Remit of the Monetary Policy Committee
of the Bank of England
4. The remit of the Monetary Policy Committee
of the Bank of England, which was established by the Bank of England
Act 1998, is:
(a) to maintain price stability; and
(b) subject to that, to support the economic
policy of Her Majesty's Government, including its objectives for
growth and employment.
5. The Act requires that the Government specify
at least every 12 months its economic policy objectives, including
what price stability consists of. The MPC's remit is to hit the
inflation target set by the Chancellor of the Exchequer, which
since the establishment of the MPC has been 2.5 per cent for the
6. The target is symmetric in that deviations
above and below it are of equal significance. All deviations matter,
but a special explanation is called for only when the deviation
is more than 1 percentage point.
7. Our predecessor Committee has discussed the
MPC's remit several times in the past, in relation to both the
formal remit and how it is interpreted.
The formal remit is defined very narrowly, which has always troubled
us. We have increasingly come to appreciate that in practice the
remit is interpreted more flexibly.
8. The MPC's policy instrument is the short-term
interest rate. Obviously, if the MPC has only one instrument at
its disposal, it can aim at only one target.
Equally important, a single target is compatible with the proposition
that, if the outcome deviates from the target (in this case the
inflation rate) or is expected to do so, there is still room for
manoeuvre in establishing the best path back to the ultimately
desired position. Too abrupt a change may cause instability and
damage the real economy. Too slow a change may take the inflation
rate too far away from the desired level and incur associated
costs. There is also likely to be a connection between the short-term
inflation outcome and the long-term ability to hit the target.
Such a trade-off was mentioned by Mr Geoffrey Dicks of The
Times Shadow Monetary Policy Committee (Q189).
9. One Deputy Governor of the Bank of England,
Mr Mervyn King, said: "The point of bringing inflation back
to target over a horizon longer than two years in some circumstances
is solely in order to reduce the risk of being further away from
the target at other times" (Q113). He referred to volatility
of demand (Q90). The Governor, the Rt Hon Sir Edward George, also
referred to undesirable volatility of output which "would
have implications for future inflation as well as output"
(Q113). Mr King also mentioned "undesirable volatility in
outputs" in his answer to Q136.
10. In evidence, Mr Matthew Taylor MP, Treasury
Spokesman for the Liberal Democrat Party, stated clearly his opposition
to a dual mandate
(Q204). He recognised that the MPC considers gross domestic product
because it affects volatility and inflation. He also said that
according to the Federal Reserve Act 1913, the goals of Unites
States monetary policy did not actually give more weight to growth
(Q204). The Treasury Spokesman for the Conservative Party, the
Rt Hon Mr Michael Howard QC MP, was also happy with the mandate
specified in the Bank of England Act 1998. He referred to the
second limb "to support the economic policy of [the]
Government, including its objectives for growth and employment"
(Q244). His view of the House of Commons Treasury Select Committee's
recommendation that the mandate be re-examined was clear: "There
is no harm in re-examining things, but my personal view is that
the case for changing the mandate has not been made" (Q245).
Mr Dicks and Ms Diane Coyle, both of The Times shadow Monetary
Policy Committee, were also content with the present remit. Indeed,
Ms Coyle said that "differences between the Bank of England
and the Fed are more apparent than real" (Q196). She added,
in terms similar to those of Mr Taylor: "It is a very long
time since the Fed sacrificed its simple inflation target for
the sake of the economy". Mr Martin Weale and Mr Anatole
Kaletsky, both of The Times shadow Monetary Policy Committee,
took a similarly broad view.
11. Differences in policy approaches can be illustrated
as follows. In the event of a recession, or when a recession is
anticipated, most economists would say that the correct monetary
policy response would be to cut interest rates. One explanation
of this is because recession is associated with a lowering of
inflation rates; therefore, hitting the inflation target requires
an easing of monetary policy. Another explanation is that a recession
is undesirable and it is safe to ease monetary conditions because
there is no danger of exceeding the inflation target. In practice,
the two lines of reasoning result in the same conclusion - that
interest rates should be cut. The MPC adopts the former reasoning;
others, including the Federal Reserve Bank, the latter.
12. For example, following the February cut in
the interest rate, the MPC explained that "over the next
few years the prospects for demand, both globally and domestically,
are somewhat weaker than anticipated."
