Introduction to Government response

The Government welcomes the Committee's conclusion that "The Chancellor's decision to transfer day to day control of monetary policy to a politically independent Bank of England has been vindicated so far in the transparency and technical quality of the process of decision making."

The Government's response focuses on those specific recommendations that concern the overall monetary policy framework, for which the Government remains accountable. The Bank will respond separately on those matters that concern the implementation of the Government's policy, which is now the responsibility of the Monetary Policy Committee (MPC). A copy of the Treasury Paper "The New Monetary Policy Framework", released on 19 October, is attached.[1]

Letter to the Chairman from the Governor of the Bank of England

In its eighth report, "The Monetary Policy Committee—Two Years On" the Treasury Select Committee made a number of recommendations. Some of those were directed at the MPC itself and others were aimed at the Court.

We have discussed these recommendations and the underlying analysis thoroughly within the Bank. There is much to welcome and agree with in your report. The MPC has prepared a response to some of the recommendations, which has been noted by Court. That is attached. I also attach the Court's response, which they agreed at a meeting yesterday.[2]

Committee conclusion

(a)  It is too early to draw strong conclusions on the record of the Monetary Policy Committee (MPC). The Chancellor's decision to transfer day-to-day control of monetary policy to a politically independent Bank of England has been vindicated so far in the transparency and technical quality of the process of decision-making. It is clear that the MPC have begun to affect inflation expectations favourably, though the full effect on inflation itself may not be clear until about two years after the interest rate changes concerned. The MPC has had initial success in establishing credibility, in helping to ensure that inflation has been so close to target over the last six months, and in helping to manage the consequences for Britain of instability in the world economy (paragraph 16).

Government response

The Government welcomes the Treasury Committee's conclusion that the decision to make the Bank of England independent has improved the conduct of monetary policy. As set out in a recent Treasury paper, the MPC has performed very well over its first 2½ years as demonstrated by its success in keeping inflation close to target; in reducing inflation expectations; and in helping to steer a stable course for the economy in the face of considerable instability in the global economy. A forward-looking and vigilant approach will continue to be needed to maintain this good track record.

Committee conclusion

(b)  Witnesses told us that survey evidence of the type seen in the second half of 1998 had in the past always been a strong indicator of an economic recession. In the light of this, the actions of the MPC have helped to stave off recession (paragraph 18).

No responses.

Committee conclusion

(c)  We are concerned that the MPC should not be open to the criticism that occurred following the suspension of the earnings data. Faulty data series may lead to mistakes that could damage the credibility of the monetary framework. It is too early to be sure that the interest rate increase of June 1998 was not a potentially serious mistake. We will expect the non-executive directors of the Court of the Bank to give the issue of the quality of data provided to the MPC a high priority in their oversight of the work of the MPC, and in particular to monitor very carefully the implementation of the service level agreement between the Office for National Statistics and the Bank (paragraphs 22-23).

Government response

The Government is committed to enhancing the integrity of official statistics, an important element of which is assured quality. The Government recognises that official statistics must be sufficiently accurate and reliable for the purposes which they are required. That is why it acted quickly and decisively in the case of the revisions to the average earnings index in October 1998.

The Green Paper, Statistics: A Matter of Trust,[3] sought views on the best way to achieve the Government's aim, and following an extensive consultation exercise the Government has set out its decisions in this area in the White Paper, Building Trust in Statistics.[4] The centrepiece of the new framework for official statistics is the creation of a Statistics Commission, independent of both Ministers and the producers of official statistics. The Commission will play a key role in quality assurance and priority setting, ensuring that official statistics are trustworthy and responsive to public needs. The Government also believes that it would be desirable for Parliament to play an enhanced scrutiny role within the new arrangements.

The Government also welcomes the introduction of a service level agreement on statistics between the Bank of England and the Office for National Statistics as an effective means of highlighting key issues and requirements and ensuring effective dialogue between the two parties.

MPC response

A service level agreement between the ONS and the Bank has now been signed. This gives the Monetary Policy Committee an opportunity to offer its views to the ONS about the priorities for statistical work on economic data over the coming year. It provides a framework within which the ONS and the Bank can work more closely together to exchange views and ideas. The non-executive directors of the Court of the Bank have taken a close interest in progress towards signing and implementing the service level agreement, and will continue to do so.

