The Rt Hon Sir Edward George GBE: Central bank independence
Speech by The Rt Hon Sir Edward George GBE, Governor of the Bank of England, to the SEANZA
Governors' Symposium in Colombo, Sri Lanka, on 26 August 2000.
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Governor Jayawardena, fellow central bankers, I am honoured, personally and on behalf of the Bank
of England to participate in your celebrations.
On behalf of the Bank of England, and, I am sure, of all your guests here this morning, I congratulate
you, Mr Governor, on the great contribution that the Central Bank of Sri Lanka has made to the
development of your beautiful country in your first fifty years and I wish you continuing success in
your task in the years to come.
You invite me to speak about Central Bank Independence, which of course I am happy to do
- although I should perhaps make clear at the outset that it is a concept which I find somewhat elusive.
Like so many other debates, the debate about central bank independence often seems to become
unduly polarised.
At one extreme it seems that some of those who resist central bank independence as undemocratic - or
even some central bankers who favour it - assume that it involves an elite body of individuals, who,
once appointed are, by virtue of statute, beyond political influence, with extensive but only
generally-defined powers to affect the financial environment - and hence the lives of individuals and
businesses throughout their currency area. At the opposite extreme it sometimes seems that the only
alternative is for the central bank to be simply another arm of government, subservient to finance
ministers and their officials.
Now I don't know how many of you would recognise yourselves under either of these extreme
categorisations. I guess not very many.
I have to confess that - however attractive this definition of independence might appear as a central
banking career option - if this really were the choice to be made, then, as a citizen of a democratic
society I would have to choose the non-independent alternative. But, of course, the real debate is much
more subtle and extends across a much narrower part of the spectrum between these polar extremes.
The real debate is in fact well described by John Exter, the Federal Reserve Board official, who
advised on the establishment of the Central Bank of Ceylon, as it then was, and stayed on to become
its first Governor.
In his Report - published in November 1949 - Exter presented a draft bill accompanied by a
commentary. It is still well worth reading. In that commentary Exter first outlines the case for the new
central bank being "non-political" and having "a considerable amount of independence" - essentially
on the grounds that central banking "puts the government into the business life of a country at
especially critical points, namely banking and other credit activities, capital markets, foreign exchange
markets and the supply of currency", and that it "embraces problems which are of an unusually
technical nature"!
But Exter goes on to recognise that "there are many important problems of monetary policy, especially
those relating to fiscal policy, on which a central bank must necessarily work in close harmony with
the government". Noting that many governments had learned to value the sort of independent and
objective, detached, advice that central banks are able to give, Exter nevertheless acknowledges that
"on matters of vital interest to the state it would be impossible for a central bank to adopt a policy
contrary to the policy of the Government of the day". His killer argument is that no central banker can
help but be "acutely conscious of the fact that, since no Parliament can bind its successors, their
independence is limited by the ultimate power of the Government to change the law".
He concludes that the exact degree of independence of the central bank is likely to vary from time to
time (giving the example of a peacetime and wartime economy) and he describes the ideal as one in
which there will be continuous and constructive cooperation between the central bank and the
Government. The effectiveness of this cooperation - he says - will depend more upon the men
occupying the key positions at particular times than upon any legal formula, no matter how carefully
or elaborately it might be worked out.
I have quoted from Exter's Report at some length because of its particular relevance to this
anniversary occasion, but also because, although he was writing in the particular context of Sri Lanka
at the end of the 1940's, contemplating a move from a currency board to a central bank, much of his
comment is timeless. I should like to elaborate upon - or supplement - some of his themes drawing
upon our own experience in the United Kingdom.
For just over 50 years - from 1946 to 1998 - the Bank of England operated under legislation which,
remarkably, did not attempt to define our objectives or functions - they were simply assumed to carry
over from our earlier long history. The 1946 Bank of England Act conferred upon us powers, subject
to the agreement of the Chancellor of the Exchequer, to issue directions to bankers - though the term
"bankers" was not defined; and it provided for the Treasury to give such directions to the Bank as,
after consultation with the Governor, they thought necessary in the public interest. Such directions
would necessarily have been made public: none were in fact ever given. In any event the Bank of
England was in a formal, statutory, sense throughout this period well along the spectrum towards the
subservient polar extreme which I described earlier, in relation to policy making, although we did
enjoy elements of independence, for example, in relation to security of tenure for the duration of fixed
term appointments for Governors and Directors, and in some degree in relation to our finances.
