Select Committee on Monetary Policy Committee of the Bank of England First Report



APPENDIX 5

Government Response to the Committee's First Report: 27 July 1999, Paper 96, Session 1998—99

The Government welcomes the Committee's conclusion that "The Government was right to give operational independence for monetary policy to the Bank of England, and to place it on a statutory basis".

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. [not printed]

The Government's response to the Committee's specific recommendations is set out below.

1.  The Government was right to give operational independence for monetary policy to the Bank of England, and to place it on a statutory basis (paragraph 7.3).

·  The Government welcomes the Committee's support for its decision to give the Bank of England operational independence to set interest rates. As noted in a paper published on 19 October by the Treasury, this has increased the credibility of monetary policy and should help ensure that the inflation target continues to be achieved. Low inflation is an essential precondition for delivering the Government's central economic objective of achieving high levels of growth and employment.

2.  The Treasury and the Bank of England have a duty to monitor in detail the performance of the Monetary Policy Committee, and to publish their assessment of it (paragraph 7.2).

·  The Government monitors carefully the MPC's performance. A recent paper by the Treasury sets out the Government's assessment of the performance of the MPC, and the framework more generally, over the first 2½ years of its existence. The paper concludes that the MPC have been very successful in maintaining price stability while avoiding a return to the boom and bust cycles seen so often in Britain's past.

·  The new framework is characterised by a clear separation of roles and responsibilities. The MPC has a clear remit — to achieve a symmetric inflation target and thus support the Government's economic objectives for growth and employment. Economic commentators continually assess the MPC's performance. This Lords Committee report and the Commons' Treasury Select Committee report add to this high level scrutiny.

3.  We agree that an inflation target of 2.5 per cent is appropriate at this time (paragraph 7.6).

·  The Government welcomes the Committee's support for its inflation target. As the Chancellor has stated on numerous occasions, it is important to have a record of sticking to the target set.

·  The Committee also suggests that the open letter system needs explaining because inflation 1 percentage point above or below target "does not necessarily imply serious policy error". As discussed in the Treasury's 19 October paper, the open letter should not necessarily indicate failure. Rather, it provides an immediate opportunity for the MPC to explain why the divergence has occurred; the policy action being taken to deal with it; the period within which inflation is expected to return to the target; and how this approach meets the Government's objectives for growth and employment.

4.  There is a need for further clarification by the Treasury on the "subject to that" part of section 11 of the Act (paragraph 7.7).

·  The Chancellor sent the Committee a Memorandum (p387 of the Committee's evidence) which set out clearly how section 11 of the Bank of England Act is to be interpreted. This interpretation is accepted by the Bank.

5.  We are less than clear whether the decision procedure of the Monetary Policy Committee is more an art than a science. They must make their procedure clearer so as to aid public scrutiny, and re-examine this procedure in order to remove any possible bias (paragraphs 7.9 and 7.11).

·  This is a matter for the Bank of England. However, the Government believes the minutes of the MPC meetings provide a very open and transparent account of the factors that underpin the MPC's interest rate decisions.

6.  Appointments of independent members of the Monetary Policy Committee must be made in a more open fashion. Such appointments should be for five years and normally non-renewable (paragraphs 7.13 and 7.14).

·  The Nolan procedures formally cover the Court of the Bank and the MPC. However, given the highly market sensitive nature of the MPC appointments there is a need for a particularly high degree of confidentiality in the process.

·  Appointments to the MPC are subject to external scrutiny, ex post, by the Treasury Select Committee. The MPC is also much more accountable than other public bodies through statutory requirements for reporting, e.g. disclosure of decision, publication of minutes and individual's voting records, the quarterly Inflation Report and regular appearances before parliamentary committees.

·  As regards the length of appointment, there is a balance to be struck. On the one hand, terms need to be long enough for members to develop experience and familiarity with the MPC procedures. On the other hand, terms should not be too long so that high calibre candidates are not deterred from applying. The Government believes it has struck a reasonable balance.

·  The Government sees no reason why a well-performing member should not remain on the MPC for more than one term.

7.  More attention should be paid to the reasons for interest rate differential between our interest rate and that set by the European Central Bank (paragraph 7.10).

·   The Bank of England Act requires the MPC to set interest rates to meet the inflation target defined by the Government. The Government's inflation target was reaffirmed by the Chancellor in the Budget in March of this year as a 2½ per cent annual increase in the RPIX. The differential between UK and euro area interest rates reflects differences in the cyclical positions of the two economies, but has narrowed over the past 2 years.

8.  The Court needs to make full use of its power with respect to the Monetary Policy Committee and could play a more active role (paragraph 7.16).

·  This is an issue for the Bank of England.

9.  The Office for National Statistics (ONS) needs to play a more active role in dealing with all the problems that have emerged in connection with the measurement of inflation, and especially the role of the harmonised index of consumer prices (HICP) (paragraphs 7.17 and 7.20).

·  The ONS plays an active role in the statistical aspects of inflation measurement. It is actively involved in a major research programme investigating possible bias in the RPI and plays a major role with Eurostat and partner Member States in the development of the HICP. It also consults users (and price index experts) on these developments.

·  The ONS provides users with advice about the statistical attributes of its various inflation measures. In particular, it publishes RPI and RPIX as the main domestic measures of consumer inflation. It also promotes the HICP for use in international comparisons and recognises the HICP as the preferred measure of inflation in the Monetary Union area.

