Ben Ramanauskas has worked in academia and as an adviser to the government. He is currently writing a book on the UK economy
In a surprise to practically nobody, the Monetary Policy Committee (MPC) of the Bank of England decided to hold Bank Rate at five per cent after having cut it at its previous meeting. This was the wrong move. It shows that the MPC is still far too cautious and – lacking in diversity of thought.
The last few years have been characterised by timidity by the Bank’s key decision-makers. In the aftermath of the pandemic, it was too slow to start tightening monetary policy by increasing rates for fear of harming the economy’s recovery. This was despite the warning signs that money supply growth was increasing signalling that demand was too high and would lead to high inflation.
The MPC eventually started to increase interest rates, but only once inflation had reached heights not seen in recent history. Millions of households saw their bills increase drastically, with the very poorest households hit the hardest. As the MPC had waited too long to start increasing rates, and perhaps because it wanted to attempt to reclaim some credibility, it increased rates far too high and kept them there for far too long.
Again, this was despite all the indicators showing that tight monetary policy had caused money supply growth to collapse and that inflation was set to return to target much earlier than expected and then actually fall below target. As with high inflation, the restrictive monetary policy of the Bank was causing a great deal of harm to households, businesses, and the wider economy.
The MPC should have started cutting rates late last year. It finally began to do the right thing in August and started to cut rates. However, this was only by 25 basis points. This was far too modest a cut.
The majority of projections show that inflation will remain around the Bank’s target and eventually fall below target given that real interest rates are much lower. This is in contrast to the Federal Reserve which was much bolder this month by cutting 50 basis points despite currently having higher inflation and much stronger economic growth than the UK.
The fact that the MPC voted by an overwhelming majority of 8-1 for this cautious approach with only Swati Dhingra voting for a cut demonstrates that it also has a lack of diversity of thought and opinion.
In many ways, this reflects the actual makeup of the MPC. It is always made up of senior figures from the City, professors, Bank officials, and former Treasury mandarins. This is unavoidable as there is quite a small pool from which to recruit and the people need to have a good grasp of macroeconomics and be serious and credible.
However, this lends itself to groupthink – especially if their advisers are all from a similar background. An example of this is the consideration given to money supply growth when making monetary policy decisions. We know that supply-side factors do have an impact on inflation as we saw in the last few years.
Nevertheless, the great economist Milton Friedman was almost exactly right when he said that inflation is always and everywhere a monetary phenomenon. Too much money chasing too few goods will lead to inflation and money supply growth is part of this. That’s not to say that everyone on the MPC should be a monetarist, but the fact that it was given little regard by the people in charge of managing inflation in the UK is quite troubling, to say the least.
The MPC needs to reach out to a wider and more diverse group of people. This was one of the points raised by former Ben Bernanke, the former Fed Chairman, in his recent review of the Bank’s forecasting methods. It should consult with people with heterodox economic views on both the left and right as well as members of the public and business leaders to ensure that their voices are heard.
Some of this already happens. But the Bank needs to cast its net wider and ensure that the thoughts and lived experiences of these people reach the MPC members and are factored into their decision-making.
The Bank of England’s MPC is overly cautious and is beset with groupthink. It needs a shake or else the economy will never recover from its malaise.