I am bound to say though that this was not at all how it felt in practice. Even within this statutory
framework independence is rather like age - you are as independent as you feel!
The question really came down to how far we were able to influence the Government, which in turn
depended upon how far they themselves valued our advice and how far they felt a need to take account
of it in the light of possible public - including importantly financial market - reactions in the event of
disagreement. Clearly this put the ball very much in our own court in the sense that we needed to do
all that we could to persuade successive Governments, but also financial markets and the public at
large, of our integrity and objectivity on the one hand and of our technical and analytical competence
on the other. Without that our input to policy would not have been worth very much, and would not
have carried conviction. In fact integrity and objectivity together with professional competence are in
my view the essential foundations of effective independence whatever the statutory framework.
Fundamentally it is up to us!
For much of the period after 1946 two contextual factors served in any event to limit the degree of
independence we could realistically expect to achieve.
The first was the post-war context of direct intervention and controls, including initially the physical
allocation of scarce materials and consumer rationing but extended to the financial system for example
through credit ceilings and directional guidance as well as exchange controls, which were only finally
removed in 1979. Direct resource allocation rather than allocation through market mechanisms
involves intrinsically political judgements - choices between the social value of some forms of activity
against others - which cannot easily be devolved to appointed officials. It would put the officials
dangerously in the political firing line - calling their impartiality and objectivity into question - if they
were. While central banks may legitimately advise on the technical implementation of such
intervention, and be the agency through which it is carried out, it is far better all round in my view that
responsibility for the choices implicit in such policies remains clearly with the Government.
Secondly, for a long time after the war in the UK - until well into the 1970's, majority opinion did not
identify a specific role for monetary policy within overall economic policy; nor was there any very
clear understanding of the central bank's role in maintaining systemic financial stability.
Economic policy was widely seen as requiring the use of all available policy instruments - monetary
policy, overall fiscal policy, direct controls, as I say, even prices and incomes policies - in concert to
achieve an appropriate balance at any particular time between what were seen as the conflicting
objectives of growth and employment, on the one hand, and controlling inflation and maintaining
reasonable balance of payments equilibrium, on the other. Economic policy overall was in fact
directed at managing what was seen as the trade-off between these social objectives. And this again
involved intrinsically political rather than technical judgements, though in this context, too, there
clearly was a role for the central bank in proffering detached technical and analytical advice. Also
during this period, while it was accepted that the Bank of England exercised prudential supervision
over the mainstream banking system, there was no effective oversight of the deposit-taking institutions
that grew up outside the area of controls. It was only in 1979, after the fringe banking crisis of the
early 1970's, that the Bank was given formal supervisory authority, extending to all deposit-taking
institutions, but even then with the specific purpose of providing greater protection to depositors.
Our world changed, gradually but very markedly, from the 1970's onwards in all of these respects.
Direct methods of monetary control gave way to fully-fledged market-based techniques, encouraging
but also encouraged by intensified financial competition, increasingly driven by the IT revolution.
Crucially, a consensus gradually developed - with the Bank's strong encouragement - across a broad
political spectrum in the UK (as it had earlier elsewhere) which recognised that there is in reality no
trade-off between growth and stability except possibly in the short term. It recognised in fact the
nowadays near-universal central bankers' mantra that stability is a necessary condition for sustainable
growth. The consensus recognised, too, that, while overall fiscal policy had significant implications
for macro-economic stability over the medium and longer-term it was not sufficiently flexible or
adaptable to play the primary stabilising role in the shorter term. That task was specifically allocated
to monetary policy. Finally, there was an emerging recognition of the potential for conflict between
the central bank's necessary concern with systemic financial stability (you cannot hope to deliver
monetary stability if the financial system is crashing about your ears, while monetary stability is itself
a primary condition for financial stability) and consumer or depositor protection, which if carried too
far can itself undermine the strength of the financial system.
