How Rachel Reeves should reform her old employer: the Bank of England

Unlock the Editor’s Digest for free

The writer is a former professor of economics and senior adviser at the Bank of England

Most of the discussion of chancellor Rachel Reeves has been around what she will do to taxes and spending. But recalling that she is — as she has sometimes reminded us — a former Bank of England economist, it’s natural to wonder whether she might also be up for reforming her old employer and the monetary framework in which it operates.

Very little has changed since the last Labour government made the BoE independent and the time is surely ripe for a rethink. If I were one of the new special advisers in the Treasury, I’d be hitting send on my list of reforms round about now, before too much is invested in the status quo again. That list would look something like this.

First, an independent review of the level of the inflation target, to be repeated every 5-10 years. The lesson we have learnt since 2 per cent was adopted is that the potential need for interest rate cuts is much larger than we thought.

The lower the target, the lower the average level of central bank rates, and the less room there is to cut (they can’t go much below zero). There are risks to changing the goalposts. There will be some price to pay in terms of inflation uncertainty. But these, I think, will be more than worth it.

Second, the bank mandate should be changed so it more explicitly recognises the parity between stabilising inflation and the real economy following the US Federal Reserve’s so-called dual mandate. The current legislation, and the way it is interpreted by the Treasury, just about gives enough leeway for the Monetary Policy Committee to operate as though it had a dual mandate. But equally, it gives them discretion not to do so as the make-up of the committee and its circumstances evolve.

Third, the mandate needs to make clear that when interest rates hit their floor, or look certain to do so, the BoE should be encouraged to solicit help from fiscal policy to stimulate the economy. This advice the Treasury should be free to ignore or modify. If it chooses to act, the Office for Budget Responsibility would comment on the stimulus plan and its planned unwinding for consistency with long-term sustainability. This would reduce reliance on quantitative easing and help to depoliticise fiscal policy during a big recession.

Fourth, some reforms to the make-up of the MPC. There are currently five internal BoE appointments, and four external. There should be more externals appointed, so they can, if necessary, outvote the internals. Junior internals — executive directors — have a natural tendency to avoid conflict with the senior internals — the governor and deputy governors — who have a say in their reappointment or promotion and resourcing of their functions. These things constrain dissent.

The job of the external is to be independent of both the Treasury and the bank, and to disagree and be difficult. Also, the rules should be changed so we cannot have a repeat of appointments such as those of Sir David Ramsden and Clare Lombardelli straight from (or in the case of Lombardelli, not long after) their senior Treasury jobs to the BoE. This undermines central bank independence.

Treasury officials should not feel they have to curry favour with the current BoE governor, who would have a say in their move, and bank officials should not have to worry that Treasury officials they upset in defence of independent lines of work and thinking at the BoE might soon be their bosses.

Some have argued that Reeves should instruct the BoE to stop paying interest on central bank reserves, to ease the government’s fiscal position. I would advise her not to do that, and to let the bank decide these details of monetary policy operations. The chancellor can impose a tax on bank profits if it needs the money. Taxing profits in an uncompetitive banking market is better than taxing liquidity, and explicitly taxing banks in this way would probably be well-received.

A final suggestion is a name change to “Central Bank of the UK”. The Bank of England is an anachronism, dating back to before the 1707 Act of Union when there were no scruples about snubbing Wales. This name would be more logical, since the BoE is the central bank of the UK. And it would send a signal that it is supposed to serve all citizens in an era when the union faces stresses and strains and there is a common supposition that things are done to the benefit of the centre in Westminster.