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Britain s central bank is about to become even more powerful. Its new boss will
find it harder to run
Sep 1st 2012 | from the print edition
EVEN following decades of show-off modern architecture in London s financial
district, the Bank of England s headquarters in Threadneedle Street remains one
of the City s most imposing structures. It sits behind a huge neoclassical
wall, dating from an era when anti-capitalist riots were a serious matter. An
immense vault lies underground.
Yet the edifice is not nearly big enough to house all the staff needed to carry
out the bank s remit, which is being greatly expanded by legislation making its
way through Parliament. Around next April, the Old Lady of Threadneedle Street
is expected to resume the role of supervising commercial banks that it lost
in 1997. A thousand or so staff will be transferred from the defunct Financial
Services Authority (FSA) to a new body, the Prudential Regulation Authority,
under the central bank s auspices. They will move into 20 Moorgate, a building
recently vacated by Cazenove, an investment bank bought by JPMorgan Chase.
The Bank of England s headquarters will continue to house its monetary-analysis
wing, which provides the brainpower and number-crunching that informs the
decisions of the nine-strong monetary-policy committee. Set up by the previous
Labour government, the committee uses its power over interest rates and the
purchase of government bonds (so-called quantitative easing ) to hit its
mandated target of 2% inflation.
The central bank s other wing, which looks after financial stability, fell into
neglect until it was revived by the global crisis. The bank is to be granted
new powers, such as varying over the business cycle the amount of capital banks
must hold as a buffer, in order to preserve the financial system from another
blow-up. The Bank of England s overall reach will be enormous. An institution
that watched a credit boom develop and was caught flat-footed in the early
weeks of the financial crisis is being rewarded with an expansion of its
powers. Can it handle them?
Too big to nail
The bank s three main divisions will each have its own boss with the rank of
deputy governor, as well as a policy committee, or board, composed of a mixture
of senior bank executives and outsiders. Managing the strains that will
inevitably develop between them and keeping tabs on all the bank s many goals
will ask a lot of the governor. A successor to Sir Mervyn King, who stands down
next June after serving two five-year terms in the top job, is likely to be
decided before the end of the year. The job will soon be advertised. The joke
is that only superheroes need apply.
Even the most gifted leader needs a staff with the right mix of skills. One
concern is that the bank has lost too much of the tacit knowledge of the
workings of the financial-services industry needed to be a good all-round
regulator. When the bank took over interest-rate policy from the Treasury in
1997, it gave up its role as manager of public debt as well as its job
supervising banks. That reduced the contact between bank staff and the City.
And the primacy of the inflation mandate diminished the status of the bank s
financial-stability wing. Ambitious youngsters steered clear; some experienced
staff left. When crisis struck, the bank was stuffed with smart economists but
short of folk with a feel for finance. It will take time to restore the
balance.
A bigger worry now is that the proliferation of committees will lead to
internal strife. What if, to halt a credit boom, the bank s new
financial-policy committee (FPC) decided to increase the sum banks must set
aside against unexpected losses on home loans? Such action, if effective, would
also slow the economy and might cause inflation to undershoot its target. The
monetary-policy committee (MPC) ought then to cut interest rates. But that
would stoke the demand for credit that its sister committee was trying to
curtail in the interests of financial stability.
It would be better to merge the two committees into one, say some economists,
including Sushil Wadhwani, a hedge-fund manager who sat on the MPC until 2002.
That way, when the two priorities come into conflict, the same group of people
would be forced to decide the best trade-off between them. A single body might
also find that an increase in interest rates is a more reliable way of
preserving financial stability than the newfangled tools that will be at the
FPC s disposal. Academic estimates of the effect on GDP of varying capital
requirements differ by a factor of ten, Mr Wadhwani pointed out to a
parliamentary committee recently.
