2.3 The Bank of England – a bigger role in regulation

In the next video, Andy Haldane, chief economist at the Bank of England, talks about the Bank’s responsibility for monetary policy and the range of factors its Monetary Policy Committee takes into account when setting the level of the ‘official interest rate’ (or ‘Bank Rate’).

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MARTIN UPTON

Well we're here at the Bank of England and Andy Haldane is the Bank of England's Chief Economist. Good morning Andy.

ANDY HALDANE

Good morning.

MARTIN UPTON

Several questions I want to ask but the first one is about monetary policy. In 1997 the government handed the Bank of England responsibility for monetary policy. Is it better for the Bank to run monetary policy rather than the government?

ANDY HALDANE

Yes - I think it's better for the economy. I think it's better for society. I think it's better for the government as well actually for something like monetary policy to be put into the hands of the Central Bank.

Now why do I say that? Well what we found in the past in the UK and what many other countries have found historically is that leaving monetary policy, interest rates, in the hands of politicians leaves it rather at the whim of elections. So the pattern we sometimes saw in the UK and elsewhere was for example monetary policy being loosened, interest rates being lowered, in the run up to elections; which might not have suited the needs of the economy. It might have generated bouts of inflation; the sort of thing we saw during the 1970s and parts of the 1980s. So emerging best practice internationally over that period was to delegate responsibility for the setting of interest rates to a central bank, arms-length from elections, from the political process, and that way there's less chance of stoking up inflation pressures ahead of elections.

And as best we can tell, on the basis of experience, both in the UK and internationally, those countries that have handed monetary policy to the Central Bank have better been able to keep inflation under control. In the UK since 1987 when the Bank was given operational independence interest rate setting, inflation has averaged the target of around two per cent. So I think that's been a good outcome for the economy, for society and ultimately it's good for the government as well.

MARTIN UPTON

You mentioned the target for inflation of two per cent and how the MPC, the Monetary Policy Committee, when setting interest rates, had its eye on that. And I think now you also look at something called 'excess capacity' within the economy as well and how that might impact on inflation.

Well - what about the poor old savers? I mean do you think about them when you're setting interest rates because, after all, a lot of people with savings, particularly in later life, rely on interest for income?

ANDY HALDANE

Yes - absolutely we do. So when setting monetary policy, interest rates, you're right. We have an inflation target of two per cent to hit but that's not the only thing we have a weather eye on. We also have objectives to support the economy and to support the government's objectives for employment and growth.

So all of the time we are looking at not just at price pressures in the economy but levels of employment and levels of activity and how our interest rate decisions are affecting both borrowers and savers.

Now of course we can't keep everyone happy with one interest rate. If you're setting the interest rate low you're benefiting borrowers somewhat to the expense of savers and vice versa when interest rates are high. What we have to do is balance those interests and ask ourselves what is best for the economy as a whole and that's what we do.

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Following the financial crisis, the role of the Bank of England in the oversight of the financial services sector has been enlarged.

Since 1997 the Bank of England has managed monetary policy in the UK through its Monetary Policy Committee (MPC). The MPC sets the level of the ‘official’ rate of interest (also known as Bank Rate). By setting the official rate of interest, the Bank of England is able to influence the general rates of interest applied by financial institutions. The MPC determines what official interest rate to set by reference to the aim of ensuring that economic activity in the UK is maintained at a level consistent with the achievement of the medium-term target for price inflation, as established by the government.

The prevailing medium-term target (in 2016) is an inflation rate of 2 per cent per annum as measured by the UK’s Consumer Prices Index (CPI). This focus on controlling price inflation altered to a degree in 2013 when the Canadian, Mark Carney, took over the role of the governor of the Bank of England from Sir Mervyn King. The new governor indicated that monetary policy would focus more on helping to contain and reduce unemployment. This approach was subsequently revised to a focus on the more general indicator of ‘spare capacity’ in the economy.

As you saw in Week 1, in April 2013 the Bank also took on responsibility from the FSA – via its new subsidiary, the Prudential Regulation Authority (PRA) – for the regulation of the banks and other deposit-taking institutions, investment firms and insurers.

Additionally, the Financial Policy Committee (FPC) was established to monitor the economy and to identify macro-economic and financial issues that could threaten stability. The committee, chaired by the governor of the Bank of England, addresses these potential threats to financial stability by instructing the PRA or the Financial Conduct Authority (FCA) to take regulatory action with respect to the financial firms involved. To assist in this process the PRA and the FCA produce annual Risk Outlooks that set out an assessment of the economic and financial trends in the UK as a context for regulatory decision making and the supervision of financial firms.