·  Publication of the HICP was brought forward last year and now appears with the RPI and RPIX in a joint First Release that includes commentary on the relationship between the measures.

10.  Response to observation that "ONS should undertake or commission research to determine (a) whether there are significant regional differences in inflation rates, and (b) how important in quantitative terms normally is the distinction between domestically caused inflation and imported inflation".

·  ONS are aware that there is a growing demand for regional data in general. ONS will continue to consult with users about their needs and evaluate these relative to other priorities in the context of its annual planning round. The development of regional inflation measures would require a major development programme to resolve a number of technical matters. Also there would be a need to expand significantly the Family Expenditure Survey to provide regional consumption patterns. This would involve significant additional expenditure involving millions of pounds rather than thousands.

·  The ONS does not explicitly produce measures of domestically generated inflation. There are certain conceptual differences in decomposing inflation between domestic and imported sources. These are discussed in the August 1998 Bank of England Inflation Report (page 39). Nevertheless, a range of measures of domestically generated inflation can be derived from existing ONS inflation indices such as RPI, import prices and the GDP deflator.

11.  Clarification is required of the part that the external value of sterling plays in the transmission mechanism of monetary policy to the real economy (paragraphs 7.22-7.23).

·  The Bank of England published a paper "The transmission mechanism of monetary policy" in its May 1999 Quarterly Bulletin, which set out the role the exchange rate plays in the monetary transmission mechanism.

19 October 1999



LETTER FROM THE GOVERNOR OF THE BANK OF ENGLAND TO THE CHAIRMAN OF THE COMMITTEE

I understand that the House of Lords will be debating your Report on the Monetary Policy Committee next Tuesday. The MPC and the Court of the Bank have considered your recommendations and the Court have prepared a written response to recommendation 8, which I enclose. The MPC have noted the other recommendations and will be happy to give further evidence if required.

E.A.V. George

28 October 1999



RESPONSE BY THE COURT OF THE BANK OF ENGLAND

The Committee recommended "The Court needs to make full use of its powers with respect to the Monetary Policy Committee, and could play a more active role".

In the body of the report it said, "The 16 outside members of the Court are all part-time. Our interpretation of the Act is that they are involved with the accountability process. We are concerned with the way in which they have undertaken this task so far. On the face of it, they have an important role in setting the parameters under which the Bank itself and the MPC operate. It was also our impression that they would play a central part in the preparation of the Annual Report, and in assessing the work of the MPC. While accepting on this as on everything that these are early days, we are surprised at the reluctance shown by the Court in exercising their functions in relation to the MPC. We would expect their role to be stronger in future, not least in connection with the quality of data made available to the MPC".

Court as a whole is responsible for the management of the Bank, apart from the formulation of monetary policy. The non-executive Directors on Court have been delegated a range of particular functions, including reviewing the Bank's performance in relation to its objectives and strategy (which are set by Court), monitoring financial management, reviewing internal financial controls and setting remuneration. They are also required to review the procedures of the MPC, and in particular, determine whether the Committee has collected the regional, sectoral and other information necessary for formulating monetary policy. Non-executive Directors must contribute a section to the Bank's annual report on the discharge of their functions, and this report is sent to the Chancellor and laid before Parliament.

Court plays a very active role in managing the Bank as a whole, taking responsibility for the same high level management, investment and financial control issues as the board of a public company, and preparing and publishing audited accounts each year in accordance with Companies Act requirements. Court also has an Audit and Remuneration Committee, in line with private sector practice.

In relation to the MPC, Court made full use of its powers, to review the procedures of the MPC, and examine the collection of information. These powers are delegated to the non-executive Directors, who commissioned and considered in Court, and in meetings of their own sub-committee between October 1998 and April 1999, eight papers on the work of the MPC. In particular, there were lengthy and detailed discussions of the quality of data made available to the MPC. Non-executive Directors reviewed the difficulties experienced with the earnings figures at the earliest possible opportunity after the problem came to light. Proposals for improvements, based on a service level agreement with the Office for National Statistics, were put to Court and endorsed by the non-executive Directors.

External members of the MPC were invited to many of the discussions on MPC procedures. The 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. Most of the non-executive directors also attended one or more of the pre-MPC meetings with Bank economists, which take place the Friday before the decision-making meeting, to see for themselves how the process works. The non-executive Directors discussed peer group reviews of the MPC procedures, including the views of other visitors to the pre-MPC meeting. In particular, they interviewed a team from the International Monetary Fund which reviewed the British monetary policy process as part of the Article IV consultations with the British Government.

Finally, the non-executive Directors were closely involved in the preparation of the annual report of the Bank, and contributed their own section to it. As described in this year's annual report, the non-executive Directors decided that they would, as far as practicable, rely on processes established for and work done for or in Court. Certain of the work required to fulfil their delegated functions was already carried out by the Audit and Remuneration Committees of Court. The work of these Committees is considered in Court. The terms of reference of these Committees were modified where necessary in order to align them with the Act and to facilitate the discharge of the non-executive Directors' responsibilities. The result was that a substantial amount of the work for which the non-executive Directors are responsible was in practice done in Court- 16 of whose 19 members are non-executive — or in committees of Court, which are entirely comprised of non-executive Directors. Therefore, to avoid duplication of work described in other sections of the report, the non-executive Directors kept their sections short, by referring wherever possible to other sections of the Annual Report, for which they, as members of Court, are also responsible. The non-executive Directors met regularly during the year to satisfy themselves that their delegated functions were being satisfactorily discharged.


 
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