Subject: Banking Supervision and Regulation
Committee Member: It would appear that the use of interest rates for controlling inflation alone is not an adequate basis for the banks ongoing role, and I would highlight the fact that the inflation target seems to have resulted in too low interest rates, which have created excessive mortgage debt and a house price bubble.
Furthermore, the bank has had to resort to quantitative easing and that the quantitative easing requires Treasury approval and so it would seem that the bank has lost some of its independence, and furthermore that the tripartite agreement does not appear to have worked. I wondered if you would like to comment on those concerns?
Mervyn King, Governor of the Bank of England: That is several quite different issues all wrapped into one.
Committee Member: Indeed but thought I might as well get them all out.
Mervyn King: Well let me start with the most basic one, which is obviously similar to the question that the Chairman asked. I believe that an inflation target is a necessary, but not a sufficient part of our policy framework to achieve stability overall. I think it is a necessary part, because I think to set monetary policy on any basis, other than to try and achieve low and stable inflation, is a recipe for really making mistakes.
Every single time I have come across people who have wanted to pursue something other than an inflation target, in the last 15 years, on every single occasion it has been in the cause of lower interest rates, never higher. So whatever people say in abstracts, about the benefits of having a different objective for monetary policy, higher interest rates, in practice, I have never come under pressure, or seen off or on the committee, really argue for these other motives in order for us to have higher interest rates, only lower.
One of the great merits of an inflation target is that it holds the feet of the committee to the fire, in saying that you may be unpopular. Don't go for popularity go for what is necessary to meet the inflation target. I think that is fundamental otherwise we will be lost in monetary policy. But an inflation target is not sufficient; we have seen that because you can still get a build up of credit within the financial sector.
I think what is most extraordinary about the last decade, is that two thirds of the increase in credit was within the financial sector. Not credit extended to the non-financial sector, companies or households, but within the financial sector and it was that expansion of credit, that if anything needed to be controlled, and bank rate is not the weapon to do that.
If we have raised bank rate to a level that might have slowed that growth rate of credit within the financial sector, we would have undoubtedly slowed the real economy to a point where inflation would have been falling below the target on average, and we would have seen rising unemployment. So I think we just need additional instruments to do that, but you are right in saying that we do need additional instruments. I am conscious that I have not tackled all of the other parts of your question perhaps you could remind me.
Committee Member: Well there was the point about quantitative easing and the impact that has on the banks independence, because it requires Treasury approval. And the final bit was a comment on the tripartite agreement.
Mervyn King: I don't think quantitative easing is a question of getting Treasury approval. What it has to do in order to work, is it must be carried out in tandem with debt management, which is the Treasuries mandate. There is no point our pretending we are independent. Our decisions on quantitative easing are our own decisions. We remain an independent central bank. But no central bank can engage in, what I prefer to call, conventional unconventional operations, without having agreement from the Debt Management Office that they themselves won't then engage in debt management operations that would offset the operations that we want to carry out.
And that is just as true going into this, as it will be for the exit route. So any kind of operation of that sort, which involves buying and selling assets, has to be done in conjunction with the Debt Management Office, just to make sure that we do not get in each other's way. But it is not a question of affecting the independence of the central banks.