For release on delivery
10:00 a.m. EDT (3:00 p.m. local time)
September 28, 2017
The Independent Bank of England--20 Years On
Remarks by
Stanley Fischer
Vice Chairman
Board of Governors of the Federal Reserve System
at
"20 Years On," a conference sponsored by
the Bank of England
London, England
September 28, 2017
It is a pleasure to speak at this commemoration of 20 years of Bank of England
monetary policy independence. In my remarks today, I will consider how central
banking in the United Kingdom and the United States has evolved in response to the
challenges of recent years. I will address a limited set of topics and will have time to
touch only briefly on each.1
These remarks are divided into three parts. In the first part, I will discuss several
aspects of aggregate monetary policy: central bank independence, policy transparency,
and policy tools. In the second part, I consider differences between the approaches of the
two banks to their lender-of-last-resort function. And, third, I will close with brief
reflections on the central bank's responsibility for financial stability.
Revisiting Goal Independence versus Instrument Independence
We start by considering a central bank that influences economic activity only
through its influence over the general level of interest rates.2 More than two decades ago,
Guy Debelle and I offered two terms--goal independence and instrument independence--
to describe such a central bank's degree of independence. Our definitions were as
follows: "A central bank has goal independence when it is free to set the final goals of
monetary policy. . . . A bank that has instrument independence is free to choose the
means by which it seeks to achieve its goals."3 In May 1997, the Bank of England
4
achieved instrument independence--something the Federal Reserve has long had.
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Under the new law, the Bank of England's Monetary Policy Committee (MPC),
rather than the Treasury, set the policy interest rate. Inflation targeting, which began in
the United Kingdom in 1992, continued under the new system and was codified in the
Bank of England Act of 1998.5 The MPC was given an explicit numerical inflation
target, corresponding to effective price stability, alongside an implied stabilization goal
for real economic activity.6 Consequently, the Bank of England from 1997 had the
combination that Debelle and I advocated: instrument independence but not goal
independence.
We also judged that the vagueness of the Federal Reserve's statutory objectives
meant that the Federal Reserve "has considerable goal independence."7 Today both the
FOMC and the MPC have a numerical inflation goal--2 percent. However, this
numerical goal is not specified in legislation in either country. In the United Kingdom,
the Chancellor of the Exchequer sets the MPC's inflation target: currently 2 percent per
year for the U.K. consumer price index.8 In the United States, in the FOMC's Statement
on Longer-Run Goals and Monetary Policy Strategy, first issued in 2012 and discussed
annually, Committee participants have judged that the longer-run inflation objective that
5
See the text of the act in Bank of England (2015a). (Since 1998, the U.K. Parliament has made a number
of amendments to the Bank of England Act 1998--among them a change, in 2016, to the frequency of MPC
meetings, from monthly to eight times a year. See Bank of England (2017a).)
6
From the start of inflation targeting in the United Kingdom in 1992, it was made clear that the authorities,
when faced with a situation in which inflation was different from the target rate, would generally not seek
to restore inflation to target as quickly as possible. Rather, they typically would opt for a policy that sought
to bring inflation back to target gradually, without unnecessary destabilization of real output. See
LeighPemberton (1992) and Bernanke and others (1999, pp. 156-57). This approach has continued in the MPC
era, as discussed later. It is an approach consistent with the MPC's remit in the Bank of England Act 1998
to achieve the inflation target through policies consistent with the economic policy of the U.K. government,
"including its objectives for growth and employment."
7
See Debelle and Fischer (1994, p. 217).
8
For the most recent statement by the Chancellor of the Exchequer on the inflation target to be pursued by
the MPC, see Hammond (2017).
- 3 -
corresponds to the Federal Reserve's mandate is a rate of 2 percent per year, as measured
by the change in the price index for personal consumption expenditures.9
In practice there is little difference between the policy goals of the two central
banks, or between the variables that are targeted. But there is a subtle difference between
them in terms of who sets the inflation target. To date, that difference has not generated
any major divergence between the approaches to monetary policy of the two central
banks.
Although much has changed in central banking since the 1990s, the case for
instrument independence, alongside statutory goals (lack of goal independence), remains
sound. Let me briefly give some of the main elements of that case. First, instrument
independence requires the central bank to make technical judgments about the instrument
settings most appropriate for achieving the statutory goals--and this choice is typically
based on a discussion of the central bank's monetary policy committee, informed by the
analysis of its staff. Second, monetary policy decisions aim at affecting economy-wide
interest rates and, thereby, aggregate economic behavior. The aims and tools of monetary
policy are therefore distinct from those of fiscal policy--whose instruments of taxation,
government purchases, and transfer payments are often used in the pursuit of
distributional or region-specific objectives. Decisions about fiscal policy should
therefore rest directly with the legislature. Third, when the statutory goals include price
stability, central bank instrument independence reflects the judgment that monetary
- 4 -
policy should not be driven by the revenue or financing needs of the fiscal authority.
Historically, this judgment has been the most prominent part of the case for central bank
independence.10 Fourth, the same arrangement precludes the monetary authority from
seeking the short-run boost to economic activity that might be associated with a
permanent increase in the inflation rate. Fifth, this arrangement seeks to avoid
undesirably low inflation: The policy committee, in pursuing a symmetric inflation
objective, should provide accommodation when needed to prevent inflation from being
persistently below that objective.
Transparency, Accountability, and Communications
In a paper written for the Bank of England's tercentenary, I considered how an
instrument-independent central bank might conduct itself.11 My discussion noted that an
independent central bank should adhere to the "principle of accountability to the public of
those who make critically important policy decisions."12 Accountability, in the senses I
defined it, included the requirement "to explain and justify its policies to the legislature
and the public"--that is, policy transparency and communications.13 Transparency,
public accountability, and policy communications form the quid pro quo of central bank
independence, and they can also contribute to achievement of macroeconomic goals.
These were points the FOMC recognized in its Statement on Longer-Run Goals and
Monetary Policy Strategy, which observed that clarity concerning policy decisions
"increases the effectiveness of monetary policy, and enhances transparency and
- 5 -
accountability, which are essential in a democratic society." In my coverage of these
issues today, however, I would like to concentrate on the Bank of England, which in the
past quarter-century has been an innovator on accountability and transparency in several
ways.
Calls for more transparency concerning U.K. monetary policy and the Bank of
England's monetary actions predated independence. For example, in the late 1950s,
Richard Sayers observed: "It may not be wise to turn the central bank into a goldfish
bowl, but at least some relaxation of the traditional secretiveness would make for better
14
health in the nation's monetary affairs." And some Bank communications vehicles,
Quarterly Bulletin
such as the economic analysis in the and testimony and speeches by
the Governor and other Bank officials, were of long standing by the mid-1990s. But the
Bank of England made further strides toward improved transparency and
communications during the 1990s. In 1993, it initiated the Inflation Report. From the
beginning, the Inflation Report was intended to increase transparency about the U.K.
monetary policy reaction function--that is, the connection between policy instruments and
economic variables, including the goal variables.15 After independence, the Inflation
Report presented the MPC's inflation forecast. Furthermore, alongside other Bank
statements, the Inflation Report provides a publicly available analysis of the economy
and of economic implications of developments like Brexit. The content reflects the
- 6 -
Bank's change in focus--from markets in the pre-inflation-targeting era to
macroeconomic implications of financial and other developments.16
The Bank expanded its policy communications after 1997, publishing MPC
analogues to the FOMC releases (some of them only recent innovations by the Fed):
postmeeting MPC statements and meeting minutes. And an innovation of Mervyn King
in the early years of inflation targeting that has continued in the era of independence is
the Inflation Report press conference. Here, senior Bank figures discuss the MPC's
forecast and the state of the economy. This innovation was a forerunner of the Federal
Reserve Chair's press conference, begun in 2011, in which the Chair describes the latest
policy decision together with the Summary of Economic Projections (SEP) of FOMC
participants.
New Monetary Policy Tools
The MPC and FOMC have extensively--particularly in recent years--used two
monetary policy tools other than decisions on the current short-term interest rate. These
tools are forward guidance and asset purchases.17
Monetary authorities used to be very reluctant to discuss the future course of the
policy rate.18 By 1997, however, there was widespread recognition of the merits of
16
The MPC arrangements also require that a letter be written from the Bank Governor to the Chancellor of
the Exchequer in the event of an overshoot or undershoot of the inflation target that is in excess of 1
percent. As well as providing accountability, this arrangement gives the Bank an opportunity to emphasize
the longer-term nature of the inflation goal and the consideration given in MPC policy decisions to the
stabilization of real economic activity. For example, Carney (2016) outlined, among other things, "the
horizon over which the MPC judges it appropriate to return inflation to the target" and "the trade-off that
has been made with regard to inflation and output variability in determining the scale and duration of any
expected deviation of inflation from the target."
17
In addition to these tools, the MPC has used the Funding for Lending Scheme to boost bank lending. It is
beyond the scope of my talk to discuss this further innovation.
