§ 7.16 p.m.
§ Lord Ezra rose to ask Her Majesty's Government whether they consider that additional responsibility should be given to the Bank of England to assist in securing long-term price stability.
§ The noble Lord said: My Lords, I start by thanking those noble Lords who have stayed until this late hour to debate this Unstarred Question. They are a small but highly qualified group.
§ I have put down this Question for debate because of the continuing importance of the issue of inflation and the need to reassess the long-term approach to it, particularly following sterling's withdrawal from the exchange rate mechanism. Membership of the ERM introduced for the first time an institutional element into the policy for dealing with inflation. Now that that has gone, perhaps for some time, it seems to me to be desirable to consider what alternative institutional means can be developed.
§ Before doing so, however, I think it would be helpful to put Britain's recent experiences with inflation into historical perspective. The Governor of the Bank of England referred to this in his important speech to the London School of Economics on 11th November. He showed that persistent inflation is a relatively modern phenomenon. From the mid-13th century until the start of the 20th century the value of the currency had been relatively stable, with the exception of a period of inflation in Tudor times and at the end of the 18th century, at the time of the Napoleonic wars. However, even in those two cases, the increase in inflation had been relatively slight compared with what has occurred in the present century. An analysis of inflationary trends in this century shows that the period of greatest price instability was concentrated in the 1970s and the 1980s. In the 1970s, price inflation reached a peak of 24 per cent. in 1975. It was subsequently brought back to 8 per cent. in 1978 by actions taken by the Labour Government on wages and on public spending. The peak of inflation in the subsequent decade was reached in 1980, largely as a result of the increase in VAT. By 1986 inflation fell to 4 per cent. but rose again to almost 11 per cent. in 1990. This was followed, as we know, by severe monetary tightening with interest rates going up to 15 per cent. Since then, and helped by entry into the ERM in October 1990, inflation has been brought down to the most recently announced figure of 3 per cent.627
§ So, the experience of the past 20 years, during which inflationary pressures have been the most intense in our recorded history, has shown that governments have tended to act after high inflationary levels were reached and then brought the level down again. While this may have appeared to indicate some success of government policies, it has also had the effect of substantially destabilising the economy and accentuating the succession of booms and recessions to which we have become more prone in Britain than in other Western countries. To avoid this going on into the future, it seems essential that some longer-term system for securing price stability should be devised.
§ In this connection, it is instructive to consider what has been going on in other Western countries. Let me start with Europe and then move to some countries outside Europe. The role of the German Bundesbank is well known. It has the primary responsibility by law to safeguard the currency by regulating the supply of money and credit in the economy. Its main weapon for doing so is the level of interest rates. It is perhaps less well known that a number of other European central banks also have a major responsibility for ensuring price stability in their respective countries. For example, the independence of the Banca d'Italia has significantly increased over the past decade. It now has statutory authority to set the official rates on discounts and advances, and a Bill currently before the Italian Parliament would eliminate its remaining links with the Treasury. In the Netherlands price stability is the primary policy objective of the central hank. It has considerable operational autonomy, although in the last resort responsibility lies with the Finance Minister. He may give directions to the bank but so far has not done so. In Austria the central bank has the formal responsibility of maintaining both the internal and the external value of the currency. This responsibility was introduced with the National Bank Act 1955. In Switzerland the National Bank has the responsibility for monetary policy including the setting of interest rates. In France the central bank has formal responsibility for the regulation of credit and operational monetary policy, although it, too, like some other countries, is subject to directions from the Ministry of Finance.
§ Moving outside Europe the responsibility of the Federal Reserve of the United States is as well known as the role of the Bundesbank. But the role of the Bank of Canada is perhaps less well known. It has the responsibility for carrying out policy to achieve inflation targets agreed with the Minister of Finance. In New Zealand the Reserve Bank was given independence in 1989 in the formulation and implementation of monetary policy. Inflation targets are set by agreement between the Minister of Finance and the Governor of the Reserve Bank and currently are set at between 0 and 2 per cent. by 1993. The Reserve Bank is accountable for its performance to Parliament and publishes a six-monthly monetary policy statement. The Finance Minister has the right to sack the Governor for non-performance. So far he has performed.
§ It seems to me that, in the light of this review of 628 what has been happening in a number of leading Western countries, the time has come to re-examine the role of the Bank of England in helping to achieve price stability. Some steps have, indeed, already been taken in this direction. In the Mansion House speeches of the Chancellor and the Governor delivered on 29th October 1992 explicit targets for inflation were set with the objective of achieving less than 2 per cent. over the longer term, and a move was taken towards more institutional and open procedures for achieving this objective. Regular monthly meetings are to be held between the Chancellor and the Governor starting this month, and the monthly report which would be considered at that meeting would be published. The first such report has already been issued. Whenever a change of interest rates takes place the authorities would set out an account of the reasoning behind it. This was done on the occasion of the last two changes in interest rates. Furthermore, the Bank would produce a regular quarterly report on inflation which would analyse inflationary trends and pressures in the recent past and would take account of likely future developments.
