Did New Labour’s gamble pay off? As the Bank of England celebrates 25 years of independence, it is facing one of its toughest challenges to date
Four days after Tony Blair swept into Number 10 in 1997 his comrade and rival Gordon Brown staged his own event at Her Majesty’s Treasury.
Economic journalists (including this writer) were summoned to the grand Churchill Room.
To the astonishment of all present, Chancellor Brown put an end to the ‘Ken and Eddie’ show – the cosy meeting between his Tory predecessor, Ken Clarke, and Bank of England Governor, the late Eddie George.
Taking centre stage: The Bank Of England was given operational independence to set interest rates four days after Tony Blair was made prime minister in 1997
He was granting the Bank operational independence to set interest rates. In so doing he removed it from the political arena and aligned practice with that at the Federal Reserve in Washington and the Bundesbank in Germany.
After the momentous announcement, Ed Balls, his then senior economic adviser, now better known for his dancing prowess, took me and others aside and explained that the ultimate objective was for the Bank of England to develop into a monetary and economic institution with a reputation matching that of the inflation-intolerant Bundesbank.
As emerged a few hours later, so determined was New Labour that the newly independent Bank would not be distracted from its mission of calming price rises that its role as the regulator of the banks and the City of London was hived off to a new institution.
It was a decision which almost forced George’s resignation.
A quarter of a century on this week, the big central banks are in a very different place.
Under its current Governor, Andrew Bailey, the Bank of England is seen as having lost sight of its core mission of controlling inflation, with forecasters projecting double-digit price increases this year.
The Bundesbank no longer acts as the bulwark against German inflation, a task sub-let to the European Central Bank (ECB).
This has had damaging consequences in a country where the hyper-inflation of the Weimar Republic in the 1920s is etched in the memory.
In the US, the Federal Reserve, under the current chairman Jay Powell, is seen as having lost the plot by pursuing growth and full employment at the expense of letting inflation spiral out of control.
Under its current Governor, Andrew Bailey (pictured), the Bank of England is seen as having lost sight of its core mission of controlling inflation
Going back four decades – after inflation soared into double digits across much of the developed world – central banks and economic decision makers, led by the Federal Reserve chairman Paul Volcker, were spurred into action.
With politicians fearful of upsetting voters, the bankers moved to centre stage.
Using monetary tools advocated by the Chicago school of economists, led by Milton Friedman, they were able to crush the over-supply of cash to economies.
The result was that the average rate of inflation in the US, Britain, Germany and Japan, which reached 8 per cent in the 1970s (peaking at 25 per cent in the UK), was brought down.
In the years from 1990 to 2007 it averaged 2.1 per cent and only rarely since has it strayed above the 2 per cent target adopted by most of the central banks.
Before Covid arrived in 2020, the big debate in Western chanceries was whether the world was heading into a period of deflation, and should central banks adopt negative interest rates so as to penalise commercial banks which declined to lend.
Stagnation across the eurozone, following the Greek debt implosion and pressure on the whole eurozone, led the Frankfurt-based ECB into this territory.
In early 2021 Bailey wrote to the commercial banks asking them how negative rates might affect their businesses.
Steady Eddie: The late Eddie George (inset) was Bank of England Governor for 10 years between 1993 and 2003
The skill with which central bankers controlled inflation through most of this century turned them into global celebrities.
Former Fed chairman Alan Greenspan was worshipped by financial markets and politicians alike for his brilliant reading of the data and ability to steer the US economy through the difficulties posed by inflation while not smothering unemployment.
Mark Carney was regarded as such a star for guiding Canada through the financial crisis of 2007-09, without serious hiccup, that an impressionable British Chancellor, George Osborne, persuaded him to take over the Bank of England.
When Mario Draghi’s term at the ECB expired, he was drafted in to save Italy from economic and political disaster.
And the French managing director of the International Monetary Fund (IMF), Christine Lagarde, could not resist a power base at the ECB.
So how did it all go wrong?
During and after the financial crisis, central bankers discovered all kinds of new tools and were given ever more responsibilities by their political masters.
At the ECB, Draghi’s determination to do whatever it takes to save the euro meant that the Bundesbank’s restraining influence was overridden.
In the US, the historical responsibility of the Fed for lowering unemployment led to interest rates being cut to the quick.
The US central bank pumped trillions of dollars into the financial system through a bond buying programme.
Power grab: French managing director of the International Monetary Fund, Christine Lagarde (pictured), could not resist a power base at the ECB
Here in the UK, financial stability, one of the Bank of England’s primary roles, edged inflation concerns as the main worry.
When Covid changed the world in March 2020 the new Governor, Bailey, found himself slashing interest rates to 0.1 per cent, the lowest levels in the Bank’s history.
The volume of quantitative easing (QE) was eventually pumped up to £875billion, causing a monetary explosion. Instead of all the cash going into the real economy of goods and jobs, much of it, on both sides of the Atlantic, ended up in financial assets.
The tech boom over-inflated floats of firms such as The Hut Group, and the surge in the price of bitcoin.
Phenomena such as ‘free’ stockbroking at Robin Hood were consequences of over-exuberance.
So focused were central bankers on saving people, firms and economies from Covid that inflation – becalmed for so long – became a secondary consideration.
When the former Bank of England chief economist, Andrew Haldane, shared with this paper the view that the inflation genie was out of the jar in May 2021, Bailey chose to ignore his caution.
Instead, as price pressures built over the summer and autumn last year, the cry went up that the surges were ‘transitory’.
There appeared to be no grasp of the fact that supply chains had been permanently disrupted, that recovery would place huge pressure on limited energy markets and that the unprecedented long period of low interest rates and a monetary splurge would spark persistent inflation. Central banks are now playing catch-up.
This might not have mattered so much had the Russian war on Ukraine not come along.
But the ‘crisis on crisis’, as the IMF called it last month, has turned something temporary into a persistent condition.
The pressure on energy prices has been exacerbated and food costs are soaring across the globe as grain and fertiliser shortages emerge.
The Bank of England is desperately catching up with events and is forecast to take the first steps this week towards selling back to the market the £875billion of bonds it bought through its QE programme. This will empty cash from the financial system.
A further hefty rise in its official bank rate from 0.75 per cent to perhaps 1.25 per cent is anticipated.
Across the water, the Federal Reserve is engaged in a rearguard action, which could eventually see American rates rise from the current 0.25 per cent to 0.5 per cent range to 2.75 per cent or even higher.
The die has been cast and the central bankers have been made to look like chumps. By becoming more political and obsessed with growth, climate change and much else they have endangered treasured independence.