George Osborne and Ed Balls.

Q44 The Chair: Good afternoon and welcome to this hearing of the Economic Affairs Committee. I am delighted to welcome George Osborne and Ed Balls to give evidence to us. Normally at this point we ask you to introduce yourselves, but we know you both very well.

This inquiry has set itself a very simple question to answer which is: how is independence working in this 25 years or so after the Bank of England was granted independence? I am going to start with a question directed at you, Mr Balls, just to really set the scene if possible. I have before me the letter that the then Chancellor wrote to the then governor in May 1997—when Mr Osborne was probably nursing his wounds after the election, as was I—and it states, “Our manifesto commitment is to ‘ensure that decision-making on monetary policy is more effective, open, accountable and free from short-term political manipulation’. The reforms I lay out below will put the arrangements for monetary policy-making on a sound and stable footing for the long term”.

Looking back to that juncture, Mr Balls, what were the concerns you had about what independence might mean in practice and have any of them been borne out? If you can just try to give us a sense of scene setting about that.

Ed Balls: The first thing to say is that when you enact a big reform, the question in your mind is, “Is it going to last?” One of the things that George and I have both learned in our time in politics is, in the end, the only things which last are the things which become consensual, which become cross-party, become the established way of doing things. Back in 1997-98, previous Prime Ministers and Chancellors had decided not to make the Bank independent. It was contentious. It was voted against in Parliament at the Second Reading in 1998, but over 25 years, certainly on the monetary policy side, it has become established and cross-party consensual. When George became Chancellor in 2010, I do not think there was any question he was going to rip up the framework as far as monetary policy is concerned.

If you actually look at the letter and you look at the detail of policy now—the inflation target, its definition, the committee, the independent external members—the framework has lasted. We said for the long term; I am not sure whether we would have thought 25 years was in the realm of the long term. We might have thought that was a lot longer than the long term, but here we are. Over that period we have delivered low inflation and less output variability than in previous decades, so in some sense it has worked.

Our concerns at the time were twofold, beyond “Would it last?”. One was about the decision to give up power. If you go back to the view of Margaret Thatcher, for example, she felt that giving over the setting of interest rates to an independent Bank of England would not be taking her responsibility seriously and that was something which was in the mind of Gordon Brown in those first few days.

The second question was, “Would we end up with an approach to monetary policy-making which would either be deflationary or with worse outcomes for output or employment, would there be a lag, or, with a small C, would the committee be cautious?” To solve those things, first, the decision to make the setting of the inflation target the responsibility of the Chancellor was a very important way of taking responsibility from the Treasury for the goals of policy which, by the way, has given huge cover politically to monetary policymaking ever since. We are now in a position where even the European Central Bank has moved in our direction in terms of the inflation target. I will come to that in a second.

So, first, owning the inflation target was very important. Secondly, the decision to go for a symmetric inflation target—this is where the ECB has copied us—so that inflation going too low as well as too high was a problem was, in retrospect, a very important decision. If you remember back in the autumn of 1998, interest rates had risen a lot. Eddie George went to the meeting of the Trades Union Congress to reassure people that he cared about unemployment and growth. This was not a deflationary central bank, but the symmetric target meant that as the economy slowed in the autumn of 1998, the Monetary Policy Committee was as aggressive about cutting interest rates as it had been about raising interest rates to meet the inflation target in the previous period. The symmetry was very important.

The third thing was that we were concerned as to whether there would be a caution in the Monetary Policy Committee, that there would be a desire for everybody to follow the lead of the chair, and so the decision to appoint four external members who would have views which they expressed publicly, we thought would lead to more activism, and that is absolutely how things have turned out. The fact that there was a clearly defined inflation target, symmetric, set by the Chancellor with a structure which encouraged activism, both raising rates and lowering rates, is at the heart of why, in monetary policy terms, things have succeeded.

The final thing I would say, because you asked me a rather big question, is that the big change which then happened after 2010 was the introduction of the Financial Policy Committee. The change in the nature of the Bank's responsibility for macroprudential, but also microprudential leadership, is more challenging. We have a much shorter track record than on monetary policy and the jury is still out as to whether this has worked. I hope it does, but the target is much less clearly specified. There is not an obvious symmetry and we have not seen the kind of open debate and expression of view in the FPC that we have seen in the MPC. Those are issues which are still a matter of concern. On the monetary policy side it has worked and we are where we started 25 years ago.

The Chair: Mr Osborne, would like to comment on that? Looking back, how do you think operational independence has worked?

George Osborne: I broadly agree with Ed, which I am finding I do more these days than I used to. When I came into office in 2010 there was never any question in my mind that I would substantially change, or in fact change in any way, the monetary policy arrangements. We made substantial changes—which Ed alluded to and I am sure you are going to come onto—to financial supervision and macroprudential measures, but basically I stuck with the remit and the approach to monetary policy.

I would say one thing, and Lord King, who was the governor at the time, is here; I did think there was a responsibility amongst the principals to make this arrangement work. There is a real responsibility for the Governor of the Bank of England, the Chancellor of the Exchequer and the Prime Minister in particular, to make these arrangements work. You can prescribe all sorts of frameworks in legislation, but if the individuals concerned do not want to make it work, you are going to start grinding through the gears of the British constitution. You saw that in Britain last autumn when you had a Government, a Conservative Government, who did not particularly value the then Governor of the Bank of England, made no secret of it, and ended up heavily depending on the Bank of England in a crisis that they had created.

When I became Chancellor in 2010, my number one priority was actually to establish a good working relationship with Mervyn King and make sure that not only would we have a formal relationship in terms of exchanging letters and the like, but that we could have a proper informal partnership which did not in any way compromise his independence but enabled us to both fulfil our functions of trying to make sure the British economy was a stable and prosperous place.

The Chair: Before I turn to Lord Davies, can I just ask you, in terms of that relationship, to talk us through, maybe without giving a specific example, but to try and give us some light on how that relationship works between the governor and the Chancellor so that you are sharing views without actually infringing independence? It is very interesting and both of you, and obviously Lord King, have that experience. I want to get a sense of how those kind of meetings work, those informal relationships, because this is a sort of grey area and you could say even, to mix metaphors, a black box in terms of how independence works in practice.

George Osborne: The first thing I would say is that, during the six years I was Chancellor, I was fortunate that we never had a really stressful situation where there was a strong institutional difference in outlook between the Bank and the Treasury and the rest of the Government, so this relationship, either with Mervyn or with Mark Carney, was not tested to destruction. As the Minister, you start with enormous respect for the Bank of England Governor and their officials and the job that they have to do. You have to respect that they are not your servants. This applies more to the Civil Service, but I hate the kind of attitude of “We are the masters as the Ministers and the civil servants are the servants”. These are two different professions.

I started with a lot of respect for Lord King and his colleagues, and a respect for their role. I think it was, by the way, entirely appropriate that Mervyn King had reached out to me as shadow Chancellor and had met with me on a couple of occasions beforehand, so we had met and already established that relationship. The main thing—it sounds a bit old school, but it did not feel like it was—is that we would have dinner once a month, either at the Bank of England or No. 11 or the Treasury. It was generally better food and better drink at the Bank of England than at the Treasury, and the only people I would have with me would be the Permanent Secretary at the time, Nick Macpherson, and my most senior special adviser, Rupert Harrison. Mervyn would have his Private Secretary with him. There were just five of us and we would talk about everything and anything, and it was not minuted, there was not a particular agenda, although we would both come with things that we wanted to discuss and the private secretaries would have established in advance that these were things that both sides would like to raise.