§ These are important steps forward. But I believe that the publication of analytical reports and an indication of possible future trends does not go far enough. I hope we shall be told in addition what conclusions the Bank has reached. These could be included in the quarterly review to which the Bank is now committed. Indeed, the quarterly analyses would in my opinion be incomplete if they did not conclude with the action recommended by the Bank in the light of those announcements.
§ I wish to suggest that the time is now ripe for the Bank to be given greater responsibility in securing long-term price stability and that in the discharge of this responsibility it should be directly accountable to Parliament. I submit that it is essential that an effective institutional framework should be established to secure price stability in the long term and, above all, to avoid the ebbs and flows which have been so damaging to the British economy, particularly in the past 20 years.
§ Inflation is now at a low level and, according to most estimates, is likely to remain low for the next year or so. But, on the basis of past patterns, inflationary pressures could begin to take hold once more as the momentum of economic recovery gathers pace and the impact of sterling evaluation works its way through the system accompanied by a widening trade gap. Indeed the first signs of this have already become apparent. It has just been announced that the producer input prices, seasonally adjusted, rose by 2.4 per cent. in November. That is the biggest monthly rise since October 1976–16 years ago. Compared with November last year, input prices rose by 4.1 per cent., well above the current annual level of inflation. Inflationary trends must be anticipated and suitable action must be taken before, not after, the next inflationary spurt.
§ The review of experience in other countries shows certainly that there is no unique blueprint for dealing with this issue. I would therefore like to suggest that the subject of identifying the most practical means of 629 securing long-term price stability should be remitted to an ad hoc committee of this House, for which provision has been made following on the Jellicoe Report. I would visualise the task of such a committee being to analyse past trends on prices and inflation, to review what is being done in other countries to contain inflation and to make recommendations.
§ Recent history has shown that it is possible, through government action, to bring down inflation once it has reached an unacceptably high level. What has so far proved elusive is to maintain inflation at a low level over a long period. This is the problem to which I feel we should now address ourselves with urgency.
§ 7.28 p.m.
§ Lord Boardman
My Lords, before dealing with the main argument of the noble Lord, Lord Ezra, perhaps I may pick up one point that he made in regard to the rise of 2.4 per cent. which has just been published. The noble Lord should surely recall the familiar 'J' curve, which inevitably means that after a deflation of one's currency the immediate consequence for some months is an increase in import prices before the benefit of the increased export prices comes through. I would be very sad if the figure which the noble Lord quoted were taken as undermining confidence in the attack on inflation which has been so successful and which I believe will continue to be so.
I have no present interest to declare but I was for some years the chairman of one of our leading clearing banks. In that capacity I had many discussions and meetings with the Bank of England. I know quite a lot about its operations from that end. A long time before that, when I was Chief Secretary to the Treasury, I saw quite a lot of the Bank of England from the other side of the table. I saw its operations in the relationship with the government of the day. While the noble Lord does not go so far as to suggest that there should be an independent Bank of England, it must be an almost inevitable consequence of his speech—giving greater responsibilities to the Bank of England; and indeed, to pick up a phrase that is often used by some on the Benches opposite, the independence of the Bank of England is something that should be secured. I strongly disagree with that. If I deal with that point I may not be dealing directly with the point made by the noble Lord about setting up a group to study the issue. I shall deal with what I believe to be the worry underlying the Question that he has tabled. He gave various examples of countries which allocate different responsibilities to their central banks. I shall not try to cover all the countries. I do not know the conditions in many of them.
Perhaps I may pick upon three of the countries to which the noble Lord referred. I shall take Germany first. The Bundesbank has always been held up as a great example of the independence of a bank from the political considerations of the Government. That is a much overstated claim. When Germany created unity and brought in East Germany, the Bundesbank said what it believed should be the rate of exchange between the ostmark and the deutschmark, but it was 630 Chancellor Kohl who said what it would be. It was Chancellor Kohl's political decision that dominated. The views and advice of Karl Otto Pöhl were overruled, with the inflationary consequences that we are all seeing in Germany today.
The noble Lord also referred to the Fed, about which I know a little. He must take care when comparing the system in the United States with any system that might be applicable here. As we know, there is the presidential office on the one hand and Congress on the other, with the Fed stuck between them. The Fed is subject to many political influences and political appointments which severely constrain its freedom. It is not an effective parallel.