18
For example, Federal Reserve Chairman Arthur Burns once noted (Burns, 1977, p. 717): "Federal
Reserve officials are extremely careful to avoid any public comment that might suggest or imply some
particular outlook for interest rates." In the United Kingdom, in 1981 Chancellor of the Exchequer
- 7 -
clarity on the reaction function and of having long-term interest rates incorporate accurate
expectations of future policy. These considerations led to the FOMC's use of forward
guidance regarding the short-term interest rate in its postmeeting statements during the
mid-2000s. The MPC, in contrast, for a long time generally preferred to let markets infer
likely future rates from the extensive communication it provided about its reaction
function.19
Beginning in 2008, with the policy rate at or near its lower bound, regular forward
guidance acquired new efficacy.20 Through forward guidance, additional
accommodation from short-term interest rate policy could be provided by communicating
how long the policy rate was expected to remain at its lower bound. The knowledge that
the short-term policy rate likely would be lower for longer would put downward pressure
on longer-term rates. The FOMC has provided forward guidance on the policy rate in its
postmeeting statements ever since the target federal funds rate was brought to the lower
bound in December 2008. In addition, the SEP shows individual FOMC participants'
expectations regarding the policy rate, though it does not identify the individuals in the
Geoffrey Howe observed (Howe, 1981) that it was not the authorities' "practice to forecast interest rate
movements."
19
Although it provides an inflation forecast in the Inflation Report, the MPC does not form an interest rate
forecast in conjunction with that inflation forecast. Instead, its current practice is to report a "CPI inflation
projection based on market interest rate expectations" (Bank of England, 2017b, chart 5.1). The fact that
the MPC's Inflation Report forecasts (for real output growth, inflation, and the unemployment rate)
condition on market expectations of interest rates is one difference between the MPC forecasts and the
FOMC participants' projections that are summarized in the SEP. Another difference is that the SEP
consolidates information on the projections constructed and submitted separately by the individual FOMC
participants, while the Inflation Report's economic projections are arrived at collectively by the MPC and
are therefore the forecasts of the committee as a whole. This is another aspect of the differences of
behavior between the two monetary committees that is both interesting and possibly important, but for
which there is not enough time for a more detailed discussion.
20
Woodford (2013) provides an analysis of the value of forward guidance under various conditions,
including the case in which the policy rate is at its lower bound.
- 8 -
interest rate dot plot. In the United Kingdom, the MPC started providing forward
guidance in its postmeeting statements in 2013.21
As the policy rate--Bank Rate--is still at its lower bound in the United Kingdom,
it remains to be seen whether MPC forward guidance will continue during policy firming.
For its part, the FOMC has provided forward guidance in its policy statements during the
tightening phase that began with the increase in the target range for the federal funds rate
in December 2015.
Asset purchases are less of a new tool than forward guidance. In the early post-
World War II decades, both U.K. and U.S. authorities sporadically attempted to influence
long-term interest rates directly by transacting in longer-term Treasury securities. By
1997, however, monetary policy operations in longer-term securities markets had fallen
into disuse.22 The financial crisis changed matters, with both countries' central banks
expanding their balance sheets through large-scale purchases of longer-dated securities to
put downward pressure on longer-term interest rates and set in motion movements in
asset prices and borrowing costs that would stimulate spending by households and
businesses. It is widely, though not universally, recognized that these asset purchases
helped contain the economic downturns in the United Kingdom and the United States and
underpinned the subsequent recovery in each country. This experience raises the
question of whether the balance sheet will continue to be a routine tool of monetary
- 9 -
policy once interest rates normalize.23 The FOMC has indicated its preference that,
barring large adverse shocks to the economy, adjustments to the federal funds rate will be
the main means of altering the stance of monetary policy.24
Changing Perspectives on the Lender of Last Resort
The financial crisis and recession confirmed the value of central bank tools that
affect the financial system, beyond those most associated with monetary policy. One of
these tools is the discount window or lender-of-last-resort function. As of the mid-2000s,
the posture of the Bank of England and the Federal Reserve toward the lender-of-last-
resort function reflected the principles enunciated by Bagehot and the long absence of a
severe financial crisis: The discount rate stood above the key policy rate by a fixed
amount; the discount window was not used for macroeconomic stabilization; and
depository institutions were the users of the discount window, typically on a short-term
basis.25
In 1978, Rudi Dornbusch and I noted that the lender-of-last-resort function should
imply that "the central bank steps in to ensure that funds are available to make loans to
firms which are perfectly sound but, because of panic, are having trouble raising
26
funds." In the financial crisis that started in 2007, wide-ranging measures were taken
along these lines. In order to improve the functioning of U.S. credit markets, the Federal
Reserve made numerous changes to its lending arrangements: The spread of the discount
rate over the policy rate was lowered, lending was extended to include loans to
nondepository financial institutions, and facilities were created allowing longer maturity
of, and broader collateral for, loans than was usual for the central bank.27
After its own experience during the financial crisis, the Bank of England
permanently widened lender-of-last-resort access to include not only commercial banks,
but also other systemically important financial institutions.28 In the United States, the
discount rate has for several years been back to its normal relationship with the policy
rate, and the special lending facilities have long since been wound up. Emergency
lending facilities of the type seen during the financial crisis remain feasible, if needed,
though subject to approval from the U.S. Treasury.