These profound changes in underlying philosophy - which, as I say, spread across much of the
political spectrum - were in our case fundamentally important in opening the way to a more clearly
defined and distinctive role for the Bank of England and a necessary condition, in my view, for the
delegation by the Government to the Bank of greater independent, technical, responsibility.
Even so, although those changes were a necessary condition, they were not in themselves sufficient,
and greater independence did not come all at once.
As often happens, sadly, a big step forward came after a major setback. In 1992 after we had been
driven unceremoniously out of the European Exchange Rate Mechanism (following the boom and bust
of the late 1980s / early 1990s), the Government of the day adopted an explicit inflation target as the
nominal anchor for monetary policy. Interest rate decisions in pursuit of that target remained with the
Chancellor of the Exchequer after consultation with myself as Governor and my senior monetary
policy experts at the Bank. But the really novel feature of the new arrangements was their
transparency. The Bank was required by the Government to publish a quarterly Inflation Report
setting out the background to the monetary policy decisions and the prognosis, and, going further,
Chancellor Kenneth Clarke, subsequently decided that minutes of our policymaking meetings should
be published six weeks or so after the event.
This degree of transparency was a bold and far-reaching step. Before that - apart from the dozen or so
people directly involved in the decision-making process - no one knew with any certainty whether the
mistakes that were made were a result of intervention by the Prime Minister, bad decisions by the
Chancellor, with or without advice from Treasury officials, or bad advice from the Governor and/or
his colleagues at the Bank. We all kept our heads down when things went badly, only putting them
above the parapet when things went well. The Bank was, it is true, able within limits to explain its
thinking publicly when summoned to appear before the relevant House of Commons Select
Committee, or through Governor's speeches, and this possibility may have acted as some kind of a
constraint on the Government, but such opportunities needed to be used with discretion or they could
have caused a breakdown in the "continuous and constructive cooperation between the central bank
and the Government" which Exter rightly identified as the ideal - I would say even essential
relationship.
I think successive Chancellors came to recognise that the opaqueness of the existing decision-making
process was inappropriate in principle in an effective democracy, which requires that we should each
be accountable for the decisions that we take or for the advice that we give. They may also have
thought that the public generally and Parliament in particular would not put up with it for much longer
anyway. Or they may simply have felt that they were no longer prepared to carry the can for the bad
advice they received. Whatever the motivation it is to their great credit that they were prepared to put
their own reputations - as well as that of the Bank - on the line in this way! It not only allowed the
Bank to express its own analysis and judgements about monetary policy publicly, it actually required
us to do so. That really concentrated the mind I can tell you; and it provided us with added stimulus to
sharpen up our act. But for it to have this effect it was crucial that the intended integrity of the process
was respected. What you saw in the minutes of "the Ken and Eddie show" was verbatim the advice
which I gave to the Chancellor and which I had discussed with senior colleagues beforehand.
This new transparency was a big step towards greater independence for the Bank. But it was carried
much further by Chancellor Gordon Brown, as literally the new Labour Government's first act of
policy - just four days after coming into office in 1997 - when he announced that the Bank would
henceforth be independently responsible for the operation of monetary policy. This commitment was
subsequently embodied in a new Bank of England Act that came into effect in 1998.
The key characteristics of the new legislation were clarity of definition of the Bank's responsibilities,
and transparency and elaborate provision for public accountability for the manner in which those
responsibilities are carried out.
In relation to monetary policy in particular the new Act defines our responsibility as "to maintain price
stability and, subject to that, to support the economic policy of the Government including its
objectives for growth and employment". It is the Chancellor who defines what, more precisely, is to be
understood by "price stability" which he has done in the form of a symmetrical 21⁄2% target for a
particular statistical measure of retail prices. So we have "instrument" rather than "goal"
independence.
It is sometimes suggested that this is a second best arrangement. In our national context at least I
disagree with that view. The precise objective of policy - even within the confines of the concept of
price stability - remains a political decision: there will always be those who argue for a somewhat
higher or somewhat lower target, and the fact that the Government endorses a precise target rather than
just the vaguer goal of "stability" certainly strengthens our hand by allowing us to concentrate upon
our essentially technical task. I am bound to say that in practice it seems to me to be rather a second
order issue anyway given the narrowness of the range of definitions of "stability" that would carry
conviction with the public, including financial markets.