I would be really careful about overly prescribing that conversation. You have to allow a safe space, if you like, where senior policymakers from different institutions can have that informal discussion. In that informal discussion, I would say, “I have a Budget coming up, I am thinking of this, I might not do this, I might cut this tax, I might not”. In other words, things that were highly politically sensitive, but I would trust, obviously, the governor and this would also apply to Mark Carney, that he would treat that all in confidence. If I asked for it, he might give me informal advice, not on politics or fiscal policy but on overall economic policy, by saying, “Well, taking that into account, this might be the monetary policy response”. I do not think that in any way compromises the independence; the independence comes from the self-confidence of the institution and that is how you actually make it work. When it does not work is when those relationships break down and you cannot have those conversations.

Ed Balls: Again, very much continuity with the way things had been in the previous 13 years. I had a series of meetings with Mervyn when he was chief economist prior to the 1997 election. In fact, I remember Gordon joked that the only person who was actually guaranteed a job in the new Labour Government in 1997 was Mervyn because the manifesto specified that the chief economist would become a member of the Monetary Policy Committee when it was established.

I also had very regular meetings with the then private secretary to the governor, Mr Andrew Bailey, for months before the 1997 election, and that relationship carried on. There was lots of change happening and it was complicated, but I remember, at the Mansion House dinner when Eddie George stepped down, he presented Gordon with an open letter which said, “Dear Chancellor, I have never had to send you an open letter,” and everybody smiled; that was an expression of the warmth which was established over those years in that relationship which then carried on with Mervyn.

Since 2010, it is more complicated with the shifting of responsibility into the Bank of England and also the different deputy governors. There was an open conversation with the governor, but then the decision on interest rates was not made with the Chancellor, it was made by the Monetary Policy Committee, with votes, chaired by the governor. We are now in a different situation where you have, within the Bank of England, different decisions being made by different bodies with different deputy governors responsible. There will be times in the future where there is a potential tension between the view of the systemically concerned governor, deputy governor, or the monetary policy-making deputy governor, and then the microprudential regulating deputy governor. I am not sure whether we have yet worked out the forum within which those conversations occur, including the Chancellor. In our time, it was always clear that the governor and the chief regulator had a direct line to the Chancellor, and that is less clear today.

George Osborne: One of the reasons we brought about the reforms around financial supervision was precisely to force these trade-offs to be made and resolved. I will take a practical, real-world example from the last year. In the autumn of last year, the Bank was trying to tackle inflation and, at the same time, there was a financial stability crisis in LDI pension funds. Instead of the Monetary Policy Committee of the Bank of England coming to the Chancellor and saying, “We’re sorry about your problem with the pension funds, we are doing this on interest rates,” or “We are doing this on quantitative tightening,” then some other regulators coming and saying, “But we've got a real problem with the pension funds”, you have Andrew Bailey as the central point having to reconcile both, coming up with a solution which is, “We're going to buy gilts for a week or two. By the way, we're not going to put this to the Chancellor because, if we do, he’ll want to buy gilts for the next three months”. That is a good example of a difficult situation where you had MPC objectives going one way, FPC objectives going the other way and you force the institution that we have charged with these responsibilities to resolve it, and you have forced the person who, obviously, by definition, you have confidence in, the Governor of the Bank of England, to make the trade-off.

Ed Balls: I do not agree with what George has said and there are some real issues here which we need to talk through, but I do not know if you want to discuss this now.

The Chair: We will come back to it; I have definitely noted it. I just quickly want to bring in Lord Griffiths.

Q45 Lord Griffiths of Fforestfach: I warm to the idea that the Treasury and the Bank get on closely together. On the other hand, is there a danger that the closeness becomes so great that you end up with fiscal domination and you end up with quantitative easing financing what the Treasury really wants?

Ed Balls: The Chancellor and the Treasury are responsible to Parliament for the setting and arrangements to meet the inflation target, and for the setting and arrangements to meet the target for financial stability. In the end, there has to be a dialogue which involves the Chancellor because that is where the responsibility will ultimately lie and also where the balance sheet guarantees will come from. It would be a mistake to cut the Chancellor out of that.

Secondly, regarding fiscal policy, fiscal policy is a matter for the Chancellor and for the Treasury. We can discuss this. I do not think there is any evidence that our system has done anything that allowed the proper management of the co-ordination of monetary and fiscal policy over the last 25 years. Quantitative easing is an issue which is the responsibility of the Bank of England in meeting its objectives, set by the Chancellor. It is on that basis that the Bank of England has been held to account for those decisions, and it is on that basis, through the setting of the target, that the Chancellor is accountable to Parliament. I do not personally feel that anyone has established there has been either a conflict, a tension, a lack of accountability, or the wrong decisions made as regards the co-ordination of monetary and fiscal policy. We could debate 2011 to 2013 later, if you like, as there I am not fully sure, but as far as QE is concerned, I do not see the evidence.

The Chair: We can come back to QE. Lord Davies.

Q46 Lord Davies of Brixton: Our study is focused on the success of operational independence; the problem is that we only have a sample of one. Given the varied experience of the 25 years, with the movement of China into world trade, with the 2008 crash and the subsequent measures taken to solve that, and then more recently with what has happened in Ukraine and also Covid, it is very difficult in that whole mass of factors to pick out what bit of that was due to operational independence. Perhaps another way of asking the question would be, if the Bank had not had operational independence, would anything have been any different? In which case, we cannot really form a conclusion on independence.

Ed Balls: The first thing to say is that systems are tested in the face of shocks, and we have had a whole series of shocks; the semiconductor in 1998, LTCM, we had the tech bubble bursting, the Iraq war, the financial crisis, interest rates stuck at the zero lower bound and then a pandemic. The reality is this way of making monetary and fiscal policy, but monetary policy in particular, has been robust in the face of those shocks, so afterwards the system emerged and carried on with continued political and public support. We have a whole series of points where the system could have failed, and it did not. The one time where the system nearly failed was when politics looked like it was throwing into doubt the operation of the framework, independence, proper budget processes, the role of the OBR; that was the only point where we have had a crisis which looked like it was going to run out of control. The reason we came through it was because the system was re-established. So I feel more optimistic than you about the operational framework.

George Osborne: There are two specific examples. If Mark Carney had not been an independent bank governor, his words on the immediate morning after the Brexit referendum would not have carried such weight in financial markets and calmed financial markets. If he had been seen as a placeman of the Government I was part of, the Cameron Government, people would have said, “Well, he's not going to be here for much longer”. The fact he was independent helped enormously in that situation.

I come back to the autumn of last year, which is an important test case because that was the first time in the last 25 years you have had a Government that was not ideologically committed to independence of the Bank of England, was badmouthing the Governor of the Bank of England and, when it came to the OBR, which I know is not the subject of your inquiry, was actively seeking to bypass it or indeed dismantle it. If anything, I would like the OBR to be put on more of the independent footing that the Bank of England is on, with powers to conduct its own forecasts, powers to request information from the Treasury so you do not get the situation you had last autumn where the Chancellor announces what in effect is a Budget—certainly the most consequential fiscal statement of the last 25 years—and the OBR was not allowed by the Chancellor to do its job. I would learn from that experience and learn from the Bank of England's independence and find ways to make the OBR more independent and more robust in the face of political vandals.

