That Thursday morning, amid a general sense of national humiliation and government incompetence, saw a vivid coda to Black Wednesday. As early as 7.50, George was on the telephone to Burns, having learned that Major and Lamont had agreed the previous evening to cut interest rates back to 10 per cent before the Cabinet met at around 9.30. Such a move, he explained, ‘would be disastrous, giving an impression to the markets of total confusion among the authorities’; and he added that he was ‘not in principle averse to reducing rates to 10%, but it was extremely important that it should be done in an orderly manner’. Half an hour later, Burns phoned back ‘to say that the Chancellor was content for the announcement of the interest rate reduction to be delayed until Friday’, but that Alex Allan in the prime minister’s office ‘was much more resistant for presentational reasons’. Straightaway, George was on the phone to Allan, reiterating that reducing interest rates to 10 per cent that morning would, in the view of the governor as well as himself, ‘give an impression of panic and gross incompetence on the part of the authorities and could produce a massive over-shoot in the exchange rate’; but Allan, after asking George not to repeat to Lamont what he had to say, told the deputy that ‘for political reasons the Prime Minister was adamant that interest rates should be reduced before the Cabinet met that morning’, adding: ‘If the Chancellor made the interest rate announcement before the Cabinet meeting, he could regain some of the initiative. But if he waited until later it would look as if he had been forced into doing so by the Cabinet.’ The conversation ended with George remarking, perhaps rather grumpily, that ‘someone, whether the Chancellor or the Prime Minister, needed to give the Bank a direct instruction to make the rate reduction’. The rest of this chamber drama played out in three more phone calls:
8.35. Sir Terry Burns telephoned the Deputy Governor to say that he had just received a message from Number 10 to the effect that, unless there was an announcement before 9.15 am, that there would be a reduction in rates to 10% either that day or on the following day, the Chancellor would not survive the Cabinet meeting. The Deputy Governor asked whether that was an instruction to the Bank to make the change and Sir Terry replied that it was not clear; the Chancellor was not aware of the message and had previously said he would be content for the announcement to be made on the Friday. It was agreed that Sir Terry would consider how best to approach the Chancellor and in the meantime the Deputy Governor would think about how best to carry out an instruction to reduce rates.
8.45. The Deputy Governor telephoned Sir Terry to say that, after taking advice, he had concluded that if a rate cut was to be announced that day, it would be best to implement it straightaway rather than announce it that day to take effect on the following day; this would have the minimum disruptive effect on the markets.
9.07. Sir Terry telephoned the Deputy Governor to say that the Chancellor had agreed that the cut should be announced that day at 9.30 am, just before the Cabinet meeting began.16
Black Wednesday in September, the Bingham Report in October – the autumn of 1992 was hardly a happy moment as the Bank began to think about how to mark its imminent tercentenary. In a highly critical assessment in the Spectator, Stephen Fay argued that the ERM debacle owed at least something to the Bank’s ‘culture of secrecy’, a culture resistant to explaining to the outside world either motives or arguments and reasons; as for Bingham, that had revealed the Bank as ‘an introverted organisation, unwilling to trust outsiders, especially from abroad, and reluctant to take advice’. A member of the Treasury Select Committee, Giles Radice, was similarly critical. ‘We are astonished by the complacent attitude of Eddie George,’ he recorded in his diary a few days later, after the deputy governor had given evidence about the Bank’s handling of BCCI. ‘In the end, after persistent questioning, he admits that mistakes may have been made. He would have done well to say that at the beginning.’ Yet, even during that autumn, developments were under way that would transform the very nature of the Bank by early in its fourth century; and within weeks, there were some insiders who were privately referring to the tumultuous events of 16 September not as Black Wednesday but as Grey or even White Wednesday.
The charting of a new course started, albeit somewhat uncertainly, as soon as Thursday the 17th. ‘Yesterday was, in an obvious sense, a crushing defeat for policy,’ began George’s memo to senior colleagues. ‘But it also presents us with an opportunity to break free from the intense conflict between domestic and external objectives which ERM membership in the exceptional circumstances of German re-unification has involved us in over much of the past year.’ Thus, in the welcome absence of monetary policy having to be ‘directed solely towards maintaining the exchange rate’, necessitating ‘interest rates at levels which were inappropriately high in relation to domestic inflationary pressure and domestic activity’ – in turn resulting in fiscal policy being relaxed by government ‘to a degree that would otherwise have been clearly inappropriate’, indeed even leading to the Bank itself ‘untypically’ advising the chancellor ‘to undertake further fiscal expansion’ – George instead looked forward to a post-ERM context in which ‘the opportunity now presents itself to revert to a more appropriate policy mix’. Another memo came from Mervyn King, who since the previous year had been chief economist and an executive director. ‘If we remain outside the ERM, and there is no independence for the Bank,’ he concluded, ‘a clear and coherent framework for the formulation of monetary policy will be necessary, in my view, to restore any semblance of credibility to our policy stance. Otherwise, we shall have to hope that we shall be given the opportunity to build up credibility by the pursuit and achievement of price stability.’
That afternoon, the Bank’s top men assembled to discuss what, in the vacuum left by the suspension of ERM membership, the framework for UK economic and monetary policy should be. The first speaker was King:
It would not be enough to cast policy in terms which boiled down to an assurance that the authorities would make the right judgements, since ultimately these judgements would fall to politicians and be prey to the political pressures which they inevitably face. Independence would be an ideal outcome but absent that a new framework was needed. In response to the Deputy Governor [George], Mr King offered monetary aggregates as one possible candidate and said that a ‘trust us’ approach would have zero credibility. If an alternative framework could not be found, the arguments for going back into the ERM were, in his view, strengthened.
Others present expressed their views. Crockett said that he was ‘anxious that the Bank should not simply abandon the objective of using the exchange rate as some sort of guide for monetary policy’; Plenderleith observed that if the choice of ‘framework’ – defined as ‘a published definition of policy from which the authorities could not easily depart’ – lay between adherence to the ERM or what ‘might be no more than a statement of intent to pursue a policy designed to produce stable non-inflationary growth’, the reality was that ‘either approach needed to enjoy broad-based credibility and legitimacy’, adding that ‘it was clear that the public had not been persuaded that the ERM was the right way of pursuing growth’; while Leigh-Pemberton, after noting that in the short term ‘the inflationary bogey was not that great’, accepted that ‘we plainly did need to have a framework and it would not be good enough to rely on “seat of the pants” judgements and to encourage the market to “trust us”’, but was disinclined to change horses, telling his colleagues that he ‘continued to find the exchange rate a potentially attractive criterion, since it was a visible and well-understood indication to the market and the international community of our position and policy’. Accordingly, the meeting ended with the governor expressing his belief that ‘the ERM remained a potentially attractive framework once conditions had improved’.
A week was a long time in central banking that autumn; and exactly seven days later, amid the ongoing policy vacuum and an increasing realisation-cum-acceptance in both the Bank and the Treasury that Britain�
��s ERM era was over, King had an important message for the Court:
Our immediate problem is that we need a nominal anchor. This takes us to the old debate between rules and discretion for the conduct of monetary policy. Until last week we had a rule – our ERM parity. We now have total discretion but precisely for that reason no credibility. The policy of ‘trust us we are clever’ is associated with Mr Lawson. And look where that got us. But I do not want to pretend that there is any new simple rule – such as a monetary or other aggregate – that would carry conviction. The obvious alternative, and one that has been canvassed by most academic and journalist commentators, is independence of the Bank of England.
In the meantime, it would make sense to focus directly on the objective most relevant to a central bank, namely the rate of inflation. We have a target path for the inflation rate that leads us to price stability. We also have a number of indicators of inflationary trend. These can be weighted together by the information content in each indicator. And the Economics Division is carrying out the statistical analysis necessary for this. Policy then compares the expected inflation rate with its target path, and monetary policy is tightened if expected inflation exceeds the desired target range. In one sense that is the usual discretionary policy which in practice we followed for some time before entering the ERM. But it has a much more precise focus because it is clearly targeted on inflation. That should be the main responsibility of the central bank. The immediate problem, however, is to find a way of restoring some semblance of credibility to UK economic policy.17
Inflation targeting, in short, was moving towards the centre of the picture; but it was not quite there yet.
King himself was emerging as the key Bank figure during this tantalisingly – but also seductively – blank-canvas phase. An academic economist for most of his working life before coming to the Bank full-time in March 1991, initially on a two-year contract, he more than anyone seized the moment, in the process doing much to raise the standing within the Bank of the Economics Division. That was not an uncharged matter. Back in 1983, an earlier chief economist, Christopher Dow, had listened to ‘an hour’s quiet monologue’ from George about how the economists in Threadneedle Street were as a species ‘incapable of being useful to him’ and how ‘he would not trust them with information anyhow’; King himself had already ruffled some feathers by restructuring the division so that, in his subsequent words, ‘those dealing with the analysis of financial markets and those dealing with economic analysis worked together’, with the aim of ensuring that ‘the analysis matches the operations’, as distinct from there being ‘just a group of economists working on a large econometric model’; while when in June 1992, during the annual review of ‘Objectives and Resources’, Leigh-Pemberton asserted that ‘it was important for the Bank to recruit economists, but the Bank should not restrict itself to economists, because we would then lose some of the most able generalists’, and added that he ‘wondered whether the policy of concentrating on economists was short-sighted’, King countered by saying that he ‘thought non-economist graduate recruits should be willing to become economists and that that should be made clear to them before recruitment’.18 Traditionally, of course, the Bank had always prized the generalists. It was an irony of the situation that King himself, heading the economic specialists, possessed one way and another an appreciably broader hinterland than some of the generalists.
Late September and early October inevitably involved, whether at the Bank or the Treasury, considerable discussion about the future direction of policy. King went to the Treasury and floated to Burns the idea of putting considerable focus on the inflation target; Burns responded quite positively; and in due course, he and the Treasury’s chief economic adviser, Alan Budd, sought to persuade their political chief to go down that road. Even so, there were still some distinct qualms at the Bank. On 6 October, two days before Lamont was due to unveil the government’s new, post-ERM economic strategy, George rang Burns to say that he and the governor were ‘very exercised about the possibility that future monetary policy would become set in stone before the Bank had had a chance to give its input’; and he added that ‘the Bank was keen to be able to line up side by side with the Government on any new policy statement, but if this were to involve specific inflation or monetary aggregate targets, the Bank would find it very hard to support’. Understandably, after his various experiences going back to the early 1980s, George had no great fondness for targets – whether of a monetary or an exchange rate nature – and, befitting his own technical virtuosity, instinctively preferred discretion to rules as the basis for policy. Even so, the tide was now irresistibly flowing towards a new orthodoxy: based not on the money supply, not on the strength or otherwise of sterling, but on the requirements of the inflation target. On 8 October, in a speech to the Tory conference at Brighton and in a letter to the chairman of the Treasury Committee, the chancellor set out his stall, at the heart of which was an inflation target in the range of 1–4 per cent, to be reduced by the end of the Parliament (probably 1997) to a range of 1–2.5 per cent. Such an approach, Lamont assured the faithful, would restore the confidence of the markets. And if the government failed to hit its inflation target? ‘It will have a duty,’ he pledged, ‘to explain how this had arisen, how quickly it intended to get back within the range, and the means by which it could achieve this.’
A certain whiff of Mr Solomon Binding was undeniable, to sceptics anyway; but just under a fortnight later, on 19 October, Burns visited Leigh-Pemberton to put forward a proposal, duly summarised by the governor’s private secretary:
Treasury Officials, impliedly although not absolutely clearly with the Chancellor’s support, were giving very serious consideration to the ‘openness’ issue and the general arrangements by which monetary policy decisions were formulated and reached. In particular, Burns envisaged a monthly monetary policy meeting between the Chancellor and the Governor, each supported by Officials, to review the economic and monetary situation on the basis of a [Treasury] paper which would be published …
The objective would be to make it much more difficult for No 10 to intervene in interest rate decisions, and make it similarly difficult for a non-orthodox Chancellor to make interest rate movements which were – or at least whose timing was – motivated by political considerations …
Next day, at an internal meeting, George supported the idea of a monthly chancellor/governor discussion of monetary policy and suggested that the Bank undertake for public consumption a quarterly ‘Inflation Report’ – a report, insisted King, that would be ‘entirely free from Treasury comment’. A week later, on 27 October, two days before the chancellor’s Mansion House speech, Lamont, Burns, Leigh-Pemberton and George gathered to discuss its intended proposals ‘for greater openness and accountability in the conduct of monetary policy’. After observing that they would be ‘very welcome’ from the Bank’s point of view, the governor additionally proposed as part of the package the Bank’s own quarterly inflation report, a suggestion that the chancellor ‘welcomed’; and both sides agreed that, in Leigh-Pemberton’s reported words, ‘the validity of the inflation report would depend in part on acceptance in the markets that, in the end, the inflation report represented the opinions of the Bank and not the Treasury’. On the 29th, Lamont spelled it all out, with one or two extra twirls, to the City’s bigwigs: the Bank, as monitor of the government’s progress in meeting its inflation target, to publish a quarterly inflation report assessing ‘thoroughly and openly’ the outlook for inflation; the Treasury to have an early sight of that report, but no powers to change it; monthly meetings between chancellor and governor, with the dates to be revealed in advance; a report of each meeting to be published by the Treasury; and a panel of seven independent economic forecasters to be established which ‘would publish regular assessments of economic conditions’.19 Greater credibility, greater openness – those by now were the government’s buzzwords, and the almost inevitable implication was an enhance
d role for the Bank.
On 11 November the governor gave the inaugural LSE Bank of England lecture, written for him by King and in effect laying out the underlying long-term economic justification for the new emphasis on price stability:
In this country, inflation became a serious problem only after the Second World War. Creeping inflation at an average rate of around 3% a year in the 1950s and 1960s caused concern but little revival in official circles of the traditional view that inflation was a monetary phenomenon. In the 1970s inflation rose rapidly and prices more than trebled. Progress was made in the 1980s with the adoption of firm counterinflationary policies. Nevertheless, we should not forget that prices rose by more between 1970 and 1990 than they had done in the previous 200 years. Some of you here tonight are part of a generation – the inflation generation – which grew up believing that rapid rises in prices were an inevitable feature of a growing economy. I want to persuade you that inflation is not a natural condition. Far from it. It is a condition which derives from a combination of outdated economic theory and flawed policy implementation. And now that both theory and practice have been immeasurably improved, it is a phenomenon which should be confined to the history books once more.
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