The Act confers the responsibility for meeting the Government's inflation target specifically on a
newly created Monetary Policy Committee, comprising myself as Chairman, the two Deputy
Governors, two Executive Directors appointed by the Governor after consultation with the Chancellor
and four members appointed from outside the Bank by the Chancellor. The Governors are appointed
as members of the Committee for their full five year (renewable) terms; the remaining members are
appointed for three year terms which are also renewable. The Committee's policy meetings are also
attended by a senior Treasury Official in the capacity of an observer, who may participate in the
discussion - essentially to inform the Committee of any relevant aspects of the Government's wider
economic policies and explain the Committee's thinking to the Chancellor - but he may not express a
view on the monetary policy decision or, of course, vote on that decision.
One can argue endlessly about the precise composition of the Committee, their term of appointment
and so on. The key consideration for me is that all nine members need to be genuinely independent,
technical experts in the field of monetary policy or a closely related field, not representatives of any
particular social or industrial grouping. The objective of policy is appropriately determined by a
democratic process; the Committee's job is, as I say, a technical one, which requires relevant technical
expertise.
The transparency of the Committee's decision-making process is assured by continuation of the
requirements that we should produce our quarterly Inflation Report and publish minutes of our
monthly meetings, which we have now chosen to do with just a two week delay. Transparency is
further enhanced by a requirement that the minutes should record how each individual member of the
Committee voted on the interest rate decision.
As before, it is vital for public confidence in these new arrangements that their intention is not
subverted by the evolution of informal conventions - that the integrity of the procedures is respected.
In this context we take great pains to ensure that the true nature of the policy debate is reflected in the
minutes and that the range of views around our inflation forecast is properly reflected in the Inflation
Report. In fact I think we probably tend to err on the side of drawing too much, rather than too little,
attention to differences of opinion within the Committee which are often largely a question of nuance.
But it is better in my view to err on that side rather than to attempt to submerge the differences. We do
not, however, attribute particular views to particular individuals. To do so would invite prepared
statements and militate against the inter-active debate which is an outstanding and immensely valuable
characteristic of our meetings. It would suppress the kind of "what if" discussion in which the same
individual may explore alternative views. No attempt is made to concert the outcome of the policy
decision; in fact I go out of my way to discourage any kind of collusion, whether between the internal
or external members of the Committee - we are, and must remain, nine independent members,
individually accountable for our decisions as to how we vote.
This, of course, means that the Committee is divided as often as not; but although this initially led to
public comment to the effect that the Committee did not know what it was doing and could not make
up its mind, it is now generally accepted as the natural order of things and helps to underline to the
public at large that monetary policy making cannot be a precise science - however much it needs to be
informed by all the science available to us. That, in our context, is I think now much easier to
understand than a more consensual approach would be, but there was certainly a learning period.
It has been suggested to me that the arrangements I have described somehow diminish the position of
the Governor. Well if that's true this Governor at least welcomes it! I am sure that all of you are well
aware of how finely balanced monetary policy decisions are at the margin, and that all of you have
agonised, just as I have, over the right thing to do and the right time to do it. I find the cross-bearings
on those decisions provided by the other Committee members - and they are I remind you all highly
qualified experts in their own right - immensely reassuring. If a majority of them argued for a
particular decision, that would certainly weigh heavily with me, although - as a matter of personal
integrity - I always reserve the right to take a different point of view from that of the majority on those
occasions when I am particularly confident of my own judgement. That has not so far happened but it
almost certainly will; people should not be unduly surprised.
Finally, in relation to monetary policy, let me say a few words about accountability. In the terms of the
new Act the Monetary Policy Committee - apart from its public accountability through the Inflation
Report and the minutes of its meetings - is accountable for the adequacy of its procedure to the
Non-Executive Members on the Bank of England's Board of Directors, who in turn report to
Parliament through the medium of the Bank's Annual Report. We are all accountable to Parliament in
the sense that we may be - and regularly are - summoned to appear before the relevant Select
Committees of both Upper and Lower Houses. And we are accountable to the Chancellor in that the
Chairman of the MPC is required to write him an open letter if the rate of inflation diverges by more
than one percent either side of the 21⁄2% target explaining why and what steps we propose to take to
bring inflation back within that range and over what time period. Finally, the Treasury has the power
to give the Bank directions in respect of monetary policy if they are satisfied that the directions are
required in the public interest and by extreme economic circumstances.
Again, some observers have suggested that these elaborate accountability provisions are onerous and
constrain the Bank's independence. I take the contrary view, that they are essential to the legitimacy of
the arrangements as a whole and so actually reinforce our independence - provided of course we are
able to provide convincing explanations of our conduct! And the likely public and financial market
reaction is, in my view, the most effective protection against abuse of the Treasury's emergency
powers.
What I have described up to this point relates solely to monetary policy. But the new legislation
similarly deals with the Bank's other key responsibility - maintaining financial stability. And at the
risk of trying your patience let me say a few words about that. Less than a fortnight after announcing
the Bank's new independent responsibility for the operation of monetary policy, Chancellor Gordon
Brown announced that the Bank's responsibility for banking supervision would pass to a new
institution - the Financial Services Authority, or FSA - which would assume responsibility for the
regulation and supervision of all financial institutions in the UK. This was widely seen as the price we
had to pay for our enhanced monetary policy role. But at the same time the Chancellor confirmed the
Bank's continuing responsibility for the stability of the financial system as a whole, so that in fact
what this has done - as in relation to monetary policy - is to distinguish and clarify the respective roles:
of the Bank, which now focuses upon systemic risk - and retains its lender of last resort role within
parameters that are broadly defined by the legislation; of the FSA which oversees both the prudential
and business conduct of all individual financial institutions, including the banks, with the emphasis on
consumer protection; and the Treasury, which has ultimate responsibility for both these dimensions.
The new arrangements make a good deal of sense in the UK context where traditional distinctions
between banks and other types of financial institution have progressively eroded and where there has
been a general movement towards greater consumer protection across a much broader front. But at the
same time as clarifying our respective responsibilities, and providing in each case for transparency and
separate accountability for the way in which they are carried out, the new legislation recognises the
vital importance of close coordination between them and establishes a framework for that. It is early
days to assess the effectiveness of these arrangements, but my impression is that so far they are
working well.
Governor Jayawardena, there are many aspects of our new regime that I have not touched upon
- including questions relating to our capital, our revenues, expenditure and allocation of profits and
how they are reported and accounted for - which can also affect the degree of independence we enjoy.
Perhaps we might explore these together with the other issues in our discussion. But I hope I have said
enough to draw a few conclusions.
My starting point had been that central bank independence in the extreme sense of exemption from
democratic control is unrealistic and inappropriate. Yet wise governments in many countries around
the world have recognised that they can gain advantage - in terms of public and market credibility
from detached and unbiased advice in its field of competence from the central bank. The value that
they put on the central bank's role depends very much on the quality of that advice - the central bank's
objectivity and its technical expertise and professional competence. That is largely down to us. But the
benefit a government derives from it depends too upon the advice being seen to be detached and
unbiased, as well as technically expert and professionally competent. And that depends also upon the
government. It can discourage the central bank from expressing views in public but gain little in terms
of credibility from doing so; it can to varying degrees encourage greater independence on the basis
that this would strengthen public confidence but accepting that it could involve a greater degree of
constraint on its policies; or, where there exists a sufficient consensus on the particular role of
monetary and financial policy, it can devolve operational responsibilities to the central bank, holding it
publicly accountable for the way in which it exercises those responsibilities but accepting the
limitation that such arrangements place on the government's own operational discretion.
There is no single model to fit all situations. The appropriate arrangements for a particular country at
any particular time depend upon the economic and financial environment and upon political
perceptions relating to the approach to monetary and financial policy. I believe that we are now well
served in the case of the UK by the present arrangements involving operational independence, based
upon the principles of clearly defined responsibilities, transparency and accountability, which I have
described. But I am very conscious that, whatever the formal arrangements applying to the central
bank, the political and public confidence on which our position depends is something that we, all of
us, need continuously to earn through personal and professional integrity, objectivity and competence.
It is in the end, as I say, up to us.