There's been only one significant economic announcement in the Tory leadership contest, despite all the bickering of when and how to cut taxes, and it's what Liz Truss, the foreign secretary, had to say about the Bank of England in the Sunday Telegraph. Truss says she would "look again" at the Bank of England's mandate "to make sure it is tough enough on inflation". She says she fears "some of the inflation has been caused by increases in the money supply". She adds: "For me, handling inflation is an issue of monetary policy" and she would "have a very clear direction of travel on monetary policy". Truss, who is currently third favourite to be Britain's next prime minister, with everything to play for, seems to be saying either she would change the mandate of the Bank of England, for the first time since it was given control of interest rates by Gordon Brown in 1997, or that as prime minister she would be less respectful than her predecessors of the Bank of England's independence.
Unless her words are meaningless, it has to be one or the other - which is a very big deal. The point is NOT that the Bank of England is a flawless institution. It has always made mistakes and will continue to do so. But giving it independent control of the setting of interest is widely regarded as one of the more successful structural reforms to the UK economy of the past 30 years. No government has seriously considered mucking around with the Bank's mandate or independence - because till recently, the UK has had no kind of serious problem with inflation since 1997, and there is no compelling evidence that the recent surge in inflation is all or even mainly the fault of the Bank of England.
That said there is a very strong argument that the Bank of England could and should have increased interest rates more than it has down since last summer. And it would be perfectly reasonable for Truss or anyone to point that out. But even if the Bank had raised rates earlier and more, inflation would still be a big problem in the UK, because of soaring energy prices, supply chain disruption and labour shortages. What's more Truss's statement that inflation is being caused by an increase in the money supply is not born out by the basic facts: money supply growth has collapsed. Truss may be embracing a particularly fashionable trope among right-wing politicians and thinkers in the US and UK, namely that quantitative easing - money creation by central banks, especially during Covid - has been the cause of soaring global inflation (leadership candidate Tom Tugendhat also made this dubious claim the other day). I haven't heard this sort of argument since the heyday of Truss's heroine, Margaret Thatcher. And although I am almost nostalgic about it, there is no compelling empirical evidence of a link between Covid-related QE and today's surging prices. But let's say the born-again monetarists are right. What follows? Well, even if you share Truss's article of faith that big QE equals inflation, you don't have to change the Bank of England's mandate to rein in future QE.
What Truss doesn't seem to appreciate is that all and every significant instance of money creation or QE by the Bank of England requires authorisation by the chancellor. The government has the power now to block QE. If Truss as prime minister didn't want more QE, she could instruct her chancellor to veto any Bank-of-England request for it, without any alteration to the Bank's mandate. Which begs the most important practical question for Truss. Would Truss have vetoed QE during the Covid crisis, and risked the chancellor being unable to finance that £400bn of economic support for households and businesses - which included the much praised furlough scheme? For the avoidance of doubt, QE has brought a significant cost to the government, namely that it has made the amount it shells out in interest payments much more sensitive to changes in interest rates (for reasons I've explained here before). But if Truss is saying that she wants to rein in the Bank of England's ability to be the buyer of last resort of UK government debt - which is one interpretation of her less-than-clear statement - that in and of itself could lead to the Treasury having to pay considerably more to borrow.
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