Mike Newton was Conservative parliamentary candidate for Wolverhampton West, and worked for the Bank of England during his career in the financial markets.
To control the levers of economic power is to control the political agenda. The outsourcing of monetary policy to the Bank of England was a key reason the party lost not only in July 2024, but in the locals and regionals in May 2024 and various by-elections.
There is now a generational opportunity to change a life-expired set of arrangements and put elected politicians back in charge. And this should be done quickly to allow markets to get used to the idea while we are in opposition.
Whenever a government chooses to subcontract the key lever of political power, its control over the economy, to technocrats, it runs the risk that the subcontractor will not deliver. The Bank has made multiple mistakes in recent years.
Through its wrong analysis from 2021 onwards that inflation was temporary, CPI blew through the 2% target and has generally stayed above it ever since. As a result of not having acted pre-emptively, the Bank then went into overkill mode.
Mortgage rates went up sharply, killing the party in the suburbs and beyond. Rishi Sunak got the blame, not Andrew Bailey. Knocking the doors of owner-occupied homes in the seat I contested, the great bellweather marginal of Wolverhampton West, young families now paying 5.5% rather than sub-2% were in no mood to understand the nuances of how monetary policy in this country works.
Our own fiscal mistakes were a partial factor in mortgage rates rising, but by the Bank’s own admission in a July 2024 paper the mini-budget was responsible for only about half of the spike in gilt yields in September 2022.
The rest was caused by selling to fund derivative obligations from pension funds (LDIs), and one does not have to make excuses for the Truss team by noting that there are still open questions about how effective the Bank was in its analysis and communication of the LDI issue. The underlying problems of the policy framework are not negated by the mini-budget.
As a Conservative, I do not believe in technocrats having a free hand. Democratic input must be a factor in operational decisions across all areas of government. Narrow experts often lack an understanding of the bigger picture, and are frequently unaware that the basis on which they make decisions may have changed.
The current Bank of England framework was introduced in 1998, and was effectively Gordon Brown’s insurance policy to reduce the risk premium from government borrowing. The markets did not fully trust Labour, so to expand the scope for borrowing Brown took a bet on the Bank being able to reassure the markets in a way his own team never could.
Former Fed Chairman Ben Bernanke was invited to write a report on the Bank’s performance, which was published in April 2024, and excoriated it from top to bottom. The Bank has been allowed to operate as an independent technocratic arm of the state, insulated from scrutiny.
Criticism of it is viewed with the same disdain from the professional commentariat once reserved for criticism of the monarch. This has led to the development of the serious structural problems that Bernanke referred to.
There will never be a better opportunity for the party to get control back over this lever.
The new leader should propose repeal of the 1998 Act and introduce a framework where the Chancellor and the Bank’s Governor jointly make decisions on the direction of interest rates. In the event of disagreement, the Chancellor should have the final say. They would be advised by a new, and smaller, Monetary Policy Committee.
Is it still right that the Bank should formally just target inflation, or should a broader range of factors form part of the mandate?
There is an argument that important real world variables such as the level of sterling and house prices should form part of the policy framework. I am not wholly convinced on this, as when the Bank has drifted into areas such as ESG and income equality, it seems to have been at the expense of performance in its core competency of inflation.
But house prices are particularly interesting. They have gone up both absolutely and relative to incomes relentlessly for a variety of reasons, from net migration to changes in family structure. Though the key reason is almost certainly that interest rates have been too low for too long, thus inflating prices artificially.
I am reluctant that the state should determine how much an average house must cost, as it feels a short cut to the Socialist original sin of state capital allocation. But at the very least whoever sets interest rates in Britain needs to be super-mindful that there is a causal relationship between the price of a house and the price of a loan to buy it with.
At conference, there was extensive praise for Mrs Thatcher and her personal commitment to a variety of policies, including free markets. But I never heard anyone mention the technical framework that underpinned this, which was an understanding of the monetary aggregates.
If one namechecks Thatcher, Joseph, Harris, Seldon or Sherman, it is intellectually inconsistent not to acknowledge, even in the most en passant of en passant ways, the monetarist doctrine that opened the way to the Thatcherite economic and political boom.
Monetarism has earned a bad reputation, and has largely died out from central bank use. It is unfashionable. However, the paradox is that financial markets continue to use an iteration of it quite aggressively, namely financial conditions (or liquidity as it is also known).
It is at the very least a useful handrail for policy. Should we require a re-imagined Bank of England to look more seriously at the monetary aggregates, even if the hard-targeting approach, as was the case with Sterling M3 in the early 1980s, is a step too far at this point?
To control the levers of economic power is to control the political agenda. Under a new leader we now have a free hand to look again at what we want from monetary policy. It may be that the above proposals are too radical, but they do at least address a problem that has been allowed to fester.
But hanging on to Labour legislation from 1998, that has deprived us of the ability to control our own economic and political destiny, without a proper policy debate cannot be right either.