The noble Lord mentioned New Zealand. Superficially it seems to be an attractive argument. The system in New Zealand is new. It started in 1989, or something like that. It has been effective in bringing down the rate of inflation, but no more effective than have been the Government in bringing down the rate of inflation in this country, where we are now down to the level quoted by the noble Lord. But at what price? When one sees the economic conditions in New Zealand which have resulted from applying those measures, one wonders whether it is a price that the New Zealanders will think is worth paying.
I ask your Lordships to consider the consequences of giving to the governor or the Bank of England itself a greater responsibility. It would be giving to a non-elected body the responsibility for a large part of our economic policy. Economic policy has to be dovetailed in with fiscal policy. It is the two together that form the basis of the political decisions that have to be made by the political body of the country. In our case it is this House and another place. One cannot have one body with responsibility for monetary policy and a political body to deal with fiscal policy.
The noble Lord suggested that it should be the Bank of England's responsibility to control inflation. That is something that we should all like to see severely controlled. If it were decided that it was necessary to have a massive increase in interest rates to control inflation, would it be right for some non-elected body to impose that upon society, regardless of the enormous unemployment that it might cause and the effects upon our overseas trade that might result from it? I challenge the suggestion that an unelected body should be given that responsibility.
§ Lord Boardman
My Lords, I follow that, but it seems to me that the inevitable consequence of the noble Lord's speech must be greater independence, if not complete independence, for the Bank of England. That would have serious political and economic consequences. Let us just look at the present position. The Bank of England has a large measure of freedom at present. It has close consultations with and gives a 631 great deal of advice to the Treasury. The noble Lord referred to measures that have been taken recently, even as recently as October when we have the monthly monetary report and wide consultations. Some may feel—I sometimes do—that the degree of wide and open consultation is too wide and too open to achieve the right objectives.
The advice given by the governor and the Bank of England is not something that any Chancellor of the Exchequer can lightly ignore. I was Chief Secretary to the Treasury a long time ago and the then Governor of the Bank of England was my noble friend Lord Richardson of Duntisbourne and the Chancellor of the Exchequer was my noble friend Lord Barber. I remember the Governor of the Bank of England coming to the Treasury and laying down firmly what would be the economic consequences of a certain action. He spelt out the consequences of the alternative courses. He made firm and strong recommendations as to what he believed was then appropriate. I shall not enter into what happened as a result or to what extent that advice was followed. But the power of the then Governor of the Bank of England, no doubt still enjoyed by the present governor, to tell the Chancellor of the Exchequer what he believed was necessary and right in the circumstances was strong and compelling. That advice would not have come more strongly or powerfully from an independent Bank. The noble Lord said that he was not suggesting an independent Bank, but that is what flows from what he was saying.
The ultimate weapon of the Governor of the Bank of England, if the Government and the Chancellor of the Exchequer take a certain course which he believes to be extremely damaging to our economy, is to say, "I have the right to and will resign". That is the ultimate weapon. The resignation of the Governor of the Bank of England because he felt so strongly about some economic matter would make any Chancellor of the Exchequer sit up and think hard before going ahead with the decision.
There is a further complication. The international markets result in enormous funds flowing across boundaries at the touch of a button. That makes it difficult to regulate and control the various factors that go to make up inflation, let alone all the other consequences of the flow of funds. Let us just contemplate Black Wednesday, which will be well known and remembered by most of us here. Your Lordships will recall that interest rates were increased twice in a few hours and then brought down as the country came out of the ERM. It was not a happy picture.
Who is to have the power to increase interest rates? If the greater responsibility were to be with the Bank of England, it flows from the point made by the noble Lord, Lord Ezra, that that power would be in the hands of the Bank of England. It would have the responsibility of putting up and pulling down interest rates. I do not know who would have gone to Brussels that night to see how the ERM could be rejigged. I do not know whether it would have been the Governor of the Bank of England, the Chancellor of the Exchequer, or both, trying to compete as to who got 632 onto the aeroplane first. That is an example of what happens if one tries to shift the responsibility away from the Government and the Chancellor to some other source, however important that source may be.
I believe it to be important that the Bank of England should retain its present relationship with government. It has the power to advise the Chancellor, the right to be consulted and the right to have an important influence upon this country's monetary policies. It also has a vast range of other responsibilities. It may be only right to mention its responsibilities as a regulator and supervisor of the banks and many of the financial services of the City of London. That is a vital and difficult task, with all the foreign banks in the country and the various financial arrangements that exist. The Bank has to bear with, be supported by and suffer from all the regulations and legislation that have been passed in Parliament—the Financial Services Act and Banking Acts galore.
