Monetary Policy under Labour
Besley, Timothy, Sheedy, Kevin, National Institute Economic Review
This paper analyses Labour's record on monetary policy and the record of the MPC which it created. The paper begins by discussing the conceptual framework and institutions behind inflation targeting as it operates in the UK. We then discuss the successes that it enjoyed up to 2007 and debate the lessons that are being learned as a consequence of the experience since then. We then raise some of the formidable challenges that UK monetary policy must now face up to including maintaining the credibility of the inflation targeting regime in the face of greater interdependence between monetary and fiscal policy, and between monetary policy and support to the banking system and financial markets.
Keywords: Monetary policy; inflation targeting; UK macroeconomic policy
By 2006, monetary policy in the UK was approaching its 'end of history' moment. The arrangements that had evolved to target inflation after 1992, culminating in Bank of England independence and the creation of the Monetary Policy Committee (MPC) in 1997, had not only slain the inflationary dragon but appeared to have delivered wholesale macroeconomic stability. Gordon Brown's claim to have found the ingredients to end boom and bust seemed credible and central bank independence as a means of securing this stood as a proud monument to Labour's economic achievements.
But the more recent global economic chaos has tarnished this record and is now leading to global debates about the proper conduct of monetary policy, in particular the right mandate to give to central banks and the framework that is needed to deliver it. Thus, despite the achievements, a legacy of monetary policy under Labour will be in the form of some unanswered questions.
In this paper, we will go through Labour's record (and the record of the MPC). We will discuss the successes that it enjoyed tip to 2007 and debate the lessons that are being learned as a consequence of the experience since then. The first ten years of Labour saw a remarkable period of stability whether benchmarked against the UK's historical record or against global experience. This was a period that was dubbed the great moderation and much has been written about its causes--good luck, good policy, and structural change being the three main candidates. Throughout this period, inflation remained within 1 per cent of the Government's target and interest rates moved in small steps (typically 25 basis points).
Since late 2008, the story has been quite different. Following the failure of Lehman Brothers, a period of global economic turmoil ensued with the UK experiencing a 6 per cent fall in GDP. This led to a dramatic loosening in monetary policy and, from March 2009, a series of unconventional policy measures frequently referred to as 'quantitative easing'. The cornerstone of this has been purchases of almost 200 [pounds sterling] billion of government debt via the creation of central bank reserves.
We write this paper at a point, therefore, when some of the conventional wisdom on monetary policy is being debated again after a significant period of consensus on its broad goals. Unlike fiscal policy, Labour's record on monetary policy is not an election issue. Indeed, all major political parties in the UK now accept the broad notion that monetary policy is best conducted independently and technocratically. Back in 1997 when the Bank of England was granted independence, it was not greeted with universal acclaim though--it was strongly opposed by the Conservatives (the policy was supported by the Liberal Democrats, who had put forward a proposal to make the Bank independent in their 1992 election manifesto). Conservative opposition to Bank of England independence was finally reversed in 2000. However, the recent financial crisis and subsequent recession have taken the gloss off the current Government's claim to have provided an end to boom and bust, for which independent monetary policy was often given star billing. …