Committee conclusion

(d)  We propose that the MPC consider whether adopting the approach used by the Federal Reserve's Open Markets Committee (FOMC)—whereby the FOMC announces in its minutes, and sometimes immediately after its meeting, the bias, if any, of future policy—would enhance the current system (paragraph 28).

Government response

It is a matter for the MPC to decide how best to present its interest rate decisions and the outlook for future policy. The MPC's minutes provide a full and transparent discussion of the issues affecting the policy decision.

MPC response

The Report asked us to consider whether the MPC should adopt the approach used by the FOMC in the United States which sometimes, but not always, announces a "bias" in its future policy. The MPC has considered the question carefully, and has decided that it does not wish to announce a bias. The Committee does not reach a collective view about the future path of interest rates. Decisions are made month by month. The range of views among the Committee is published in the minutes, together with the votes, less than two weeks after the previous decision is made. To try to summarise those views in terms of a single statement of "bias" would not be helpful. Indeed, the practice of the FOMC caused some market uncertainty about the interpretation of both the adoption and subsequent omission of a reference to a "bias to tighten" in the middle of 1999. The Inflation Report contains projections for both output and inflation over the following two years and that document is published every three months. Taken with the minutes, that is a much more comprehensive guide to the analysis of the MPC's decisions than could be contained in references to a supposed bias about future decisions.

Committee conclusion

(e)  We welcome the clarity with which the minutes have explained potentially complicated policy decisions and the openness with which the MPC have discussed their decisions in their appearances before this committee (paragraph 31).

No responses.

Committee conclusion

(f)  We welcome the Bank's efforts to explain the work of the MPC and encourage it to continue to devise new and innovative ways of enhancing public awareness and understanding of the MPC's actions. This will be crucial in order to bring the inflation expectations of the public in line with those of professionals. We look forward to seeing evidence from the Bank in a year's time on how they have broadened the reach of their information campaign (paragraph 33).

Government response

The Government supports efforts by the MPC to increase awareness of its actions and to enhance the recognition of the importance of low inflation for the long-term performance of the economy. This should help to reduce inflation expectations and improve the prospects for keeping inflation close to target. The Bank convened a special working party to look at these issues.

MPC response

The Bank has continued to explore ways of building a constituency for low inflation; that is in addition to the regular speeches and presentations already undertaken by members of the MPC and the Bank's regional Agents around the UK. A working party on this subject was chaired by Deputy Governor, Mervyn King. Its recommendations were accepted by Court. They comprise a continuing programme to expand knowledge and awareness of the Bank's responsibilities, and the importance of maintaining low inflation. Several concrete steps have been taken. The first is the commissioning of quarterly opinion poll surveys about inflation, the way in which interest rates are set, and the work of the Monetary Policy Committee. The second is the planning of a new monetary policy competition for schools throughout the United Kingdom. Students of economics and business studies will be asked to present a case for a level of interest rates, based on a dossier of supporting material prepared by the Bank. The competition will build up through regional rounds to a national final at the Bank in London. The eventual winners will be chosen by a panel, including MPC members. A third step involves the internet. The internet will play an increasingly important role in the dissemination of information to schools, universities and other groups. The Bank is working with an organisation, Biz/ed, to design a "virtual" Bank of England. Biz/ed has undertaken a number of educational projects, most recently with the Institute for Fiscal Studies (IFS), the ESRC Macroeconomic Modelling Bureau, the Nuffield Foundation and the BBC. This "virtual" Bank will help to explain the importance of low inflation and the role of the Monetary Policy Committee in delivering it.

Committee conclusion

(g)  We would encourage members of the MPC to visit sectors of the economy and regions and nations of Britain to make themselves and their views better known and to hear the views of others. We would also encourage the MPC to hold meetings and hearings outside London (paragraph 34).

MPC response

Members of the MPC have made many visits throughout the UK. They have continued to make their views known around the country, and to listen to the views of those working in the regions which they have visited. It is helpful to the MPC to hear views from all areas of the UK to complement sectoral and regional insights provided by the Bank's Agents and members of Court. But the Committee's policy meetings take place during a "purdah" period. So there would be little benefit to the Committee or the regions for the MPC to hold these meetings outside London, because MPC members could not speak publicly during that "purdah" period before and immediately after MPC meetings. There is no comparable "purdah" period for the Court of the Bank, which has met outside London. Further such meetings of Court are planned, the next being in Edinburgh in January. These meetings do provide a good platform for the members of Court and the MPC to hear others' views and to make their own views better known.