This can be interpreted as meaning: (a) that inflation is predicted
to be below target, so monetary policy has been eased; (b) that
inflation is predicted to be below target, so it is safe to intervene
to stimulate demand for output and labour; or (c) that demand
prospects are poor, and priority must be given to stimulating
them. The MPC rejects the third view, but we consider that this
rejection involves an element of semantics rather than economics.
13. Although the operation of the MPC has mostly
been satisfactory, we reiterate our earlier view that something
like the formulation of the remit of the Federal Reserve Bank
would benefit the United Kingdom economy. In practice, the MPC
has been successful both because it has interpreted its remit
in a more sophisticated way than its strict remit might appear
to suggest, and also because the economy has not been hit by a
major demand shock and (until now) no significant supply shock
14. Although the operation of the MPC has
been satisfactory so far, we conclude that a re-examination of
its remit to include broader concerns than inflation alone might
benefit the United Kingdom economy. We will carry out such an
examination in a later report on the MPC.
Appointment and Transparency
15. At the moment, the MPC has nine members -
the Governor of the Bank of England; the two Deputy Governors;
two Executive Directors of the Bank; and four independent experts
appointed by the Chancellor of the Exchequer.
16. Our predecessor committee has in the past
expressed concern about how independent members are appointed.
We favour a more open process, conducted in accordance with a
Code of Practice analogous to the Code of Practice for Public
Appointments published by the Office of the Commissioner for Public
Appointments. We favour such an approach, partly as a matter of
principle and partly as a way of enlarging and deepening the pool
of people who might be considered for membership. The Chancellor
has always rejected our view on the matter.
17. Similar considerations apply to the appointment
of staff of the Bank of England who become members of the MPC.
It is difficult to discern any formal appointment procedures.
As far as we can ascertain, posts are not advertised, and we do
not know whether references are required.
18. Mr Howard suggested that Parliament should
approve the appointment of members to the MPC. We have never considered
that to be part of our job, especially as the Bank of England
Act 1998 makes it clear that neither House has a role in the appointment
of MPC members. It has never seemed to us to be a useful contribution
on our part to suggest that a particular person was below standard
or that another was satisfactory. Mr Howard referred to a Joint
Committee. Although we do not reject such a proposal out of hand,
we are not persuaded by its feasibility or the value of the likely
19. Despite the reservations we have expressed
about appointment, we consider that the independent members are
fulfilling their duty of objectivity. Compared to its counterparts,
notably the European Central Bank and the Federal Reserve Bank,
the MPC is refreshingly transparent, and its members are not loath
to express their own points of view. We have no doubts about the
ability of individual members. We note, however, the limited range
of backgrounds from which they are appointed. We understand that
the Treasury has a list of possible candidates.
We have never seen the list and have no idea who is on it, and
what their levels of expertise and experience are. Furthermore,
as far as we know, the Treasury has never given any public indication
of the qualifications and experience prospective candidates are
expected to have. In taking evidence, we have not heard any argument
that has caused us to change our previous view.
20. We therefore recommend, as we have done,
consistently, before, that members of the MPC should be recruited
and appointed in a manner consistent with Nolan principles.
21. We also draw attention to the length of appointment
and reappointment of MPC members. No member has been reappointed,
although it has been reported that Dr Sushil Wadhwani was invited
22. Mr Howard, suggested that the term of appointment
of independent members should be four years rather than three
and should not be renewable. He believed that five years was too
long. On the assumption that the first year is spent learning
how the MPC works, the present arrangements leave only two years
in which independent members can make an active contribution.
23. Bearing in mind that independent members
tend to be full time, there are limits to how long they can be
away from their original jobs assuming that they retain
them or be out of the labour market if they have left
their previous appointment. Extending the length of the term might
make it harder to recruit both academics and non-academics.
24. We conclude that the terms of appointment
should be re-examined. A more flexible approach would involve
consideration of both length of appointment and whether members
should be full or part time.
25. Although we have raised the issue of lack
of transparency in the appointment of members of the MPC, in other
respects we consider that the MPC operates transparently. In evidence,
Mr Andrew J. Smith from KPMG compared the European Central Bank
and the Bundesbank to the MPC. He compared the low transparency
of the Bundesbank coupled with its high independence with the
high transparency of the MPC (which is equally, if not more, independent).
He said: "Five years ago we came as a whole new ball game.
We designed our own central bank. There are these cultural differences.
So to say whether the model is better or not we have to say that
from an Anglo-Saxon point of view, we prefer the ex ante transparency"
(Q60). He recommended that the European Central Bank: