home page The reason the Bank of England was made independent Recent comments by Tony Blair on the issue of who thought about giving independence to the Bank of England fails to admit what the real motivation was. This is spelt out quite clearly in Chapter 15, "The Economy & Policy Initiatives" in "The Briton's Quest for Freedom - Our unfinished journey"1 . With the permission of the publishers we reproduce some of the salient points. "Economic Management Lessons" "During the last 15 years, the Treasury has undergone a significant change from a comprehensive organization dealing with the macro-economy to one largely concerned with micro-economic aspects of revenue raising and intervention through policy. This change can be traced back to Black Wednesday. ... On 16 September 1992 the Conservative government was forced to withdraw the Pound from the European Exchange Rate Mechanism (ERM) as a result of pressure from currency speculators. The most notable speculator was George Soros who is reported to have profited to the extent of around US$1 billion from his financial dealings around this event. This event became known as Black Wednesday. Black Wednesday did not just affect Britain, the Italian lira also left the ERM and the Spanish peseta was able to remain only as a result of a drastic devaluation. The ERM was supposed to be a means to help stabilize exchange rates, encourage trade within Europe and help control inflation." "Accordingly the inappropriateness of policy and decision-making surrounding exchange rates of the Pound within the European Exchange Rate Mechanism (ERM) was exposed with the Pound leaving the ERM. In 1997, the Treasury estimated that the cost of Black Wednesday was a loss of around £3.4 billion in reserves. The wrong decisions were taken as a result of ignoring some of the tactical options available to the Treasury to sustain the value of currency holdings. If the government had maintained adequate foreign currency reserves and the pound had fallen by the same amount, the UK would have made a £2.4bn profit on Sterling's devaluation." "The image and confidence of the Treasury was undermined by this episode since it demonstrated that the Treasury did not have an adequate grasp of macroeconomic realities. Somewhat like the past experience with Keynesianism and stop-go in the 1970s, this raised doubts concerning the inherent stability of political decision-making on monetary issues. The experience with the ERM emphasized the difficulty of governments managing fiscal affairs, exchange rates and monetary policy (interest rates) within a system serving many different European economies at different stages of economic development, or at different stages in their economic cycles. Indeed, the system implicitly assumes that all member countries accept that some will be forced to operate at less than their potential and would be required to undertake interest rate and fiscal (taxation) adjustments." "Stop-go" "The ERM debacle was not the first major demonstration of the incompetence of the lack of expertise and economic management capacity on the part of British political parties. Conservative and Labour governments had been consistent in their failure to exert a sufficiently refined control over the economy through policy interventions. In the post-1945 period this was largely the outcome of the use of crude and simplistic policy instruments such as interest rates, taxation and government spending as the main "governors" of the economy. In short, post-1945 policies, largely based on Keynesianism (tax and government expenditure) and subsequently Monetarism (interest rates) created too much instability . This instability was generally referred to as the evil of stop-go policies." "Interest rate debacle" "Following the UK's expulsion from the ERM, interest rates were raised and there was a mild economic decline. The result was that around one million householders who could not pay their mortgages suffered home repossession and there was a significant rise in unemployment. In spite of a sound economic recovery, the Conservative party, because of the Black Wednesday and this interest rate-related repossession debacle, lost much of its image as a competent manager of the economy. This was a contributing factor to the Conservatives losing their control of governance in the 1997 election." "Strategic lessons in political risk" "The example of the expulsion of the British pound from the ERM and the social impacts of the necessity of raising interest rates to bring the economy back on course served as a chilling warning to the Labour party. The power strategy2 was after all to gain and remain in power. They recognized the very damaging political impact the Conservative party had suffered as a result of the house repossession debacle caused by a rise in interest rates. Labour also appreciated how both of these events had helped them win the 1997 election." "The significant strategic lesson was that the setting of interest rates by government political parties represented a significant political risk of exposure as a result of any possible damaging over- or under-shoots. Finding ways and means of stabilizing the basis of economic management and distancing political parties from any inherent management risks became the first priority of all parties and not just Labour. No one wanted to be identified with financial mismanagement since this determined their ability to hold on to power." "The logic" One of the popular themes of discussion in economic circles and a favourite question in economics courses in UK universities during the 1960s used to be, "Explain the advantages and disadvantages of passing the responsibility for setting base interest rates from government to the Bank of England." The answer according to the students who got the higher marks, and academics in general, has always been that interest rates should be managed independently by the Bank of England to remove the political vector from of the decision and thereby achieve a more stable economic environment." "No more stop-go" "It was therefore no surprise that this was the first thing Gordon Brown did as Chancellor when Labour won the 1997 election. In May 1997, the Government granted the Bank of England, just over 300 years since it started operations, the independence to set domestic interest rates. The Government retained control of the final objective of monetary policy, setting the inflation target, within which the Bank must operate when carrying out monetary policy decisions. The Bank of England Act 1998 set out the role and constitution of the Monetary Policy Committee (MPC) which in relation to monetary policy should aim to maintain price stability (sustain low inflation) and, on this basis, support Government economic policy including its objectives for growth and employment." 1 "The Briton's Quest for Freedom - Our unfinished journey.", McNeill, H.W., Hambrook Publishing Company, July 2007, ISBN: 978-0-907833-01-7 2 The power strategy was a specific set of tactics whereby the Labour Party set out to secure power. The objectives were established through a collaboration between Neil Kinnock and The New Marxists. This is described in the "The Briton's Quest for Freedom" recounting how after two electoral failures The New Marxists' strategies and tactics were shown to be more successful in Central Europe in the 1990s where power, to this day, has remains largely in the hands of the ex-Communist party operators. The power strategy became the basis for the 1997 election victory of the Labour party. Posted: 17th November, 2007. Updated: 19th November, 2007.