Interest rates since independence

John Redwood's complaints about Brown's policy towards the Bank of England are, as Matt says, strange. And they miss what for me is a curious point - that it's not clear that interest rates have been much different as a result of Brown's decision to give the Bank independence in 1997.
The chart shows what I mean. It compares actual three month rates to those predicted by a simple Taylor rule, of the form:
     Rates = (1.5 x RPIX) + (0.5 x output gap) + 1.5
I've used the Treasury's own estimate of the output gap, and set the constant term so that if RPIX inflation were 2.5% and the output gap zero, rates would be 5.25%, giving a real rate equal to trend GDP growth.
The chart shows that, for the first five years of independence, the Bank tracked the rule closely. Rates were lower than the rule forecast in 2003-04 - as the Bank took out insurance against the risks of US deflation and a recession caused by weak stock markets. And they are lower now, because the Bank anticipates a slump (pdf) in inflation as utility bill rises drop out of the annual comparison soon.
I suspect that, if the Treasury were still setting rates, there'd be a similar pattern.
This suggests that independence might not have changed the way the Bank responds to growth and inflation.
Instead, perhaps the big change is that inflation expectations are lower as a result of Bank independence, which allows rates to be lower than they otherwise would be.
This is one area where Brown shouldn't be criticized.

Comments

[dearieme]

But did Brown ever bring into the world anything as lovely as Lawson did?

[Bob B]

I don't think John Redwood makes out his case well and his analysis is arguably wobbly but he does have a point.

Brown and the Treasury have maintained a rather loose fiscal stance with a continuing public sector deficit. Hence the observation often made by economic commentators that with the prevailing low unemployment rate, the high employment rate and full capacity working, the budget really should be in surplus now or, at least, in balance.

"In March 2007, the public sector showed a deficit on current budget of £4.6 billion, compared with a deficit of £3.0 billion in March 2006."
http://www.statistics.gov.uk/cci/nugget.asp?id=206

With a more stringent fiscal stance, there would be less need for the (independent) Bank of England to raise interest rates in order to curb inflation downstream.

As the Sunday Telegraph reported near the end of April:

"The British economy is 'on thin ice' and businesses and households face 'inevitable' tax rises, according to an authoritative independent report to be published tomorrow.

"In a wide-ranging assault on Gordon Brown's management of the economy, the Ernst & Young Item Club accuses the Chancellor of 'blithely borrowing' and making 'over--optimistic' forecasts. It warns that Britain 'is living beyond its means' and is 'highly vulnerable to a reversal in financial market confidence'."
http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2007/04/22/cnbrown22.xml

Here is the Treasury's official excuse: "The Treasury has insisted that public spending will now slow, putting the public finances back on track."

Of course, slowing the rapid growth of public spending will be much less fun than the spluge in recent years.

[Neil Murphy]

I seem to remember Lawson moving interest rates around to help in shadowing the deutschmark and then the tories using interest rates to hold the currency in the ERM. An independent bank with inflation targets as its goal could not and would not do that.

Having seen the mess Brown has made of the public finances, I would be horrified at the thought of what he would do with interest rates in his grubby paws.

[Bob B]

There is nothing especially novel about recognising the advantages of an independent central bank. The Bank of England certainly wasn't the first central bank to be made independent in setting interest rates without reference to politicians - the Bundesbank in West Germany had been independent in that sense from the beginning and West Germany had a far better historic record in maintaining low inflation in the post-war period than Britain.

I can recall attending seminars in London at least as far back as the late 1980s where economists were staking out a case for setting the Bank of England free to make decisions about interest rates. Inflation targeting by the Bank was introduced as the new policy to fill the gap left by Britain's abrupt departure from the European Exchange Rate Mechansim in September 1992.

What Brown can claim credit for is the particular policy remit to the Bank - originally, the objective of maintaining the annual inflation of the RPI at 2.5% - and establishing the decision-making framework, namely the Monetary Policy Committee with publication of its minutes and voting.

[ChrisA]

One thing the graph shows is that, surprisingly, interest rates in the early ninties were lower that (your) version of the Taylor rule would have proscribed. Of course the standard explanation for the high interest rates of that period was the showdowing of the DM. Is it the case that even without this policy rates would have been high?