Q47 Lord King of Lothbury: I want to start by thanking you both for doing two things; one is setting out very clearly the arguments for independence and, as Ed said just now, there were an awful lot of shocks during that period which tested the framework. The second is stressing the importance of the informality of the relationship between Chancellor and governor, which is necessary to make things a success and cannot easily be defined in terms of remits or changes to legislation, which is something we, as a committee, might want to think about. It is very much to do with individuals, personalities and people being grown-up enough to make that relationship work. In my experience, under both parties, it worked extremely successfully; there was never a moment when either Chancellor of either party tried to, behind the scenes, put pressure on the MPC to take a decision one way or another, so it has actually been extremely successful.

What I want to probe you on now a little bit and get both of you to talk about is the extent to which the remit and responsibilities of the Bank have been expanded since both your times there. Ed, even on the MPC, we now have climate change and various other things added to the remit of the Bank; what is your view about going back to the simplicity and clarity of the initial remit? What is your view about how far it has changed? And, George, the remit of the FPC is almost twice as long now as it was when you introduced it; what is your reaction to that?

Ed, if you want to go first and then George.

Ed Balls: From the beginning in 1997, we were clear that there would be a secondary objective to support the Government's objectives for growth and employment, and that was in the original letter, and in the legislation, but it was always clear that that was a secondary objective. The primacy was the inflation target. The importance of the symmetry and the importance of the open letter was it allowed the Monetary Policy Committee to explain that there would be times—we are going through one at the moment—where there is a shock which moves inflation away from the inflation target and, at that point, the Bank has a decision to make about how fast to seek to bring inflation back to target. It does so with an eye on supporting the Government's wider objectives for growth and employment; that is what the open letter system enables. Clearly, getting back to the inflation target is the most important thing, but the pace at which you do that is key. I think that has been a strength.

The idea that you start to throw in to the mix other secondary objectives which are not really directly affected sensibly by the instrument that the Bank has in front of it, which is the interest rate to meet the inflation target, concerns me. If I was the Bank of England doing stress tests, one of the stress tests I would want to do would be to worry about risk and resilience as far as climate change is concerned. Clearly, the MPC was always worrying, in the period up to 2007, about whether or not wider financial stability concerns could impact upon the inflation target and wider objectives of growth in employment, but the Government have to be clear that the meeting of an objective like tackling climate change or reducing emissions is a matter for fiscal policy and regulatory policy and the Government. To start expecting the Bank to lead on that does not seem, to me, to make any sense.

Similarly on the Financial Policy Committee side, I was supportive and in the end we got to this point. Clearly, there is an objective for financial stability, but, subject to that, we wanted the FPC and the Bank to have an eye on the wider impact on growth and competitiveness of the City of London and the wider economy. That is important because, in the same way as you do not want an inflation target that “as low inflation as possible is better”, which is important, you do not want to have an approach to financial stability which says “financial stability at all costs”, because that would be at the expense of the operation of the economy.

Something which needs to be in the mind of the FPC as it makes decisions to use, for example, macroprudential tools, is that there has to be risk and there has to be decision. There is an inherent problem on the FPC side which is, it is easy to define the primary objective, the inflation target, to measure it and to hold the Bank accountable for that, for the public, the committee, to see that, and then in that context, to have the conversation about the impact on secondary objectives alongside. On the FPC side, as the Chair was saying about the remit, this is much harder because it is very hard to specify the remit and therefore hold the FPC to account for the meeting of that remit, and there is a danger that there is insufficient scrutiny of the impact of decisions on those wider growth/competitiveness objectives.

In some ways, it makes it more important that there is scrutiny, but let us be honest; as far as the FPC is concerned, there is much less scrutiny, and the scrutiny is much less effective. There is a less informed public debate and less discussion in Parliament of the remit letter. My answer to Lord King's question on the FPC is the secondary objective is in some ways more important, but I worry about whether we have transparency of process and clarity which properly allows us to scrutinise that effectively.

George Osborne: I agree with the implication of your question, which is that we do not have to turn these letters into Christmas trees where you put all your baubles on them. It should be straightforward enough to say, as a secondary objective, supporting the Government's economic policy and then the Government should be able to articulate their economic policy so the Bank knows what it is. Whilst I totally respect the desire to get all arms of the British state trying to deal with the challenge of climate change, I do not think it is particularly necessary to single out that objective amongst other economic policy objectives.

On the FPC, I agree, essentially, with what Ed is saying, but I think the FPC has been a very valuable addition to the Bank's tools. It will be strange not to use these instruments to try to manage macroprudential risks. They are intrinsically more complicated to understand, but there are many tools you can use. I have read up on your previous hearings with Paul Tucker and John Vickers, and I have a lot of sympathy with trying to encourage debate and voting; we should probably give more thought to see how that could be introduced, but it will not always be straightforward, because it is not just one target and one instrument as there is on the MPC, although the MPC has found some new instruments with things like QE.

I will give you a practical example. The FPC makes very important decisions about mortgage affordability, which has real world consequences for millions of families about whether they can afford a home or not. It is self-evidently the case that it is much harder to get a mortgage these days than it was 30 years ago. As a result, people in their 20s and 30s find it harder to get on the housing ladder. That might all have been done for good policy reasons like making the country more resilient to financial shocks, making bank balance sheets more robust and making sure people did not get themselves into debt situations which they could not afford but, whilst Parliament—the House of Lords and the House of Commons—goes around talking about home ownership, the regulatory system, the FPC and so on, has made that harder and harder in one particular angle around mortgage finance.

I do not think that is properly understood and properly debated, and I do not think parliamentarians give it sufficient attention. It would be good to come up with some ways to articulate these choices more clearly, explain the real-world consequences of countercyclical capital buffers and that kind of thing, which is very technical but does have enormous consequences for the ability of a small business to get finance, the ability of a family to get a mortgage and so on. And by the way, the committee knows what it is doing; it is not like the people on the committee do not know that they are doing this, and they are doing it in good faith. We could find ways of explaining in simpler terms the consequence of these decisions.

Lord King of Lothbury: If we could turn the clock back to happy days and you were in power again and you had the chance to simplify some of the remits, would you want to do that, or not?

George Osborne: It is a good question. In the governance of the Bank of England, we could have a good conversation with the governor and the FPC about how to simplify the remit and how to make the decisions more transparent to people, perhaps to have a conversation with how Parliament can engage with those decisions and scrutinise them. This is difficult territory because I have great respect for all the current incumbents, but maybe there are too many deputy governors, or we could somehow create some hierarchy amongst the deputy governors, which I know is something previous witnesses have raised. There are tweaks to the system that could be made, but, broadly speaking, it ain't broke, so don’t fix it.

Ed Balls: I would go further than that; not on the monetary policy side as the specifications target and the way that there is accountability seems to be working, even in difficult times. I do not think we are ever going to get to something that is equally clear and simple on the financial policy side, but there is a problem and George alluded to it: the reason we do not have a fiscal policy committee is that, in fiscal policy, the decisions the Treasury is taking around tax rates are first order distributionally differentiated. There are different tax rates for different individuals, or for different parts of the country sometimes, which affect people directly. In the case of interest rates, in first order terms, when the Bank sets the interest rate, it is the same interest rate for everybody. Of course, there are second order distributional impacts, but it is one instrument.

The FPC is making decisions which are more like fiscal decisions than monetary decisions. For example, if you take loan to value ratios, they have different levels and impact differently on different groups of people; this is politically more contentious, and I do not think we can simplify that. I absolutely want operational independence for the Bank, the macroprudential decision-maker, to use those tools.

