Should the Bank of England Be Independent?
Blake, Andrew P., Westaway, Peter F., National Institute Economic Review
This note examines the question of whether the responsibility for the operation of monetary policy in the UK should be ceded to an independent Bank of England. While sterling was committed to membership of the European Monetary System, this issue was pre-empted since monetary policy was effectively determined by the actions of the Bundesbank. Now, with the UK's withdrawal from the EMS and no immediate prospect of any return, the question has again returned to the policy agenda. In fact, the arguments used to justify such a delegation of responsibility are closely related to those originally associated with the decision to join the EMS itself; that monetary policy should be controlled by an authority with a strong aversion to inflation and a reputation for sticking to its announced policy. It has been argued that an independent Bank of England would offer precisely these advantages without compromising the domestic (ie UK) objectives which were overridden by the Bundesbank.
It is important to recognise, however, that an independent Bank of England may no more offer a panacea for the UK economy's shortcomings than did membership of the EMS. Nor would such a policy arrangement imply that policymakers either in the Bank or the Treasury could be indifferent to the monetary stance in the rest of Europe. So if such an institutional change is to be contemplated, it is crucial to be able to identify the circumstances under which delegation of policy would be beneficial. To do this, it is necessary to conduct a rather more rigorous examination of the policy problem than is conventionally carried out in general discussion. This must be done by analysing macroeconomic policy choices in the context of dynamic game theory which allows us to investigate how the instruments of monetary and fiscal policy should be set with respect to the particular objectives of the relevant authorities, who must take into account the current and future actions of each other and private sector agents. Only then can we analyse the circumstances in which it is advisable for the UK government to surrender its monetary policy instruments to an independent Bank of England.
We argue that it is necessary to acknowledge three crucial but logically distinct aspects to the policy question. Firstly, what should the objectives of the Bank be compared to those pursued by the government itself? This question is especially relevant if the government has some prior control over the central bank's constitutional requirements or, as in the UK context, is able to appoint its Governor. Importantly, there are circumstances where, even in a democratic society, it may be desirable to surrender monetary policy to an institution with more 'conservative' preferences than the elected government. This occurs because the 'inflationary bias' implied by the optimal monetary stance will be lower with a more conservative decision maker although this can only be achieved at the cost of a reduced responsiveness to unexpected shocks to output. Secondly, what is the ability of the Bank to pre-commit itself to its policy announcements compared to the government itself? If the policy intentions of the monetary authority are credible in the sense that the private sector believe their policy announcements will be adhered to, then this would be sufficient to remove the inflationary bias. This puts a premium on policymakers having a reputation for keeping their word. Thirdly, it is necessary to know the relationship between the fiscal authorities (which we assume to remain within the control of the elected government) and the Bank in its role as monetary policymaker; Is co-operation necessary for the delegation of authority to be beneficial or can the Bank be completely independent to follow its objectives? All three of these interrelated aspects will be clarified in the next two sections.
Ultimately, of course, the relative importance of these factors can only be determined by empirically based work. …