My Life, Our Times

by Gordon Brown

  I do not blame any individuals – Labour or Conservative – for earlier failures to make the Bank independent. Their forbearance was inherent in our political process. In the 1980s, when Nigel Lawson challenged Margaret Thatcher to make the Bank independent, he found her ‘wholly unreceptive’. ‘So far as she was concerned,’ Lawson thought, ‘she really was going to go on and on and on … [and] while she was there, she was not going to give up the levers of power which the control of interest rates, as she saw it, represented.’ When Norman Lamont twice tried to persuade John Major to establish an independent Bank – first when Britain was in the ERM, and then after Britain’s humiliating exit – he was rebuffed. Later, Lamont created what seemed to me to be a cumbersome hybrid committee of chancellor and governor, who met every month to determine the level of interest rates. The informality of these meetings between Lamont’s successor, Ken Clarke, and the governor, Eddie George, led some economic commentators to christen it the ‘Ken and Eddie Show’. But an indication of how political the process remained was that, in the months before the 1997 election, the chancellor repeatedly rejected the Bank’s advice that interest rates had to be raised. This was the kind of partisanship and short-termism from which I had already determined we would break free.

  In the early 1990s I had talked to my friend, the economist Gavyn Davies, who made a compelling case for independence. But it was in 1995 that Ed Balls, who was also already committed to that view, came up with a detailed and sophisticated plan. Long before we came into government, his plan had been written, rewritten, reviewed, finessed, tested to destruction, completed and filed. So why did we not announce this bold new initiative before the election? It was for one simple reason: if we had done so, the Tories would have alleged that, under the new system, interest rates would immediately rise and homeowners would have to pay far more for their mortgages, and businesses more for borrowed capital. Our pre-election silence was caution for a purpose.

  Ed Balls’s plan was a decisive break with the past. By fettering our discretion and accepting operational independence for the Bank to decide interest rates, it would give both the public and the markets confidence that we had put in place a framework to ensure stability and keep inflation low.

  In the blueprint for independence, we made a crucial decision: we had chosen not to go for what was called ‘goal independence’ – the right of the central bank to define price stability and set the inflation target – but ‘operational independence’. This meant that, subject to parliamentary oversight, the chancellor would set the inflation target and the Bank of England would be charged with reaching it. And unlike the targets given to other central banks, the Bank of England’s target would be ‘symmetrical’. Instead of the original Lamont target of 1–4 per cent or the current Clarke target of 2.5 per cent or less, we set what we considered to be a target conducive to growth. Inflation 1 per cent below 2.5 per cent would be as unacceptable as inflation 1 per cent above it. Although I applaud the post-ERM changes introduced, to their credit, by Lamont and Clarke – inflation targeting, a joint Bank–Treasury committee to set interest rates and the use of outside advisers – and believe this represented substantial progress, Bank independence was not just ‘putting the roof on the cathedral’, as some have suggested, but a fundamental change.

  On the morning of Saturday 3 May, I met Tony to talk about the timetable – I had told him on election day I was thinking of moving quickly – for proceeding with Bank of England independence. We did not meet in Downing Street. At this point, Tony was still working out of his London home and so, over cups of coffee and seated in comfortable chairs, we discussed the change. What would become known as ‘sofa government’ was quite literally starting in the informal atmosphere of his living room in Islington. With him was his new private secretary, Moira Wallace, a Treasury civil servant, who moved seamlessly from serving a Conservative government to working for a Labour one. Moira, who was as intelligent as she was forceful, had a very different view from mine – and I think Tony’s – on how the issue should be handled. She advised us that we ought to wait until we had run the gamut of a whole series of formalities. To be fair, she had been advised by the Cabinet Secretary, Robin Butler, that this was proper procedure, and it was – in normal circumstances.

  But on that day it sounded more like a delaying tactic that would have undermined the fresh start I proposed. Believing Bank independence would forever lock in our commitment to low inflation, I was determined to move quickly. At our Saturday meeting, Tony concluded our discussion with one word: ‘Fine.’ We would meet again on the Sunday evening when I proposed that I would phone every Cabinet member on the Tuesday prior to our formal announcement of the decision. Because of the historic significance of our plans – which I thought would be headline news in almost every serious paper around the world – I assumed Tony might request that the decision be announced by him from Downing Street. But Tony, I think, recognised that this was my initiative and left it to me.

  Later on Saturday, back at the Treasury, Terry Burns now repeated Moira’s advice to Tony and urged a pause. When I reiterated my decision that we would act immediately, Terry retreated into a more modest request: a one-day delay so we could get what he called ‘all our ducks in a row’. I replied that Tony and I had already agreed to hold to my timetable, and that prior to our announcement we would bring forward the usual monthly meeting of the Treasury and Bank on interest rates to 8 a.m. on Tuesday. At that meeting, I would propose an interest-rate rise which was clearly needed in the face of rising inflationary pressures. There was an important reason for this. Interest rates had to rise and, before handing responsibility for them to the Bank, I wanted to send an unmistakable signal that Labour would never shirk a difficult economic decision.

  I do accept that that weekend we broke with all the conventions – detailed Civil Service papers, long subcommittee meetings of officials then ministers, a Cabinet discussion and decision. While Robin Butler, Terry Burns and Moira Wallace were justified in their reservations, I was absolutely convinced that Britain needed this new start, and the best time to make it was at the very beginning of our first days in power. I was also learning about leadership. Without a clear vision and determination to see it through, you could easily be knocked off course.

  As we worked through the weekend, we found that the Treasury also had a Bank of England proposal on the stocks. A year before, the Treasury Management Board had considered a paper on what would happen to the Bank of England if we joined monetary union, put together by one of the ablest civil servants of all, Jon Cunliffe, later deputy governor of the Bank of England. I subsequently learned that Terry had a sense the day before the election that this earlier work might be needed and brought it out of the filing cabinet. So, on the day after the election, Burns met with Cunliffe. The two decided that Tom Scholar, then a young official and later the Treasury’s permanent secretary, should prepare a paper overnight. The Treasury proved, as it would in the future too, agile, fast-moving and on top of all the detail. There were some changes to Ed’s original draft. For example, Ed and Sir Alan Budd, the Treasury’s chief economic adviser, now agreed we should add what was to be called the ‘open letter’ system: the governor of the Bank would be required to write a public letter to the chancellor to explain why any deviation from the inflation target occurred and what policy actions were needed to rectify this. I later found out that officials in the Treasury anticipated receiving such a letter once every fifteen months or so: the first letter was not sent until ten years later. But to all intents and purposes, Ed’s original letter – and plan – remained unchanged.

  First thing on Tuesday morning, at what would be the last joint meeting of the Bank and Treasury to determine interest rates, we went through the motions, agreeing to a 0.25 per cent rise. We then called time on the last meeting of this hybrid group. The last episode of the ‘Ken and Eddie Show’ had aired a month before. There was not to be a ‘Gordon and Eddie Show’. Eddie and his staf
f then returned to Threadneedle Street while I went back to my office to phone each member of the Cabinet to inform them of our plans. With this done, I went straight to the press briefing at 11 a.m. in the Treasury’s Churchill Room – the room from whose balcony he had greeted the cheering crowds of well-wishers when peace was declared in 1945.

  The press conference itself was something of a surreal experience that at first confounded our expectations. I started by announcing the interest-rate rise and then proceeded to announce that the Bank of England, which the Labour government had nationalised in 1946, would become ‘operationally responsible’ for interest-rate decisions. Because I used the word ‘responsible’ and not ‘independence’, some journalists thought the interest-rate change was the real story. It took an hour before the media came to realise what a fundamental shift the announcement represented: politicians would no longer make interest-rate decisions in their partisan interest; an independent Bank would make decisions in the national interest.

  That morning I had phoned all Cabinet members that I could track down and explained our decision to them one by one. I also called all previous chancellors. Ken Clarke, by then a challenger for the Tory leadership, politely told me he would publicly and strongly oppose the move, and later the Conservative Party voted against it in Parliament. In contrast, Nigel Lawson and Norman Lamont made it clear to me that this was exactly in line with their own thinking and they wished their party had done this when in office. I did not get through to John Major, but I knew his views. Denis Healey was lukewarm, while Jim Callaghan was – as always with me – very supportive. Jim had given me his first-edition copy of John Maynard Keynes’s The General Theory of Employment, Interest and Money, originally a gift to him from a previous Labour chancellor, Hugh Dalton, and it is a prized possession, a symbol of the common ground between the Keynesian-led rethinking of the 1930s and what we were now attempting.

  Our success would depend on the effective operation of the newly created Monetary Policy Committee (MPC), five of whose nine members would come from the Bank’s staff: the governor, two deputy governors, the executive director for financial markets and the chief economist. The other four would be nominated by the Treasury. The appointment of ‘externals’ was our plan – conceived in opposition – and it was one we implemented boldly by choosing from the broadest possible group of members, including, to the dismay of many, two non-British citizens.

  When I met Eddie George on 5 May, I was able to remove the main fears he had in his mind. He was wary that the MPC would be representative of various ‘sectional interests’ – code for representatives from industry and the unions who he thought, perhaps unfairly, had no experience of macroeconomics. But I was later to learn that Eddie was ‘thrilled’ about the symmetrical target as it demonstrated a commitment to both stability and growth. In fact, when he addressed the TUC in 1998 and explained this benefit to the economy, Eddie was applauded enthusiastically – a first for any Bank of England governor.

  But it was not all smooth sailing. In our draft letter to the Bank, we said we would legislate to transfer the Bank’s responsibility for financial supervision to a new statutory body and that consultation would now begin on that basis. Unfortunately, in his exchanges with Terry Burns, Eddie seemed to form the impression that the change would not happen quickly, or perhaps not at all. So, two weeks later, when I prepared to go to Parliament to announce the creation of the Financial Services Authority (FSA) as the new supervisor, I first learned about the scale of Eddie’s concerns.

  Prior to 1997 there were nine separate financial regulators. In my long years of opposition, I had seen how the Bank had run into problems – in 1991 over the collapse of BCCI, and in 1995 over Barings. These two embarrassing banking disasters had resulted, at least in part, from an inadequate regulatory system that was essentially an informal old boys’ network dealing more in private assurances than professional monitoring. There was a strong case for locating the prudential supervision of all regulated firms in one place – the FSA, as the new single regulator – with the Bank of England, as the central bank, responsible for stability of the system as a whole.

  Eddie was later reported as saying that on hearing of my plans he had thought of resigning. But there was no substance to this; he was undoubtedly angry, but I found Eddie more intent on using the initial misunderstanding to claw back some of the powers we were to give to the FSA. After a long summer – during which, to his great credit, a very patient Alistair Darling, the Chief Secretary to the Treasury, did most of the negotiations with an irate Eddie – a memorandum of understanding was hammered out between the Treasury, the Bank of England and the FSA. But sadly, because it was a compromise, it was far less definitive on who did what than it should have been. It was an unhappy start for what proved to be a strained set of relationships. And while there was a marginal improvement with the appointment of the deputy governor of the Bank, Howard Davies, as head of the FSA, the tripartite system did not work in the way I had hoped. The irony was that little publicity was attached to another transfer of power from the Bank – its responsibility for managing and financing the national debt. This task, which the Bank had performed since its founding in 1694, was summarily passed to a new executive agency of the Treasury.

  I was not entirely happy either; in my case, with the way the blueprint was translated into legislation. First, one other innovation I had hoped for was to rename the Bank of England as ‘the Bank of England, Scotland, Wales and Northern Ireland’. This would honour its history – people would abbreviate the long name and still refer to the Bank of England – while leaving no doubt that it was there to represent the whole of the UK. However, I was told that this would have required a revision of thousands of statutes and regulations which referred to the Bank of England. Given the imperative of moving quickly, we did not have the time to do that. It is a reform that I still wish to see happen.

  Second, I wanted the Bank to have a dual mandate to keep inflation low and employment high – one that was similar to that of the American Federal Reserve. But the lawyers advised that it was too difficult legally to have two primary objectives. We got around this as best we could. The legislation defined the Bank of England’s objective as ‘to maintain price stability and, subject to that objective, to support the government’s economic policy, including its objectives for growth and employment’. Nevertheless, much of the heat was removed from this argument by the symmetrical inflation target, which promoted growth and thus employment.

  The Bank performed well. Bank independence gave an immediate boost to the economy, as bond yields – and thus the price people had to pay for borrowing – fell by 0.5 per cent and the difference between UK and European rates narrowed to Britain’s advantage. Our long-term interest rates would, for the first time in decades, come close to those of Germany. Eddie George proved to be a good choice as the first governor of the newly independent Bank. He not only held the confidence of the City of London but had a clear sense of the limits as well as the power of his new role. Sensitive to possible charges against the Bank of interfering across economic policy while being unelected, Eddie did not seek to interfere in any way with fiscal policy – privately or publicly. Over time, too, we also opened up the Bank’s procedures to even more public scrutiny and gave the House of Commons a new role in scrutinising our appointments.

  When it comes to big ideas in monetary policy, few are bigger than central-bank independence and, from the perspective of 2017, I am still convinced that it was, and is, the right policy. The timing was right – at the start of a new government – and the execution well prepared. We avoided endless press stories of a monthly tug-of-war over interest rates between a Labour chancellor and the City establishment. But the vision we had was about more than controlling inflation: it was about setting a stable long-term path for the economy that abandoned what I believed had been, despite all efforts to the contrary, fifty years of short-termism in economic management; and we ensured the choice on t
he euro was no longer between an unstable British monetary policy and a stable European regime but between two different regimes both offering stability. As a result of our decision, monetary policy decision-making now became more responsive to economic conditions and quicker and more flexible in reacting to problems. Interest rates were increased in 1997 to deal with inflationary pressures and lowered in late 1998 in response to recessionary fears and the near collapse of the massive and highly leveraged hedge fund LTCM at the time Russia devalued its currency. The Bank also acted expeditiously to prevent a British repeat of the American downturn after the tech-boom crisis in 2001–2 when interest rates came down fast.

  British inflation was kept low after 1997, helped on by low worldwide inflation, not least because China and emerging nations were flooding western consumer markets with cheaper goods. From 1997 until 2003, inflation met its 2.5 per cent target, averaging 2.4 per cent, and in the next four years kept to the new 2 per cent inflation target, averaging 2.01 per cent. Inflation was so benign that, when he retired, Eddie George wrote me a letter explaining why he had not written an ‘open letter’.

  The years that followed were less smooth. UK inflation peaked at 5.2 per cent in September 2008 and troughed at 1.1 per cent in September 2009 before increasing to 3.7 per cent in April 2010. This volatility can be explained. It was in part due to the recession, in part a result of the violent rise and then fall in oil prices, and in part due to sterling’s depreciation. The later rise reflected the return of VAT to 17.5 per cent in early 2010.

  The 1997 settlement has proved durable and more successful than any other UK monetary policy regime in our post-war history. While some still favour complete independence, I believe that the Bank’s greatest expertise lies not in setting goals but in putting them into practice. Our settlement struck the right balance between the use of experts and the need for public accountability. So I would still reject the idea that the Bank set their own target. But the singular focus on inflation – with one target and one weapon – was also a creature of a time when the economic priority was dealing with persistent bouts of high inflation.