What I worry about at the moment is that, on the financial policy, the Bank is too exposed. I would like there to be more cover given by the Treasury and the Chancellor to not just the objective, but the operation of that objective, six months to six months, to try to get closer to the way in which the Treasury owns the inflation target. One of the things I have proposed is that we do not simply have a letter sent by the Chancellor to the FPC on an annual basis, but maybe more often, maybe quarterly or every six months, the Chancellor brings together the governor and the key deputy governors who are leading on macroprudential supervision and monetary policy and they have a conversation about risk and macroprudential risk: the things which are on the agenda. From that meeting, the Chancellor then gives a remit which might have a bit more detail in it. It is then for the FPC to make its decisions, but to meet a remit which has been discussed in the group but with more specification and in which the Chancellor can give more political cover. What worries me at the moment is if something was to go wrong, the Bank of England, on the financial policy side, is quite exposed. I would rather that the Treasury was more engaged.

In America, they have a committee called the FSOC. It is not necessarily a good parallel because there are lots of complications where the American system is different from ours and complicated, but, essentially, the Treasury Secretary chairs a group, which brings together the key players, to look forward in terms of the macroprudential developments on the economy. That is a good thing. I cannot speak for George, but I think if George or I were Chancellor now, finding a way in which the Chancellor can own the financial policy objective in a more detailed way, as is clear on the inflation target, would give the Bank some protection.

Lord King of Lothbury: I take it that, although there are some differences of perspective in what you would do on financial stability, neither of you is keen to either retain or add to the baubles on the Christmas tree?

George Osborne: It is a good exercise, is it not, every few years, to try to simplify these things and thin down the remit letter.

Q48 Lord Turnbull: You have outlined how the FPC is taking decisions which have strong distribution elements; they are making them more like tax decisions. There is one other factor which I do not know quite how they deal with it; let us say, careless talk costs lives. You want to talk about some sector, but you are not quite happy, there is a risk here and a risk there and the last thing you want to do is put that out in the public domain, because you would precipitate the very thing you are trying to prevent. Maybe the answer to that is there needs to be more discussion between the Bank and the Treasury so that they have an absolute sharing of where these risk factors are, who could be on the brink and where you might need to intervene, but you do not share that with the wider public and, as I say, precipitate what you were trying to stop.

Ed Balls: I strongly agree. In a crisis, the reality is the Chancellor is going to be chairing the meeting because they have the balance sheet. However, it is not enough for the Chancellor only to hear from the governor because there may be, within the Bank of England families, different views between the microprudential regulator, the monetary policy-maker or the governor about where risk lies. If I was the Chancellor, I would want to hear those different views rather than them all being siphoned through one individual: the governor. That is why I do not agree with the way that George specified the last autumn conversation. You need to have a regular place where that conversation occurs and the remit is discussed, although it does not have to be minuted, for exactly the reasons you said. You establish in good times the relationships which you will then need in more difficult times, which means you do not have to invent an ad hoc group because you already have the group established and working. The flow of information between the Treasury and the Bank needs to be two-way and not one-way.

Q49 Lord Rooker: I am going to ask about scrutiny of the remit. In some ways, the extensive positive answers you have just given to both previous questions cover aspects of it. I was very struck with what William Hague wrote in the Times this morning about MPs having less time than they used to have to spend on national issues, and the words “Treasury Select Committee” have not crossed anybody's lips yet this afternoon. Do you think the remit letters receive an appropriate level of scrutiny? Is there a case for a bit of prior scrutiny by the Treasury Select Committee before they are issued? We get transparency afterwards, but, notwithstanding what you have just answered to Lord Turnbull, I can understand the reason for saying no, but is there not a case for a greater degree of education of the public and indeed Members of the Commons who, according to William Hague, and I think he is probably right in my experience, are spending less time on national issues than they used to?

George Osborne: I can only speak from my time in Parliament; the Treasury Select Committee was a pretty effective and tough forum to appear in front of as Chancellor. I would have two scheduled meetings a year, one after the Budget and one after the Autumn Statement, and I would spend a lot of time, given that I also had a lot of other responsibilities, preparing for those meetings. They had an element of a “gotcha” encounter where there were a couple of rising star Labour MPs—one of whom is now shadow Chancellor—out to make a name for themselves, something that I was also doing back then when I was an opposition MP. You also had a couple of unfriendly members of your own side trying to get you, who were harder to deal with. It was certainly a lot of heat; I am not sure there was that much light. It was generally understood within the TSC that this was not the big showdown in a highly charged week where you have just done the Budget and it is being argued over by the different political parties. Certainly, speaking entirely personally, you would have got more out of me in that encounter rather than getting my defences up.

We have to confront the reality that our constitution—if we can describe it as such—means the Executive is in the Parliament, so I am always a bit nervous of saying parliamentary committees—I am talking here about the House of Commons—should have vetoes on appointments, or vetoes on things like remit letters which go to the core of the Government's economic policy because, in practice, a Government should have a majority in Parliament. It would create all sorts of complications if you are trying to pretend this committee is independent when it is not really. Let us be honest, in practice, I can say now I have left, you would be going to the chair of the Treasury Committee and saying, “If you behave yourself, you will be a Minister in a year’s time”. The more weight you put on that body, the more you would force the Executive to corrupt it, essentially. So I would not give it executive power because then the Executive would want that power and find a way to get that power, but I would give it more opportunity for scrutiny. I would also find at least one occasion a year when the Chancellor has a less confrontational encounter with the TSC.

Ed Balls: On monetary policy and on fiscal policy, parliamentary scrutiny of government decision-making is effective and has become markedly more effective over the last 30 years since I was first here in the early 1990s. Part of the effect of the 1997 reforms on monetary policy was to enhance the debate and scrutiny. Once we had got used to MPC members making speeches, disagreeing and voting differently, it was hugely positive for the public debate. We have had, in the last 25 years, one of the most educated debates about interest rate decision-making in any developed economy. The reforms, and the way in which the Bank empowered those reforms and encouraged, as Mervyn did in particular, different people to take a different view, have been really good.

We do not do the same on financial stability, financial policy. When I was a Minister, I would be summoned to hearings about cash machine charges or travel insurance, but we were not talking a lot about macroprudential stability. I would be surprised if you spent a lot of time talking about those things. There was a period when Andrew Tyrie chaired the Parliamentary Commission on Banking Standards where Parliament did play that role, but it was only for a short period. It may be a fact that it is inherently more difficult or more complicated, even though we know its impact on family finances and the economy is huge, but it might be, to go back to a point we made earlier, there is very little scrutiny of the FPC minutes because they are quite boring as everything is consensual, there are no votes and people do not express differences of view. As Lord Turnbull says, you have to be careful about how you express differences of view, but the parliamentary debate and the wider public debate will follow from whether the Bank of England feels confident to air those debates in public. We have been much more confident talking about those things on the monetary policy side in the last 25 years than we have on financial policy.

From reading the transcript, I know that both John Vickers and Paul Tucker made this point, but there has been no groupthink in monetary policy for 25 years. There is more structurally we could do to move away from consensual thinking on financial policy decisions. Of course, it was really difficult in 2009, 2010 and 2011. I do not dismiss how hard it was to introduce these reforms, but I wonder whether evolving that and having more confidence in disagreement, or at least discussion, would lead to enhanced parliamentary debate and better scrutiny and accountability.

Lord Rooker: That is very helpful, but I would just like to follow up to Mr Osborne. Perhaps you could elaborate on the process of the development, because you had the opportunity over several years of producing the remit letters. For example, before you issued a remit letter, did you check it for consistency with the previous one? As you have clearly both done your homework, you will have read the exchange I had with Paul Tucker a couple of weeks ago when I pointed out that in 2021, which is Rishi Sunak’s letter, paragraph two contained, “The Government's commitment to price stability and the Bank of England's operational independence remains absolute”. The exact same letter with the exact same paragraph from Jeremy Hunt in 2022 did not contain that sentence.

George Osborne: He really needed to say it in that situation. I thought it was a very interesting question and I was wondering what the answer was. Among the policy decisions that I took as Chancellor, we would spend quite a bit of time on the remit letters. In discussion with the governor in 2012, 2013, I did consider whether we could change to nominal GDP targeting or average inflation targeting, but we never got beyond first base. We had lots of discussions about credit conditions in the economy, which ultimately led to the Funding for Lending scheme from the Bank of England.

The last remit letter I sent to Mervyn was to open the door to forward guidance and we changed the remit and allowed the committee to take a number of years to return to target if it wanted to do so. We did spend a lot of time considering it; although I have to say we spent much more time thinking of changes which we then did not do. We spent an enormous amount of time, I seem to remember, in 2012, thinking about nominal GDP targeting and came to the conclusion that it would be a pretty bad idea, but it was aired within the Treasury and it was aired in the private discussions with the governor. I certainly feel it was not a routine task in the Treasury when I was there, because we were dealing with a situation of an ongoing credit crunch and interest rates were at the lower bound and so on. It was given proper consideration and top officials in the Treasury were engaged in it.

Q50 Lord Londesborough: Can we now return to the quantitative easing and, in the current climate of high inflation, the unwinding of QE? Over the last 12 years or so, in the wake of the financial crisis of 2008, QE has grown cumulatively from £200 billion to almost £900 billion post pandemic in 2021, with events such as the eurozone debt crisis and Brexit triggering fresh bouts of QE along the way. As a result, the Bank’s balance sheet has grown by almost 500%. My question for you both is really in two parts; first, do you think that the Bank’s deployment of QE has impacted on its credibility in relation to its primary task of controlling inflation? Secondly, has QE, particularly the extent of it and the size of the Bank’s balance sheet, served to compromise the Bank’s independence?

George Osborne: I would say the answer to both question is no. First, it was to the credit of the Bank and the then Government, the Gordon Brown Government, and Alistair Darling as Chancellor, that they developed the QE framework, and, as shadow Chancellor, I said some foolish things about it at the time.

Ed Balls: I remember.

George Osborne: But sure enough, when I was actually in the real job, I adopted wholesale the Alistair Darling framework which had been agreed. It showed policy innovation in an exceptionally difficult situation for the country and the world.

I think it is a bit harsh to second guess the Bank in 2020. Again, that was an exceptional situation, a pandemic which none of us had seen in our lifetimes, a disease the impact of which none of us knew the extent of. To make a broader point about lockdown, I always remember in those first few months we were all very scared of getting this disease; we became less scared as vaccines were developed. There was a shock to markets in March 2020, and the Bank of England was worried about liquidity in the system. With hindsight, you can say the combination of QE from the central bank’s very loose fiscal policy, not just here but particularly in the US—which then continued over two Administrations in the US—contributed to the inflationary problems, but it is a bit harsh to second guess the policymakers in the spring of 2020 when they were faced with a situation which was, essentially, unprecedented in the modern era.

I would also say that QE has become a bit of a bogeyman for the failures of democratically elected Governments to do things about. It has become the bugbear for distributional impacts in society which have seen people with capital get richer but, in my view, it is the role of Governments to do something about that rather than blaming QE. Equally, on debt sustainability and all that, when I was running a high budget deficit and trying to get it down, I certainly never thought that it was okay because the Bank would be buying all my gilts; I was very conscious that we had to maintain credibility in the gilt market and we did not want failed auctions and the like. As you see with the present Government, they are aware they have to convince markets and have come up with—they do not like to use the words—austere policies to try to restore credibility and get finances into better shape. So QE has become a bit of a way out from much harder questions that should be aimed at democratic politicians about how they are going to increase opportunities for people on lower incomes and how they are going to do that at the same time as managing public finances in such a way that you do not lose confidence in markets.

Ed Balls: My answer would also be no to both of your questions. Of course it is the case that as QE unwinds and as interest rates are rising, this is going to impact upon the Government’s fiscal balance sheet and the Government will absorb that. If they do not, suddenly we would be having a different conversation about QE, but I am sure they will. I do not think there is any evidence that the Bank of England has taken decisions other than to meet its inflation and financial stability targets. I do not think there is any evidence that it took decisions it would not have made to meet those objectives because of pressure from the Government. It is true that there were periods when interest rates were very low and where the Bank was worried and thought maybe some more QE might help—and it probably did not help a huge amount, but I do not think it did any damage.

If you go back to March 2020, at that point when markets were dysfunctional in the way they were last autumn, QE played a hugely important role and was going in the same direction as fiscal policy. The evidence that QE has had big impacts on interest rates or behaviour or inflation or economic outcomes outside those periods of gross market instability is pretty weak. There were probably periods when the Bank was looking for levers and thought there was no harm in doing a bit more. I do not think it potentially did a lot of good, but equally nor did it do a lot of harm because I do not think it was hugely effective. I do not think those shifts in asset classes make a lot of difference. What it has done, as George says, is complicated political narratives and given a stick for some people to beat the Bank with. Aside from the politics, in terms of the economics, outside those unusual and important moments, QE is just not that important.

Lord Layard: I just wondered if you could clarify how you think about what is going on when you have the zero bound problem. Normally the theory is that the Government do the Budget and the Bank controls the inflation rate through the employment rate, so the Bank is in charge of the employment rate. When you have the zero bound, it begins to lose control of the employment rate and therefore the fiscal side has to become more involved in the determination of employment. How did you see that playing out during the zero bound period?

George Osborne: I would say we were saved by the bell. It was not just here; I seem to remember the Bank of Japan was leading the charge on this. There was all sorts of talk of the next stage of monetary intervention and innovation which, at some points, was going to look dangerously like monetary financing. At just that point, the world economy started to pick up and the issue started to go away. We were beginning to have those conversations in 2013: is there more you can be doing in the monetary space? It is still an interesting toolkit. There is now an expectation in any downturn that the world central banks are going to step in and stop it—not a downturn caused by setting policy to control inflation, but in any crisis there will be a massive release of money into the system and an expectation that, if that does not work, they will release even more money. I guess we never really quite reached the point where we started to examine what the more exotic instruments were that you could start to deploy in a system like ours.

Ed Balls: Although in that period, to go back to debates of 10 years ago, rather than exotic instruments, you could have just used fiscal policy more in 2011, 2012, 2013. That was a choice that the Government chose not to take. In the pandemic in 2020, interest rates were low. There was some QE, but the work was rightly done by fiscal policy. In 2007, interest rates were higher; they came down, the work was done by fiscal policy primarily in that period and with the banking crisis. Last autumn, there was instability, but actually there was inflation, so monetary policy was going in a different direction, but you could have decided in 2010, 2011, 2012, 2013 to have a more supportive fiscal—

George Osborne: We are going to go over our old parliamentary debates now.

Ed Balls: The reality is—

George Osborne: I would point out that we still had the strongest growth in the G7. We are warming up for our debate now.