Discount window lending puts public funds at risk--though I stress that the
Federal Reserve's lending during the crisis did not, in fact, lead to any losses. The lender
of last resort is also a less impersonal, and more allocative, device than aggregate
monetary policy tools, because it involves direct lending by the central bank instead of an
attempt by monetary policy to alter the overall cost of private-sector borrowing. For
these reasons, the lender-of-last-resort function is bound to be more rule driven than
interest rate policy, and it is inevitably associated with collateral arrangements and other
safeguards to protect against losses and with strict eligibility criteria.
The Financial Stability Responsibility of the Central Bank
The financial stability responsibility of the central bank is one that has been
subject to considerable institutional change over the past two decades. Until 1997, the
Bank of England had wide supervisory and regulatory powers. With the reforms of the
late 1990s, the Bank had a deputy governor responsible for financial stability, but
regulatory powers were largely moved to a different institution, the Financial Services
Authority (FSA). A decade later, the financial crisis demonstrated that financial
imbalances can ultimately endanger macroeconomic stability and highlighted the need for
enhanced central bank oversight of the financial system. In the post-crisis era, the FSA
became two separate regulatory authorities, one of which--the Prudential Regulation
Authority, created in 2012--is part of the Bank of England. In effect, regulatory powers
have largely returned to the Bank. It is fair to say that the Bank was initially glad to cede
many of its financial powers, but that it was later even more glad to have those powers
restored.
Financial supervision has also been reformed in the United States in light of the
crisis. The Federal Reserve, which always had regulatory powers, received enhanced
authority and devoted more resources to financial stability.29 In both countries, it
remains the case that not all financial stability responsibilities rest with the central bank--
so it is less independent in this area than in monetary policy proper--and that the central
bank's tools for achieving financial stability are still being refined. Indeed, as I have
noted previously, a major concern of mine is that the U.S. macroprudential toolkit is not
large and not yet battle tested.30
The Federal Reserve and the Bank of England benefit from each other's
experience as they develop and improve arrangements to meet their financial stability
responsibilities. One major innovation that deserves mention is that the Bank of England
has two policy committees: Alongside the MPC is the Financial Policy Committee
(FPC). Although they coordinate and have partially overlapping memberships, the MPC
and FPC are distinct committees.
Why have both the MPC and the FPC? I offer a few possible reasons. First, not
all of a central bank's responsibilities typically rest with its monetary committee. This is
true not only of the Bank of England, but also of the Federal Reserve: Our financial
regulatory authority resides in the Board of Governors, not the FOMC. Second,
aggregate monetary policy tools are often blunt weapons against financial imbalances, so
deploying them might produce a conflict between financial stability and short-term
economic stabilization. Macroprudential tools may be more direct and more appropriate
for fostering financial stability.31 Third, financial policy might need less frequent
adjustment than monetary policy. Perhaps reflecting this judgment, the FPC meets
quarterly, which contrasts with the MPC's eight meetings a year.32 The lower frequency
of meetings may also reflect the desirability of a relatively stable regulatory structure;
financial tools likely should not be as continuously data dependent as monetary policy
tools.
It is clear that the U.K. institutional framework for the preservation of financial
stability has much to be said for it. But it also seems clear that there is no uniquely
optimal set-up of the framework for the maintenance of financial stability that is
independent of the size and scale of the financial system of the country or of its political
and financial history.
Conclusion
It has been more than 20 years since the Bank of England celebrated its 300th
birthday with a conference focused on central bank independence. Since then, central
banks' operating frameworks have undergone substantial changes, many in response to
the financial crisis. But the case for monetary policy independence set out in the 1990s
remains sound, and Bank of England monetary policy independence is now widely
accepted in the United Kingdom, as it long has been in the United States. It is also clear
that central bank responsibilities other than policy rate decisions--specifically, the lender-
of-last-resort function and financial stability--are closely connected with monetary policy
and that these responsibilities play a prominent role in macroeconomic stabilization.
Let me conclude by observing that, while the crisis and its aftermath motivated
central banks to reappraise and adapt their tools, institutions, and thinking, future
challenges will doubtless prompt further reforms.33 Or, if I may be permitted a few final
words on my way out the door, the watchwords of the central banker should be "Semper
vigilans," because history and financial markets are masters of the art of surprise, and
"Never say never," because you will sometimes find yourself having to do things that you
never thought you would.
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