The last thing I wish to see on top of all this is that we have a consortium of people set up to look at the Bank to see what could be done to make further changes. There are imperfections in its operations, and I am sure that the Bank of England would be the first to acknowledge them. It is aware of them and is trying to improve the whole time. It deserves considerable credit for the way in which it has achieved that.
The last thing we wish to do is to pull it up by the roots and examine them just to see what further changes we should make. There has been far too much of that in the past. I believe that we should leave the Bank of England alone to develop in the light of all the experience it has had and of the many lessons that have been learnt in the past few years. We should leave it to develop and to carry on in its present form.
§ 7.40 p.m.
§ Lord Cobbold
My Lords, I am pleased to have the opportunity of supporting my noble friend Lord Ezra in the debate on this important subject. I agree with all that he has said and support fully his recommendations.
The issue at stake is ultimately whether politicians can be trusted, or, indeed, can trust themselves with the management of money creation. Is the temptation to finance expenditure by printing money rather than by unpopular taxation too great to resist? I do not agree with the noble Lord, Lord Boardman, when he says that fiscal and monetary policies cannot be separated. I believe that in theory they quite definitely can. Government have a right to tax and to borrow against future revenues. But I am not at all sure whether they have the right to borrow from themselves by running the printing presses. There is a clear case for separation of these functions.
Certainly in this country since the war our track record on monetary management is pretty bad, as my noble friend Lord Ezra has already explained. We have followed a stop go, boom bust cycle. Intermittent bursts of inflation have reduced the value of our currency to a small fraction of what it was worth at the end of the war. That policy has encouraged 633 short-termism and has had damaging long-term consequences for our interest rates and the capital development of our industry.
Rather like an alcoholic, we recognise the problem but we find it extremely difficult to kick the habit. Cynics may argue that secretly we are quite content to stay the way we are and that we prefer periodic binges and the inevitable hangovers that follow to what might be described as the boring life of steady growth. Personally I hope that this is not the case, but if the cynics are right then there is little point in changing the status quo.
However, I shall assume that the cynics are wrong and that we are still seeking the holy grail of non-inflationary sustainable growth. Indeed, it is in any event the much trumpeted policy of Her Majesty's Government in spite of our sudden exit from the ERM. It is embodied in the provisions for economic and monetary union in the Maastricht Treaty which the Government are committed to ratify.
The question therefore for debate is whether monetary policy is best left with the government of the day or whether it should be delegated to a separate institution. In the latter event, what exactly should the mandate of the institution be and to whom and by what mechanisms should it be accountable to the public?
In this country, as with many things, the management of monetary policy has evolved in a largely natural and undocumented relationship between the Treasury and the Bank of England. Even before nationalisation the Bank of England did not really have control of monetary policy. In 1937 Montagu Norman told a gathering of Commonwealth central bankers:I am a creature of the Treasury".The Bank of England Act 1946 did not define the objects of the Bank, nor the scope or aims of monetary policy. It merely codified the relationship between the Treasury and the Bank, giving the Treasury power to direct the Bank, and between the Bank and the City, giving the Bank the power to make regulations governing the operations of the commercial banks provided that they were in the public interest and approved by the Treasury—powers which in practice merely confirm the status quo.
We have never had in this country the degree of independence granted to the Bundesbank by its constitution, although I agree with the noble Lord, Lord Boardman, that in the end even the Bundesbank is not wholly independent. Therefore what we would require is not so much privatisation of the Bank to achieve this objective but, by a statute, a clear definition of and separation of the roles as between the Treasury and the Bank, followed by statutory delegation of powers to the Bank under a clear mandate, with recognisable and effective lines of democratic accountability.
The noble Lord, Lord Boardman, felt that giving the Bank of England greater autonomy in this way might have had more dire consequences for the management of affairs associated with Black Wednesday. I cannot think that anything could be 634 worse than the way in which that event was managed by our monetary authorities collectively, so I believe that that is not an important point.
The starting point now must be what exists in the constitution and powers of the European system of central banks as embodied in the Maastricht Treaty which is due to be ratified and to which we shall almost certainly become signatories. Article 105 of the treaty states:The primary objective of the ESCB shall be to maintain price stability. Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Community".These policy objectives are listed in Article 2. I believe that that definition is broadly satisfactory for an "independent" role for a central bank.