Ed Balls: The reality, as the OECD numbers show, is that for all the rhetoric of George, he actually moved fiscal policy from seeming to be about reducing the deficit to being mildly supportive of fiscal policy. So he actually did become more fiscally active, he just did not want to tell anybody that was what was going on.

George Osborne: It is best way round to do it.

Ed Balls: You could have just had a little bit more courage of your convictions.

Q51 Lord Verjee: It is not our remit to look at individual policies at the moment but, if you look at where we are today, you could make an argument that the Bank of England has got it completely wrong. Inflation has got completely out of control and something is going wrong. I agree with Mr Osborne that we are in unprecedented times with the pandemic and the war in Ukraine, et cetera, but we have someone who has got it completely wrong and then we are asking those same people to fix the problem. Is that a flaw in the system and, if so, how would you fix it? It seems crazy to me to have a situation where someone has got something completely wrong and you go back and ask them to fix it.

George Osborne: First, all central banks were probably slow to spot the inflation problem—although I know there were some people who forecast it—which came largely unexpectedly out of the tail end of the pandemic and the lockdowns, and was, in my view, turbocharged by fiscal decisions in the US. I do not think the Bank of England can be singled out among the central banks; if anything, it was actually one of the first movers—I think it might have been the first. On the credit end of the balance sheet, it dealt with the exceptionally difficult situation last autumn.

The reason I bring that up, and brought it up earlier, is that that was the time when you had an elected Government in this country challenging, essentially, the legitimacy of the Governor and the Bank of England. You had a self-induced financial crisis within this country alone at the time. The Bank managed to navigate through that, and it was the Bank's credibility that actually started to restore confidence to the markets, which then was followed by the change of government that was able to do that. Taking a recent example, although I am not saying the challenge was quite as large as in the US or Switzerland, the Bank of England handled the Silicon Valley Bank UK situation far better and with more clarity than authorities elsewhere. We did not get into a situation of guaranteeing all deposits, as the US did, and we did not get into the confusion about equity holders versus bondholders that you saw in Switzerland. The Silicon Valley Bank UK failure was handled very professionally by the Bank, and it was shepherded into the hands of a—

The Chair: If I may interrupt—sorry, I am conscious of time. We have been going for an hour. You both appear to be saying that the Bank has a pretty good, clean bill of health; in fact, it is succeeding. Mr Balls, I noted that you said we have avoided groupthink in monetary policy. If people had listened to the last hour, they would be wondering what planet everyone is on here. We are seeing inflation running amok and the Bank seems to have potentially been asleep on the job. Mr Osborne, you said that in fact, all central banks were behind the curve.

Mr Balls, what, if anything, can we learn about the track record of inflation over the last year? We were repeatedly told—in this committee, as elsewhere—by a number of members of the Bank of England, “Don't worry, it’s transitory”. What I am hearing is the structure is fine, the accountability is fine in the Bank, and actually everything is just a factor of groupthink globally. I am trying to see what I am missing here and whether or not there is any lesson at all we can be learning from what has happened.

Ed Balls: The economic policy decision-maker does not have the benefit of our hindsight. That is just the nature of the task. We talked about the robustness of the system and the monetary policy decision-making process of the Bank of England in the 2000s, but the reality was that in 2005, 2006 and 2007—in 2006 there was a meeting of the deputy governor for financial stability, and the Treasury and the FSA—nobody, all backed by big capabilities in their own institutions, was seeing the risks which were arising in our economies and communicating that either to the Treasury or to the Monetary Policy Committee. That was just a reality, and we now know that and have learnt from that, but the system was robust to those decisions.

When you move to the last two years, the reality is that supply chains worked better through the pandemic than any of us thought. I do not think people foresaw the extent to which there would be disruption after the pandemic in the re-establishing of supply chains and its impact on prices. I do not think people foresaw that we were going to have a war in Europe and its impact on energy prices. We did not foresee that the labour market would bounce back as strongly as it did. When we were talking about the end of furlough, the worry was whether we were going to see a huge rise in unemployment in our economy. In fact, things went the other way. With hindsight, of course, it would have been better if we had seen these inflationary pressures; the question is, how did the system deal with the inflationary pressures when they arose at that time?

We could have a discussion about imperfection in communication. Of course, there were mistakes made. We could say the Bank of England went first compared to other central banks, but maybe we should have gone earlier. The Bank of England went first but maybe it should have been a bit more aggressive in the early phase. However, the reality is that when inflation goes outside the inflation target, you raise interest rates to get things back under control. That is what the MPC and the Bank are doing, and, I would say, with broad-based public support. What is very striking to me is that there is a lot of criticism of government fiscal policy and energy prices but actually, so far, there has not been a huge controversy around the rise in interest rates and mortgage rates, other than for a few weeks in the autumn—

George Osborne: That is because the Government gave it cover by—

Ed Balls: With complete carnage. With the benefit of hindsight, they would have done things differently, but actually that does not mean that the system has not worked.

Baroness Kramer: I just want to push a little harder on Lord Bridges’ point. We are very good at learning the lessons with hindsight: that is what we did wrong, let us make an adjustment, let us do this differently. But we appear to be in an era where, every time you turn around, the unexpected, unknown, or whatever phrase you want to use, comes and whacks the system in a way that seems to be, from a regulator's perspective, completely unexpected. We are also in a time when financial markets move very fast, and individuals get information instantly and move money instantly. Is there some change that you could see in the way the system is set up that would give us the capacity to anticipate risk more effectively to deal it, ahead of the crisis hitting us square?

George Osborne: There are certain things which are extremely hard to—I do not want to go all Donald Rumsfeld on you: the unknown unknowns. I know there is a Covid inquiry under way, but as for the idea that the whole world should have anticipated that there was going to be some brand new virus—I question whether, in reality, you can plan for every single contingency. What is fair to say, though, is there are things that are obvious now that perhaps we should be doing more thinking about. It is obvious now that these bank runs happen in minutes, not days and weeks, and there is no point sitting around for years thinking about that; it is the case. Silicon Valley Bank UK, Credit Suisse: money moves unbelievably quickly in a digital banking age where people can move quite large corporate deposits extremely quickly. The other recent lesson has been that to think that smaller banks can be allowed to fail without any broader systemic impact is a mistake. It turned out that, in the case of Silicon Valley Bank, it was connected to a particularly important ecosystem around tech and tech start-ups and whatever, and policy-makers, after the event, suddenly realised that this bank was systemically important, but not in the way that they had previously conceived.

I do not know if you want to get into it, but one of the consequences of the financial crisis 15 years on is that we have a smaller number of very large, important banks, mainly American. There has largely been a clearout of European, large investment banks over the last 15, 20 years. To what degree do we rely on international co-operation to resolve these institutions, and do those international arrangements stand up to scrutiny? Would it actually work in a crisis? In the case of Credit Suisse and the Swiss authorities—I am not second guessing them; it is incredibly important institution for Switzerland—there is some evidence now that it was written into the bondholders that they would get wiped out if there was government intervention, so there was a sort of logic to what the Swiss were doing, but what was happening to what is an important institution in London and New York, as well as in Switzerland, certainly came as a surprise to the UK and US authorities.

The Chair: I am going to jump in because I am very conscious of time; do you want to quickly add anything?

Ed Balls: If you would allow me to, in a second I would like to say one thing about the MPC/FPC relationship, because we referred to that earlier. But just to answer Baroness Kramer's point, we have been talking about ways in which we can improve scrutiny and public debate and accountability; that is particularly the case on the FPC side. But the reality is that we thought a global financial crisis was a once in a century event, and then there was the pandemic, leaving the European Union and war on the continent of Europe. We have had four once in a century events in 14 years. The scale of shocks is astonishing.