Others believe the FPC s role is largely redundant, as long as banks are forced
to hold lots of capital and the payments system is ring-fenced should they
fail. But the big, indeed clinching, argument for a separate body overseeing
financial stability is that the cause might otherwise slip. Dangerous
imbalances can build slowly in a financial system, in ways that may not be
obvious to a group of economists whose main focus each month is whether the
monetary-policy setting is too hot or cold to hit an inflation target. And
banks are not the only source of potential trouble: AIG, a big American
insurer, had to be bailed out shortly after the collapse of Lehman Brothers in
September 2008. There is merit in having a committee charged with worrying
solely about financial stability.
Most of the time the FPC and MPC will be leaning in the same direction: credit
booms that threaten financial stability will also tend to add to the pressure
on inflation. But there is probably no institutional set-up which would make
the goals of stable inflation and stable finance compatible at all times.
Inflation is a well-understood goal and, with luck, today s monetary-policy
choices might hope to affect it within two years. By contrast, it is hard to
know how much weight to give in such decisions to the remote chance of a
financial meltdown. The two committees will have to slug it out. It may then be
up to the bank s governor to divine and explain the balance struck between the
two. Better, though, to have such conflicts aired than for financial stability
to be ignored altogether.
Outside the loop
Perhaps the greatest concern about the new arrangements is that they will
strengthen the hand of an already mighty governor and his deputies. One
potential source of power is the informational advantages the bank s executives
have over the external members of its policy committees, who are not permanent
staff. The external members are there in part for their expertise but also as a
check on the bank s institutional might and the tendency of its staff to adhere
to particular shibboleths (such as the notion that financial markets are always
efficient) that can lead to costly errors in policymaking. Critics point to the
fact that the governor and his deputies will sit on all the important
committees. Perfect if you want to pursue a policy of divide and rule , says a
former staffer.
For such critics, the way the bank s funding for lending scheme was announced
in June is an example of how the bank s insiders rule the roost. The scheme,
which was hatched by senior bank staff in co-operation with the Treasury, gives
commercial banks access to cheap money for up to four years. The cost of funds
is lowest for banks that sustain their lending to businesses and householders.
If it is effective, the scheme will boost spending and add to inflationary
pressures. But the four external members of the MPC did not decide on its
features or vote on how big it should be. If the scheme is viewed as a way to
provide liquidity to banks in an emergency, it is not strictly the MPC s
business. But not everybody sees it that way. There is a case that the MPC
ought to be sovereign over such a scheme since it, at least in part, relies on
monetary-policy tools and influences aggregate demand.
It s personal
Much of the concern about the bank s powers and the need to keep its executives
in check revolves around the present governor, a sharp intellect who can be
disdainful of those who do not share his rigour or see things as he does. Sir
Mervyn has a gift for rubbing external MPC members up the wrong way. Mr
Wadhwani challenged him on the issue of research support for external experts,
and won. Another former member, David Blanchflower, called him a cruel tyrant
. Adam Posen, who stepped down from the MPC in August, has complained about
the narrow definition of monetary policy the bank adheres to. The purist
approach he grumbled about is a hallmark of Sir Mervyn s.
His successor may prove more flexible, or at least more diplomatic. If the new
arrangements are to work harmoniously, each committee will have to be gently
dissuaded by the governor from attempting to do the job of another.
The bank s next boss will also have to ensure that information flows freely
between the bank s three wings, as well as from bank insiders to experts. The
external members of the MPC and FPC will be free to attend each others
pre-meeting briefings given by the bank s analysts. Spencer Dale, the bank s
chief economist, is said to be scrupulous in ensuring that external MPC members
get the same access to information as insiders. It should be possible to keep
the financial-policy externals in the loop, too, even though their committee
meets less frequently.
There is a reason the Bank of England has been granted so much power.
Technocrats are thought to do a better job of ensuring financial and price
stability than politicians, because their decisions are not distorted by the
pressure to win elections. Hiving off bank supervision to the FSA in 1997
contributed to the regulatory laxity that allowed financial troubles to build
up. Having handed back those powers to the bank, and added some more,
politicians must hold it to account through regular parliamentary hearings and
appoint top-class experts as external members of its committees. Sir Mervyn
gave a parliamentary committee this response to concerns about the bank s
growing clout: If you feel that these decisions are better taken by the
elected government, then you should take the power back from us.
from the print edition | Britain