Can Truss be trusted with the Bank of England?

PRINCETON  —  The Conservative Party contest to succeed Boris Johnson as prime minister of the United Kingdom has touched on a principal component of modern political economy: Central banks. Monetary policymakers, who in the 2010s could seemingly do no wrong, are increasingly under fire. All the old rhetoric about their illegitimate influence is returning to the fore.

Both contenders for the premiership, former Chancellor of the Exchequer Rishi Sunak and Foreign Secretary Liz Truss, have adopted oddly nostalgic platforms in an effort to claim the mantle of former prime minister Margaret Thatcher. While Sunak launched his campaign in Grantham, Thatcher’s birthplace, Truss (the likely winner) misses no opportunity to portray herself as the Iron Lady reincarnated, not least by starting a high-profile fight with the Bank of England.

Thatcher distrusted the BoE, which she viewed as a complacent, incompetent arm of a discredited British establishment. She referred to Gordon Richardson, the bank’s governor between 1973 and 1983, as “that fool who runs the Bank of England”. Writing in the margins of a memo that “I must put someone there I can rely on”, she complained to an adviser that, “I just don’t know how you can trust them.”

Thatcher had no patience for central-bank independence, which was just becoming fashionable in the 1980s. When her chancellor, Nigel Lawson, suggested that the BOE be given more independence, in order to improve the credibility and effectiveness of its monetary policy, she quickly shot down the idea.

By criticising the BoE’s handling of inflation and calling for a review of its mandate, Truss is treading the same path. She wants to see more coordination between the BoE and the rest of the government, in terms of both monetary policy and financial regulation.

She is not wrong, either politically or intellectually, to demand such a change. Central-bank independence, coupled with an explicit inflation-targeting regime, was a brilliant answer to circumstances that no longer apply. For years, there was a worldwide policy convergence toward lower inflation, because the addition of an enormous labor force in emerging markets pushed down global labor costs. But those days have long since ended.

Following the 2008 financial crisis, while globalisation was still holding down labor costs, the line between monetary and fiscal policy became increasingly blurred. Relying on unconventional monetary policies looked like the easiest way out of an impossible situation, so central banks started purchasing assets, starting with government debt, and introduced financial regulations to recapitalise weak financial institutions.

But all this had obvious implications for fiscal policy. With central banks monetizing fiscal deficits, control of interest rates became a highly salient political issue. It was all too predictable that once the global disinflationary environment disappeared, central banks would have to hike interest rates to contain price growth, and that the debts that governments had accumulated when interest rates were low would become unsustainable.

In criticising the BoE for not doing enough to rein in inflation, Truss has a point. The latest estimates suggest that UK inflation will reach 13 per cent by the end of the year, a level not seen since the 1970s, when economic malaise produced the need for a Thatcher.

True, the BoE also has a point when it argues that today’s inflation is largely not its fault. After all, inflation has been high almost everywhere, owing to factors that no government can control, such as pandemic-related supply chain disruptions and surging energy and commodity prices following Russia’s invasion of Ukraine. Still, the UK faces an even greater inflation challenge than other major developed countries do, owing to domestic factors, particularly the scale of its public borrowing and debt. This was also the issue that Thatcher put at the heart of her controversial anti-inflation “medium-term financial strategy” after 1979.

Throughout the era of central-bank independence, the question of how central banks should speak about government fiscal policy has always been rather vexing. When then-BoE Governor Mervyn King involved himself in the fiscal-policy debate in 2010, Prime Minister Gordon Brown was outraged, seeing the move as a political ploy to support the Conservatives in the general election.

But the fact is that central banks around the world face a dilemma. Once big security issues come to dominate the agenda, monetary policymakers inevitably become captives of their governments. If they try to maintain an anti-inflationary monetary policy, they will be accused of undermining the government by making debt funding and business borrowing more expensive. If they then stick to their guns, they may find themselves out of a job, as happened to Naci Agbal in Turkey and Tarek Amer in Egypt. But if they eschew an anti-inflationary policy and follow the government in blaming higher prices on malign foreign influences, they will be seen as government stooges, as in the case of Adam Glapiński in Poland.

Ultimately, restoring the economy’s growth prospects cannot be achieved simply through monetary policies. It requires continued global openness. This is especially true in the UK, which has a very low productivity-growth rate and a labour force that has been reduced by poor health (and an inadequate health-care system).

Truss at least is addressing the central-banking part of the problem in an honest way. But whether she can show true courage in tackling the UK’s broader economic challenge remains to be seen. If she becomes the UK’s next prime minister and is willing to pursue meaningful fiscal consolidation, she will indeed look like a new Thatcher. If not, her Britain would start to look more like Egypt, Turkey, or Poland.

Harold James, professor of History and International Affairs at Princeton University, is the author of The War of Words: A Glossary of Globalization (Yale University Press, 2021). Copyright: Project Syndicate, 2022. 

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