Of course it is imperfect, of course we could have done things better and of course the system could be improved. But the fact that we have ended up coming through this with a system which has been consensual for the last 25 years, with changes at the Bank of England, and still intact and working, is actually a triumph.

Q52 Baroness Liddell of Coatdyke: My question was, to some extent, covered earlier, but having listened to Baroness Kramer and to the responses, do we need to sit down and look again at the structures around the Bank and the relationship between the Bank and the Treasury? Things move at a much faster rate than we have ever seen them move before; how can we secure financial stability and price stability within that environment? We need to look ahead now and try to find structures that fit.

I first started thinking about this following Kwasi Kwarteng’s Budget, because there seemed to have been shortcomings in relationships during that time. How do we improve them and how do we make it work? There are good things in what has happened so far, but how do we make it better for a much quicker-moving economy and international scene—without baubles on the Christmas tree?

George Osborne: I do not really have a simple answer, because I started right at the beginning by saying that, ultimately, the system also depends on the individuals at the top. You can build in all sorts of contingency and failsafe mechanisms to protect the Bank of England's independence in extreme situations, but if you have a Chancellor going round saying he is going to fire the Governor of the Bank of England, it is quite hard to deal with that; although I guess, in the end, the system fired him.

Ed Balls: We can have a legitimate debate about whether it makes sense to have macroprudential and microprudential supervision in the same institution, but as for actually destabilising systems, you have to have a really good reason to destabilise them, and I do not think there is a really good reason at the moment. I understand why we did what we did in 1997. I understand what George did in 2010. I am not sure I would destabilise that. I am worried about two things within the system. First, I am worried about the MPC/FPC relationship because, as George said, in this complicated, fast-moving world there are issues which do potentially impact upon the remit of both committees. At the moment we have a system where you have a group of Bank of England full-time executive members who attend both committees, and independent members who only attend one or the other. If I had been an independent member of the MPC in the autumn, seeing decisions being made in the FPC which had a direct impact on the potential outcome for the thing for which I was accountable—the inflation target—on the basis of a meeting and a conversation I was not at, but the chair of the MPC was, I would have been unhappy. That may arise more often in the future.

One solution would be to have one committee which looks at monetary and financial policy considerations. I know there are risks in that, because the danger is that the MPC process, which is clearer and monthly, ends up taking precedence. There is an alternative approach. I understand that in Malaysia, where they copied our MPC and FPC system, any member of the MPC or the FPC has the right to trigger a joint meeting of both groups if they think a decision is arising that will cross over both committees. We need to think about protecting the independent members on one committee or the other from decisions happening outside of their committee which impact upon their remit. That is why I said at the beginning that I was more concerned than George about the MPC/FPC process in the autumn.

The second thing I would do, as I said earlier, is on financial policy where accountability is necessarily more opaque and clarity of objective is harder, but where political risk for the Bank is greater. I would rather there was a more structured, regular conversation involving the Chancellor and the senior members of the Bank of England, in order to have the kind of conversations Lord Turnbull talked about, and for there to be a more textured conversation about the remit. I do not think you need that on monetary policy; the monetary policy observer on the MPC is sufficient, but it is not sufficient on the FPC side. The Bank of England is too exposed, and a Chancellor ought to want to give it more cover on financial stability than it is being given at the moment.

Q53 Baroness Liddell of Coatdyke: Can I come back in on one very quick point? Do you think that financial stability and price stability should be regarded as separate areas for consideration? I am getting the impression that the line you are taking fuses them more together; is that the case?

Ed Balls: The Bank of England must have a role in monetary policy and financial stability policy. When we made the reforms in 1997, from the beginning we established a second deputy governor, as well as the monetary policy deputy governor, for financial stability. That was contentious at the time because there were senior members of both the Bank of England and the Treasury who did not want the Bank of England to have a deputy governor for financial stability; they wanted it to be separated, but that would have been the wrong thing to do.

They are separate tasks with separate tools and separate objectives, and often they can be pursued separately, but there is clearly an overlap where decisions to meet the financial stability objective can impact upon the inflation target, and vice versa. At the moment I do not feel we discuss that enough, partly because the FPC process is too opaque.

George Osborne: I am talking my book here, but the reforms in 2010 to bring microprudential supervision, which was taken away from the Bank of England in 1997, back under its remit were very important.

As I said right at the beginning, I support the changes made in giving the Bank of England independence. It was a mistake to take away from it the responsibility for supervising the nation's banks, because the judgment-based long-term prudential regulator sat uncomfortably in a rules-based conduct regulator and the Bank of England, I would observe as an outsider, lost some of its knowledge of what was going on day to day in the financial system.

There were unusual judgments, such as allowing the Royal Bank of Scotland to take over ABN AMRO in the middle of a banking crisis, which acerbated the problems the Royal Bank of Scotland had. I am not sure a Bank of England-led prudential regulator would have allowed that kind of thing to happen.

Ed Balls: George, that was strongly advocated at the time by the Bank of England. The Bank of England did not object.

George Osborne: I thought Eddie George was not very happy with losing banking—

Ed Balls: No, in terms of ABN AMRO.

This is a really interesting conversation. Actually, I have an open mind about the system now. I am not saying we should go back to how it was, but it is important to remember what was happening in 1997. We were establishing, for the first time, an independent Bank of England with huge new responsibilities. Separately, we were establishing statutory regulation for the first time, which was an enormous management and legislative task, bringing together a whole series of non-statutory regulators into one place. Our judgment was that it was too big a task for one institution, and you could not establish the FSA without banking regulation; hence, we went down that road, strongly supported by Lord King and others at the time. Then, in the period when the tripartite system was operating, the Bank of England had a huge department for financial stability and a deputy governor for financial stability—

George Osborne: It was not in the day-to-day, deep understanding of these complex—

Ed Balls: That was a choice for the Bank of England to make. It was its choice to make at the time.

Lord Turnbull: Can I just amplify the point which Ed Balls has made about the relationship of these three committees? Those three committees, I agree, should be inside the Bank, and the FCA is the bit that should be outside the Bank, but the relationship between the three is what we are all struck by. There is the governor and three deputy governors, and they go to all three. It is not necessarily the same three, but there is a tremendous amount of overlap; let us call it the caucus. That caucus must have some impact on all three of those committees, dulling the debate that takes place. They are pre-eminent because they are the only ones that go to all three; it is quite difficult for the outside members to challenge them, given that they have much less information and much less standing.

George Osborne: It is a very fair point that is worth further examination. You could look at the number of deputy governors, without wishing to be disrespectful to the current deputy governors. Again, I very much do not want to be disrespectful to either Dave Ramsden or Jon Cunliffe, who are excellent public servants, but I would not want the Bank of England to be in the habit of taking just Treasury officials as the main source of senior officials, much as we love the Treasury.

Lord Turnbull: Old boys’ club.

George Osborne: That is what I would look at. A general challenge, which we actually looked at in the Treasury while I was there, is how can we get the British economic establishment and the universities to produce people with big, macro views of the kind that the American institutions like Harvard, where Ed works, seem to churn out? As a result, finding British people to serve on the MPC as external members was actually becoming harder and harder once you had gone through all the obvious candidates.

The Chair: I am going to interrupt, because we are going to come back to that in just a second with others. Lord Layard, do you want to come in?

Lord Layard: Actually, everything I was going to ask has been covered.

The Chair: Would you like to ask anything else, very briefly?

