The Bank of England has become so powerful since the financial crisis that limits to its independence are now needed, the former shadow chancellor Ed Balls has said.
Mr Balls, who was a key architect of the central’s bank’s move to independence under Labour in 1997, warned in a joint paper for the Harvard Kennedy School that the Bank could lose operational independence altogether if it did not cede some political control.
The Bank has been under sustained attack since before the EU referendum over claims of political bias and has even faced criticism from the prime minister, who claimed that its policy of low interest rates and quantitative easing was having “bad side effects”.
Concerned that too much power has been concentrated in unelected officials, Mr Balls, who lost his seat in last year’s election and is currently a contestant on Strictly Come Dancing, right, wrote: “The old academic assumption that the more independent a central bank is, the better it is, should no longer hold.
“In order to protect their popular legitimacy, central banks in advanced economies can sacrifice some political independence without undermining the operational independence that is important in both their monetary policy and financial stability functions.”
Speaking yesterday on the BBC Radio 4 Today programme, he said: “The reforms we’ve seen over the last few years have hugely concentrated power in central banks. I think it’s unfinished business.” However, he defended Mark Carney and added that the case for operational independence for central banks remained “as strong as it’s ever been”.
After the financial crash the Bank was handed new powers with direct implications for households such as mortgage controls to prevent another crisis erupting, on top of its existing mandate for interest rates. Rock bottom rates have pushed the Bank into unconventional territory such as quantitative easing that has also affected people’s wealth and savings.
Mr Balls wrote that incursion into areas that have “first-order distributional consequences such as housing policy” threatened to drag the Bank into the political arena and spark a “popular backlash against independence”. He added: “To retreat on this now would be a serious mistake.”
To protect operational independence, he recommended a new framework for formal co-ordination between the Bank and the government on both rate policy and financial regulation.
Once rates hit rock bottom, the Bank should be able to propose a joint fiscal and monetary response that it believed would be best for the economy. The government could either sign up or “refuse to participate”.
This arrangement would help because the central bank currently faces “fiscal dominance”, as the government is able to commit to austerity and hand responsibility for driving growth entirely over to the Bank.
Under Mr Balls’s proposal, the Bank could not recommend the manner of stimulus, just the broad outline. Such a framework could be managed through an open exchange of letters once interest rates hit a pre-ordained level near zero, he wrote.
On financial stability, he suggested a new systemic risk oversight body led by the government. The body would set a mandate with clear objectives while the Bank would “have operational autonomy to implement policy to meet these objectives”.
The paper, written with James Howat and Anna Stansbury, hopes to resolve the awkward distinction between operational and political independence. The Bank has a politically defined mandate of keeping inflation at 2 per cent but operates policy independently.
Many believe that it has been working hand in glove with the government since the crisis. The chancellor and the governor speak regularly but the Bank always claims that it neither interferes in policy nor takes political instruction.