The independence of the ESCB for member governments is also underwritten in the treaty in Article 7 of the Protocol which forbids the seeking or taking of:instructions from Community institutions or bodies, from any government of a Member State or from any other body". The independence guarantee in this form is also broadly satisfactory.However, on accountability and reporting I think there is room for improvement. The reporting commitments in Article 15 are for a published quarterly report, weekly financial statements and an annual report,to the European Parliament, the Council and the Commission and also the European Council".I believe that this is not satisfactory. Those provisions should be and will have to be extended in order to achieve the necessary public credibility for the democratic accountability of the institution. There must be more public information on actual policy and operations, akin, for example, to the Open Market Committee minutes of the Federal Reserve system in the United States. Again as in the case of the Federal Reserve system, there should be more public hearings before probably the appropriate committee of the European Parliament and perhaps before combined specialist committees of national parliaments meeting together. Only in this way will true public accountability be achieved.
The Bundesbank benefits from widespread support among the German population. Any institution at the Euro level or at national levels will have to strive to achieve such popular support if it is to succeed.
Given therefore that Maastricht will be ratified, we shall be committed in any case under Article 108 to ensure that our national legislation, including the statutes of our central bank, are compatible with the treaty and the statute of the ESCB before it is established.
That is only a few years away, once again assuming ratification. I hope that the Government will take steps to move in this direction well before the time limit expires. It takes time to establish credibility, and if the Bank of England is to stand shoulder to shoulder with the Bundesbank it must be given time to play in the new rules and operating principles.
I welcome the Government's latest initiative on the monthly meetings to which my noble friend Lord Ezra has referred. I also welcome the quarterly report on inflation and on the management of monetary policy. 635 I hope we can move quickly on from here. We need as soon as possible to have a White Paper from the Government on the whole subject and to have the opportunity of a full debate in both Houses of Parliament. Once again I thank my noble friend Lord Ezra for raising this subject and I hope the Minister will take active steps to promote further action on this matter in the near future.
§ 7.50 p.m.
§ Lord Desai
My Lords, We are grateful to the noble Lord, Lord Ezra, for raising what is a very important question. As he has said, although not many noble Lords are participating in this debate the quality of it has been good. A debate such as this shows the good contributions Members of this House can make on this problem.
I start by saying, perhaps in a pedagogic way, that we are not actually discussing price stability as much as the stability of a low rate of inflation. I do not believe anyone would even try to maintain a zero rate of inflation over a period of time. What we are really talking about is stability in a rate of inflation which is maintained at a reasonably low level, roughly akin to the targets the Government have set. There is a further problem here. Which inflation rate does one take as one's measure of price stability? That has not been referred to so far.
As we have seen increasingly throughout the 1980s the retail prices index is not a satisfactory all round measure of inflation. I should like the Government to look into whether there are ways in which one can improve the measurement of the rate of inflation, especially as regards what factors should or should not be included in that measure. Mortgage payments are a problem area here. We need to know whether there is a drift in the RPI that is caused simply by the way it is measured. I shall not go into the technicalities of the matter but I could concoct cases in which the true rate of inflation could be zero but the RPI could still be either positive or negative.
We have all agreed that inflation is a problem. However, I feel we have not considered in sufficient depth some of these rather dull technical measurement problems. The noble Lord, Lord Ezra, related an historic account of inflation. During the period from 1600 to 1939 the value of the pound stayed the same on average. It went up and down a little but, by and large, it retained the same value. It is only since 1939 that we have experienced persistent inflation in the sense that—if my memory serves me correctly—not a single year has shown a negative rate of inflation. Before we all get carried away, I should say that that has also been the experience of many other advanced capitalist countries. But paradoxically that was also the period of the fastest rate of growth in the capitalist world as we know it. We must remember that.
I am not saying that inflation is good for growth or anything like that, but we have to remember that it is insufficient to consider inflation by itself. We must also consider income growth. What we really want is for economics to serve the world. The bottom line is whether people are becoming better off. We desire low 636 inflation only in as much as people can demonstrate that low inflation is a cause of high growth. I do not believe that can be demonstrated.
§ Baroness Seear
My Lords, I am sorry to trouble the noble Lord but it would help me at any rate if he could clarify a point. Does he not consider that what he has just said as regards an improvement of the standard of living must be accompanied by stability and the expectation of stability? Otherwise the standard of living will rise for a little while but after that funny things may happen to it. Does the noble Lord agree with that?
§ Lord Desai
My Lords, I quite agree with that in principle. However, there is the paradox that during the post war period, 1945 to 1975, the UK economy experienced its highest ever growth rate on a sustained basis. However, it also experienced inflation at that time. I do not wish to give the impression that I am in favour of inflation but I believe that, eventually, we will have to discuss the costs of achieving a low rate of inflation, and whether low inflation leads to growth. If it leads to growth we should aim for low inflation, but we should not aim for low inflation just for its own sake. During the inter-war period the central bank did not wish to have falling prices much less a low rate of inflation. But the cost was such that as a consequence the reputation of the central bank, in those days at least, became extremely low. I shall return later to an examination of what a central bank can achieve.
In the 1950s and 1960s we had quite low rates of inflation except for the period of the Korean War. However, as has been pointed out, the 1970s and 1980s were bad decades. That experience has convinced me that the UK economy is extremely susceptible to external shocks. Our inflation of the 1970s was to a large extent imported, due to the quadrupling of oil prices. Other people may disagree with that view. As our economy is susceptible to external shocks, we must be careful when deciding on policies to reduce inflation. Is is just monetary policy that will reduce inflation, or is it a mix of monetary and fiscal policies? In that respect I agree with the noble Lords, Lord Boardman and Lord Cobbold. It is not that monetary and fiscal policies cannot he separated: I think they should not be separated. I believe a combination of monetary and fiscal policies would eventually achieve the twin objectives of low inflation and substantial growth. If we let those two policies drift apart, I do not believe we shall achieve our objectives.
There have been three attempts to reduce inflation once it had risen. The noble Lord, Lord Ezra, has referred to this matter. In each of those three cases monetary policy played a secondary, passive role rather than a primary role. When the Labour Party was in power between 1975 to 1978 the inflation rate came down from 25 per cent. to 8 per cent. That was achieved with some monetary control but it was principally achieved with an active incomes policy. That is an important point.
In 1980 to 1983—this has been illustrated by Professor Wilfred Beckerman—the UK economy benefited greatly from a high exchange rate and falling 637 import prices. Those continuously falling import prices were important. The control element in that situation was not so much the control of the money supply, because monetary targets were not always met, but it was rather the control of the fiscal deficit. The PSBR control was important. I did not like it at the time but it was effective. The tight fiscal policy achieved the reduction in inflation and not the control of the money supply. I believe that the money supply is a hard thing to control in an open economy, especially with globalised financial markets.
The final episode I wish to refer to is that of our entry into the ERM. I do not wish to discuss whether we should or should not have entered the ERM. However, the fall in inflation coincided with a tight external discipline. I do not believe that in any of those three episodes I have referred to, one could have separated out monetary and fiscal policy. Exchange rate policy, fiscal policy and monetary policy together contained inflation.
Central bankers are suddenly in fashion. They have a great reputation for competence—I do not know why. We ought to examine the record.
Since other noble Lords have mentioned this I should point out that it is not a question of the autonomy or otherwise of the Bundesbank and the Austrian central bank. It is not often appreciated that there is a wage bargaining structure in both those countries which sustains monetary policy. That is also the case in Sweden. One needs a sensible wage bargaining structure, which we do not have and are not likely to have. It is not merely that somehow the Bundesbank controls money supply effectively and therefore achieves low inflation or that its independence is important. The important point is the wage bargaining structure.
Secondly, there is a strong anti-inflationary culture in Germany. As the noble Lord, Lord Cobbold, said, we lack an anti-inflationary culture in this country. It will not be easy to inculcate such a culture. I believe that the rumblings against the Maastricht Treaty and about the unbearable cost of our being in the ERM, which finally we abandoned were due to the fact that a sustained fight against inflation over a period of more than two years seems to be beyond the political capacity of any party.
It is not a question of the central bank being able to control inflation because of its independence. To believe that inflation can be controlled by banks one would have to believe in a strong and naive monetarist theory that somehow money supply and money supply alone causes inflation and that control of interest rates would guarantee an anti-inflationary policy. I have written a book about the subject—I do not believe a word of that theory.
I agree that we should have a great deal more information. The system should be much more open. There should be transparency in the negotiations between the Treasury and the Bank of England to the extent that such transparency would not affect market sentiment. However, in the final analysis I believe that a good anti-inflationary policy can only be achieved through a framework to which both politicians and 638 the banks can adhere and which they can sell to the population. Unless one can sell an anti-inflationary policy to the population it will be difficult to replace inflation. We have designed institutions such as our housing market which are sustained by an inflationary psychology. How is one to change people's attitudes?
While I concur with the noble Lord that a central bank has a role to play, I believe that that is much exaggerated. Inflation is a complex problem. We are grateful to the noble Lord for allowing us to discuss the matter.
§ 8.3 p.m.
The Minister of State, Department of Transport (The Earl of Caithness)
My Lords, our debate today has been both stimulating and, as the noble Lord, Lord Desai, said, well informed. It has benefited from the contributions of noble Lords who have a wide range of relevant and valuable experience. I, too, am grateful to the noble Lord, Lord Ezra, for providing us with this opportunity to examine a timely and important issue. I have to say that I agree with the noble Lord, Lord Cobbold, that the important issue is price stability, not the status of the Bank of England.
We all know the problems which high inflation causes. It erodes savings. It causes misallocation of resources. By doing so it erodes the potential for long-term growth and is, as the noble Lord, Lord Callaghan, once put it, "the father and mother of unemployment".
That is why the Government have made the control of inflation their priority since being first elected in 1979. That is why my right honourable friend the Chancellor of the Exchequer has set an explicit target for underlying inflation of 1 per cent. to 4 per cent. a year for the rest of this Parliament. It is why in the longer term we want to get inflation down to 2 per cent. or less.
Mr. Alan Greenspan, the chairman of the US Federal Reserve Bank System, has proposed a definition of price stability as being a rate of inflation which is low enough not to influence economic decision-making. Our policies can achieve that.
Some people point to countries such as Germany and claim that they provide clear evidence that an independent bank is better able to deliver low inflation. Others may go further and suggest that bank independence might be a pre-condition for such achievement or argue that it lessens the risks of inflation.
It is certainly true that Germany has over the past 40 years or so enjoyed an enviable record of consistently low inflation. But that is not simply the result of the independent status of the German Bundesbank. Both the noble Lords, Lord Cobbold and Lord Desai, observed that the German people, not surprisingly, are strongly determined to maintain price stability, having lived through the horrific hyper-inflation of the 1920s and the immediate post-war years. What is less often observed is that at the time when German inflation was at its worst— 200,000 million per cent. in 1923—Germany already had an independent central bank. That is not a good record.
639 If we look more closely at one of the recent cases where the establishment of an independent central bank has been accompanied by a fall in inflation, we find no magic at work. The noble Lord, Lord Ezra, mentioned New Zealand. New Zealand reformed its monetary system in 1988, and price stability was adopted as the goal of monetary policy. In the following year, the New Zealand central bank was granted independence so that it might pursue the price stability objective. New Zealand's inflation rate has come down from around 6 per cent. to 1 per cent. since then, but it has done so because very tight monetary policies have been applied. But, as my noble friend Lord Boardman reminded us, at the same time New Zealand has suffered a recession lasting six quarters, with a fall in output of 4½ per cent.
Some have claimed that the very act of making the central bank independent can improve credibility and so make squeezing out inflation less painful. The experience of New Zealand is enough to show us that bank independence of itself is unlikely to offer easy and guaranteed solutions.
Nor is low inflation impossible without an independent central hank, if the right policies are pursued. Over the past 20 years Japan has had one of the lowest inflation rates in the Group of 7 major industrialised countries; and more recently France has achieved an excellent record on inflation.
The noble Lord, Lord Ezra, gave an interesting summary of those countries with central bank experience. There is no single and generally accepted notion of independence. It is of course very much a matter of degree. Even for those banks with a great deal of formal independence the division of responsibilities is in practice not a simple matter, and we see hank and government working closely together.
The Bundesbank is often considered the epitome of an independent central bank. Internal monetary policy is indeed a matter for the Bundesbank, but the Bundesbank is also obliged to support the general economic policy of the federal government, albeit without risking the performance of its monetary oversight. When it comes to exchange rate policy, the picture is different. Decisions on exchange rate parities within a fixed rate system are taken by the federal government, but after close consultation with the Bundesbank. For example, Germany's position on ERM parities and realignment is determined by the government. My noble friend Lord Boardman reminded us that at the time of unification it was the federal government that made the final decision on the deutschmark-ostmark exchange rate.
The Netherlands Bank also has a high degree of independence in its determination of monetary policy but, as the noble Lord, Lord Ezra, pointed out, the ultimate responsibility lies with the Minister of Finance and the government retain the right to issue formal directives to the bank. Decision on fixed exchange rates are a joint responsibility of the bank and Minister of Finance in law. Indeed, the law governing the Netherlands Bank is very similar to that governing the Bank of England. The noble Lord mentioned that the Dutch Government have never 640 issued a formal directive to the bank, but neither have the UK Government ever used their powers to issue formal directions to the Bank of England.
In Italy, as the noble Lord, Lord Ezra, said, the Banca d'Italia was in January this year given sole responsibility for setting the official rates on discounts and advances. But it is of course far too soon to judge what effect this will have in the longer term, or what additional steps, if any, will be taken to increase the bank's responsibilities. We must remember that the bill is aimed at severing the bank's remaining links with the Treasury. It has not yet been considered by the Italian Parliament and may well not be approved, at least not in its present form.
In the cases of the Dutch, Italian and French central banks, cited by the noble Lord, the freedom of activity of the central hank is firmly hemmed in by the need to meet ERM requirements—a condition set in each case by the government.
As some of your Lordships have pointed out, the UK has not recently enjoyed price stability for more than a generation. Between 1972 and 1982 the rate of inflation varied between 6 per cent. and 27 per cent. The average rate over that period was 14 per cent. But the UK's experience has demonstrated that the right policies get inflation down whatever the institutional arrangements in place. Between 1982 and 1986 we got the rate of inflation down to a low point of around 3 per cent. because we ran tight monetary policies, as the noble Lord, Lord Desai, said, buttressed by firm control of public spending. It is true that we over-estimated the impact of the 1987 stock market crash and underestimated the impact of financial deregulation, and so allowed a build-up of inflation in the late 1980s.
But those misjudgments were shared by all parties, all institutions, and almost all commentators. They were also shared by other countries in similar circumstances. And most importantly, once the problems became clear, we acted to tighten policy. We started to raise interest rates in summer 1988.
Over the past two years, we have brought RPI inflation down from 10.9 per cent. to 3 per cent. Underlying inflation in November was 3.6 per cent., the lowest rate since February 1988. Interest rates fell from 15 per cent. to 10 per cent. between October 1990 and May this year. Those are impressive achievements and they have not come easily.
Since we left the ERM, we have seen a significant but justified easing of our monetary policy. The exchange rate is lower. Interest rates have fallen by a further 3 percentage points to 7 per cent. They are now at their lowest level since 1978. This easing of policy has come about without taking risks with inflation, and my right honourable friend the Chancellor of the Exchequer has left us in no doubt that he will take whatever action is necessary if our inflation objective, and hence our prospects of long-term growth, are put at risk.
In the United Kingdom, the conduct of economic policy is the responsibility of the Government alone. Some noble Lords have argued that this makes it more difficult to get the policy right. But it can make it easier. The Chancellor has been able to balance tight 641 control of public spending with a relaxation of monetary policy. This contrasts with the recent experience of Germany where divided responsibilities have meant that the inflationary consequences of reunification have had to be met largely by higher interest rates, as the fiscal deficit has burgeoned.
§ Baroness Seear
Would the Minister agree that if, on the famous occasion when the Bundesbank was overridden by the government over the exchange rate between the East and the West mark, the Bundesbank's advice had been taken, the position not only in Germany but throughout the Community would today be a great deal better.
The Earl of Caithness
The noble Baroness may very well be right. But the fact remains that it was the government that decided. The government have the power to decide, not the Bundesbank. It comes back to the point that I was making earlier. It is a matter of the degree of independence. That varies from situation to situation. In the case of Germany, the federal government made the decision. I share some of the thoughts of the noble Baroness as to what the consequences might have been had the Bundesbank had the power. The trouble was that the Bundesbank did not have the power.
What I have said does not mean that there is no room for improvement. We have now an explicit inflation target, which we are determined to hit. We have explained the way in which we will monitor money supply growth, changes in asset prices, the relationship between market interest rates, and other indicators of the monetary stance.
In the past we have not sought to explain the progress of our monetary policy in detail in the way we will now do. But my right honourable friend the Chancellor of the Exchequer has recognised, now we are outside the ERM, that the need for confidence in the Government's judgment is greater and that we need, therefore, to explain clearly what we are doing. In future, that is precisely what will happen. I was grateful for the welcome that the noble Lord, Lord Cobbold, gave to that. The Treasury has now published for the first time its monthly monetary 642 report, which is the document that the Chancellor and the Governor of the Bank of England have in front of them at their regular monthly meetings.
As your Lordships know, the last two interest rate cuts have been accompanied by detailed accounts of the analyses which led to the decisions. In future each change in interest rates will be accompanied by a point-by-point account of our reasoning. The Bank of England will soon begin to publish quarterly inflation reports, setting out the progress being made towards the Government's inflation objective.
The noble Lord, Lord Cobbold, raised the question of the European Central Bank and the Maastricht Treaty, which will come before your Lordships in the not too distant future. We need to distinguish between the current position and Stage 3 of the Maastricht Treaty. Under Stage 3 of the treaty Article 107 provides for an independent European Central Bank. In the event of a decision to move to Stage 3, the Bank of England, like other central banks, would become part of a system of central banks. But I have to remind the House that the United Kingdom has no commitment to move to Stage 3. At present, the Government are responsible for monetary policy. Again I come back to the point: what really matters is that the right policies are being pursued.
I have taken note of the many points that have been made in our discussions this evening. I will draw them to the attention of my right honourable friend the Chancellor of the Exchequer.
What matters for long-term price stability is that the policies pursued by the monetary authorities are right, not who decides those policies. In the United Kingdom we have a long tradition of ministerial accountability to Parliament for the discharge of economic policy, including monetary policy. We have the right policies and we have no plans to abandon our traditions or the Government's accountability.