Committee conclusion

(h)  We believe that the accountability and the effectiveness of the MPC will be increased by allowing its members to take part in new debates and new initiatives. We welcome the part played by members of the MPC in pressing for better public information and national statistics, especially for the service sector, for City bonuses, and for earnings data generally. But we consider it surprising that no presentation of the differential effects of monetary policy on sectors of the economy and on regions has been made by the Bank since the MPC was formed (paragraph 35).

MPC response

The Treasury Select Committee considered it surprising that no presentation of the differential effects of monetary policy on sectors of the economy and on regions had been made by the Bank since the MPC was formed. The Bank regularly publishes, in the Inflation Report, analyses of sectoral developments (recent examples include the construction industry, the car market, the communications industry and agriculture). The impact on different regions would largely follow from different regional compositions of economic activity in different sectors. The MPC also learns much about the sectoral and regional impact of monetary policy from members' regional visits and the work of the Bank's Agents. It is important to undertake analysis of sectors and regions, because this informs our understanding of the impact of monetary policy on the economy as a whole. The target given to the MPC is a national one, and there is a single national interest rate, which the MPC uses to meet the target.

Committee conclusion

(i)  Though the arguments are finely balanced, we remain to be convinced that MPC members' views should not be individually ascribed in the interests of accountability. We propose to return to this issue in a future report (paragraph 39).

Government response

The Bank of England Act requires that the MPC publishes the minutes of its meetings, including a voting record. The Government is not convinced that ascribing individual views will necessarily improve the quality of the MPC's decisions.

MPC response

The MPC does not, at present, propose to change the practice by which members' views are not individually ascribed. Individual accountability is met by the recording of individual votes. Ascribing views could have two undesirable consequences. First, the minutes would contain nine separate paragraphs with possibly many overlapping references to the same data and very slightly different interpretations of them. Outside observers would compare the paragraphs for nuances that might be insignificant. Second, and more important, there would be a temptation for members to come to the meeting with a pre-drafted statement that would simply be read into the minutes. The purpose, and a major strength, of our meetings is to exchange views and be prepared to change one's mind upon hearing others' arguments.

Committee conclusion

(j)  We intend to continue to hold confirmation hearings for new members of the MPC and for the re-appointment of existing members and we again formally request the Government and Parliament to put such hearings on to a statutory basis (paragraph 40).

Government response

The Government welcomes the role played by the Treasury Committee in ensuring that the MPC is held properly to account, including the holding of non-binding hearings on MPC appointments and reappointments. However, the Government sees substantial difficulties with the Treasury Committee's suggestion that it should hold statutory confirmation hearings for new members of the MPC and for the re­appointment of existing members. This proposal raises important constitutional issues which go far wider than the Bank of England. It would therefore be more appropriate for the House to consider first the issue of official appointments and the role of Select Committees in general rather than to legislate for confirmatory hearings for the MPC in isolation.

The Government is committed to appointing top calibre candidates, with appropriate expertise and independence.

Committee conclusion

(k)  Whilst we welcome the Inflation Report's explanation of the reasoning behind the MPC's policy decisions, we note the concerns expressed by the IMF about the objectivity of the Inflation Report. In the interests of transparency and accountability we therefore request that the Bank publishes a paper annually assessing its own forecasting record and, in order to ensure objectivity, gives greater emphasis in the Inflation Report to external inflation forecasts (paragraph 44).

MPC response

The Inflation Report is designed to explain the actions of the MPC and its views about the future prospect for output and inflation. The Inflation Report does contain information on as many external inflation forecasts as it is possible to obtain. Indeed, the Inflation Report led the way in encouraging external forecasters to report probabilities about future outturns for inflation and output. All of these have been published for some time on a regular basis in the Inflation Report (in the August 1999 Report, they were described in section 6.3 on page 54). The MPC also published an assessment of its own forecasting record in the August Inflation Report (page 55). That will be an annual exercise.

Committee conclusion

(l)  We agree with the Chancellor's view that keeping to the same inflation target for a period of time makes it clear that the Government is pursuing a consistent aim and adds to the credibility of its anti-inflation policy (paragraph 46).

No responses.

Committee conclusion

(m) We request the Bank to publish a paper to explain the effect on inflation of differential changes in asset prices (paragraph 47).

MPC response

A response to this request will be produced for the Committee in due course.

Committee conclusion

(n)  The recognition of the inflation target as "symmetrical" has led to important extra flexibility for the MPC. Without this flexibility the dangers of a single inflation target producing a "two tier economy" would be far greater (paragraph 51).

Government response

The Government welcomes the Treasury Committee's recognition of the importance of the symmetric inflation target. As explained further in the Treasury's recent paper, the Chancellor has set a symmetrical inflation target so that the MPC has to treat outturns of inflation below the target just as seriously as outturns above the target. This ensures that monetary policy remains neither unnecessarily tight or unnecessarily loose, while meeting the inflation target.

Committee conclusion

(o)  We fully support the role of the non-executive directors of the Court as laid down in the Act, and commend them on their approach to analysing the regional data provided by the MPC. We are however concerned that the non-executive directors appear to be interpreting their role in a narrower manner than implied by the Governor. We would therefore urge them to play a stronger role in representing their sectors and regions within the Bank (paragraph 56).

Response by the Court of the Bank of England

The Treasury Committee appears to have misunderstood the role of non-executive Directors on the Court of the Bank. A number of functions have been delegated by Statute to the non-executive Directors. These include reviewing the procedures of the MPC, which extends to determining whether the MPC has collected the regional, sectoral and other information necessary for the purposes of formulating monetary policy, and reviewing the way the Bank is managed, in particular the Bank's performance in relation to its objectives and strategy, which are determined by Court. In addition, non-executive directors must contribute a section to the Bank's annual report on their work during the year, and this report is sent to the Chancellor and laid before Parliament. As part of their role, non-executive Directors often explained to Court, and to MPC members (who are invited to attend Court for the presentation of their monthly report) views that are being expressed in their own sectors and region. Non-executive Directors also discussed the work of the Agents in Court with a number of the Agents and made a series of visits to Agencies to see at first hand how the Bank gathers regional intelligence. However, it is not part of the role set down for non-executive Directors in the Bank of England Act 1998 to be formal representatives in the sense of acting as delegates for their sectors and regions. Given the wide range of their work for the Bank, including their discussions with MPC members, Court does not accept that the non-executive Directors are interpreting their role in a narrow way.

Committee conclusion

(p)  We believe that the framework has so far avoided potentially serious conflict between coordination of monetary and fiscal policy. The Treasury have sent us a letter and a paper on the role of the Treasury representative, but we recommend that the Bank and the Treasury publish a fuller explanation of the role and practice of the Treasury representative (paragraph 60).

Government response

The Government is committed to openness and transparency in the monetary policy framework. A comprehensive note on the role of the Treasury representative on the MPC was sent to the Committee in June.[5]

The IMF stated in a report in May 1999 "experience before 1997 shows that having both policy instruments under the control of the government provides no guarantee of effective policy coordination."[6] As the Chancellor said in his evidence to the Committee, under the new monetary framework "There is, I am convinced, a much more informed discussion of the interaction of monetary and fiscal policy and as a result much better co-ordination."[7] The Governor agreed with the Chancellor's assessment when he said "I do not believe that the worry that there is not enough co­ordination between the monetary and fiscal side is a real one. I do not feel any discomfort on that score at all".[8]

MPC response

There is no conflict between the objectives of monetary and fiscal policy, because the Chancellor sets the objectives for both. Nor are the two authorities unaware of what the other is doing. A Treasury representative attends meetings of the MPC, and one of his duties is to brief the Committee on fiscal policy developments. This may take the form of advance notice of the overall fiscal stance to be announced in the Budget. Equally, he reports back to the Chancellor on the monetary policy decisions of the MPC. This clear and systematic channel of communication works well.

Committee conclusions

(q)  We agree with the Governor that a weaker exchange rate would ease the problem of sectoral imbalance (paragraph 61).

(r)  We believe that it is extremely likely that the relatively high interest rates in the UK have had a part in underpinning the strength of sterling (paragraph 62).

(s)  We agree that an exchange rate target in the present conditions in world financial markets would not be sustainable; but we welcome the Governor's assurance that the present level of the exchange rate contributes to MPC decisions (paragraph 63).

Government response

The Chancellor has set the MPC a clear objective: a symmetric inflation target that supports the Government's objectives for growth and employment. Replacing the inflation target with an exchange rate target is not the right way to secure domestic stability and would fail to learn the lessons of the 1980s and early 1990s.

Maintaining low inflation and sound public finances are the best contribution that the Government can make to sustaining economic stability, including exchange rate stability, over the medium term.