Q54 Lord Layard: I would love to hear a little more about the supply side, but also the demand side, because the appointment system is not really the same as the standard appointment system for, say, judges. If you set up a system like that, where people would more naturally come in from the outside, you might find the supply responded, too.

George Osborne: Yes. It is a very hard problem to solve; I would observe, as someone who was active in politics for 20 years, that there was remarkably little interaction between government and university life, in a way that you do not see in the United States, where there is a lot. I teach a course at Stanford University; Ed is a teacher at Harvard University. It is interesting to observe, in itself, that British ex-politicians often end up in American institutions.

Secondly, there is a tradition in these places, not just in economic policy, but in foreign policy and the like, of producing people who are equipped to participate in the public debate. When it comes to the MPC, my observation was that once the Bank of England was given independence in 1997 under the Labour Government, it went through a series of all the obvious individuals who were qualified in the British economic establishment, and they all had their turn on the MPC. I came in and was able to appoint three or four people that Gordon Brown did not like and had therefore never been on the MPC. Once we got through all of them, we had to look abroad more and more for people. Of course, there are still very good domestic British members of the MPC, but we have increasingly had to look to Americans to fill these posts because the universities do not seem to be producing macro economists with the bigger view; they tend to be in a more narrow part of the profession.

I remember with Nick MacPherson–who you might want to talk to about this. because he took the lead on it as Permanent Secretary at the time–we did talk to a number of leaders of the British academic community about what we could do to try to encourage more of a supply. You are correct, however, that we have to get the demand right as well.

Ed Balls: George is completely right; part of the purpose of the four independent members, as well as to challenge groupthink and have that open debate, was also to try to encourage more people to see it as something they would do as part of their career. It is frustrating that we have not seen the flow-through that we might have hoped for. That is clearly the case on the MPC side, and it is even more the case on the Financial Policy Committee side. I would be surprised if most members of the committee could name the independent members of the FPC; I think I would struggle to do so.

Q55 Lord Griffiths of Fforestfach: At present, one feels that when one speaks to people who are at the coalface today, there is a lot of uncertainty out there. So far, the crisis has been managed; on the other hand, there is a lot of uncertainty.

The first question is, to what extent do you think that the Bank has the macroeconomic prudential risks really pinned down, or to what extent do you think that, in different parts of the system—near banks, et cetera—there really is trouble?

Secondly, I have to say I have been very surprised today that you have almost defended the fact that there is no groupthink in what I would call the “monetary establishment”. You could make a strong case that there is a groupthink; all four deputy governors of the Bank of England have Treasury experience. I just wonder, in the way that appointments are made, is there no way of opening up the system to have greater diversity? When it started, there was greater diversity—people like Charles Goodhart and so on—but it seems to me that, as time has gone on, there has been less diversity. In that sense, we do need something; we need a lever to open the whole system up a bit.

George Osborne: Essentially, I agree with the spirit of that because I have gently suggested—without wanting to be rude to excellent current public officials—that the Bank of England should not draw all of its deputy governors from the Treasury. To be fair, two of them may have started their careers in the Treasury, but are not—

Ed Balls: Did you not you appoint most of these?

George Osborne: I appointed some of them, yes.

Ed Balls: Just checking.

George Osborne: Not all of them. Actually, I am trying to remember; only half of them I appointed. Ben Broadbent was not really a Treasury person; he was from Goldman Sachs. He brought a broader market perspective to the role. Sam Woods was a Treasury official originally, but he was then John Vickers’ official on the banking commission and exited the Treasury early on.

Lord Griffiths of Fforestfach: I take that.

George Osborne: It is wrong to say they are all from the Treasury. By the way, I would say that Dave Ramsden and Jon Cunliffe have given the country great service and give the Bank of England great service, but you are right that we want to try and encourage a bit more diversity. There is a challenge when you sit there as Chancellor and say, “Who can we appoint to the MPC?” They produce the list and all the obvious candidates have already done it.

Ed Balls: You have to decide as a society, beyond the individual appointments, to try to encourage people to move between different realms. In America, they have people who spend a period of time in academia and a period of time in the Treasury. They may go back to academia or to a thinktank, and then they may go to the Federal Reserve; it is a normal thing for people to structure careers. It is much less common in our system and it is quite hard to make that happen quickly.

As I said, with the MPC, we tried to encourage this more and I do not think we fully succeeded, but there are very many more people in public life now who have been members of the MPC or have been involved in the making of economic policy than was the case 25 years ago. There was a period when the individual members of the MPC were contributing less to public debate—which always potentially raises issues of groupthink—and it might be that, in a period when there is a great focus on forward guidance, that tends to slightly corral people into one way of thinking. However, you could not say that in the last nine months there has been groupthink in the MPC. My desire is to try to encourage the same debate on the financial policy side, where there is more groupthink and there are structural reasons why that is the case at the moment.

Q56 Lord Griffiths of Fforestfach: It seems to me that the whole economic establishment in this country has taken over the new Keynesian model. If you look at the Bank, as a result, it is fine for very short-term forecasting but in the end, it has no real theory of inflation. However, if you look at America, there is much greater diversity regarding a new Keynesian approach to the whole thinking of macroeconomic policy. That, to me, is the most difficult aspect of groupthink to come to terms with.

Ed Balls: My reply would be that, in my first lecture at Harvard as a graduate student in 1988, I was taught by a guy called Greg Mankiw, a Republican who had a dog called Keynes and whose hero was Milton Friedman. He explained to me that, actually, the right way to think about the economy was as a synthesis between important ideas from monetary theory and the historic antecedents of monetarism—which you see in the work of Friedman and Keynes’ treatise on money in the 1930s—but also to think about the way imperfections in markets and expectations can then drive inflationary processes. In the end, there is a synthesis of Keynesianism and monetarism which we all employ and within which we debate and argue.

Lord Griffiths of Fforestfach: I agree with you completely. I would say that I am a pragmatic monetarist, but what I do not see is that diversity coming out of the central bank or the Treasury.

Ed Balls: It is interesting, and when you heard evidence from Mr Paul Tucker, who I work with at Harvard a lot and who is obviously a great man, his main criticism of all these Treasury officials was that they had not spent enough time in the Bank of England. Let us be honest: being at the central bank is a profession and you do want to have that depth of expertise, but there may be ways in which we can have, in the Treasury and in the Bank of England, people who spend time in and out. We could think of that in terms of people who want to be permanent secretaries but who need to have time managing in the private sector. I remember my friend, Jeremy Heywood, and his time in the financial system, but maybe that needs to be something we think about intellectually as well as in terms of practical management experience. I am not sure whether being a 40-year lifer is the right qualification to make difficult decisions, but, let us be honest, I do not want somebody who has been a chartered accountant for 25 years and fancies a career change to do my cancer operation.

The Chair: Mr Osborne, do you have anything to add on this diversity of views?

George Osborne: No; I am still getting over the dog's name.

Q57 Baroness Noakes: Our inquiry is not looking at specific decisions that have been made by the Bank, but inevitably, the events of the last few weeks have raised some issues that are worth reflecting on.

Mr Osborne, you spoke earlier about SVB, and indeed Credit Suisse as well, highlighting the fact that money moves very fast and that smaller banks can be systemically important, though conventionally they were not thought of before. Neither of those observations is actually very new. Is one of the conclusions we draw that the FPC is not necessarily very good at understanding what is actually happening in the modern world?

George Osborne: That is a bit harsh on the FPC. If you take the Silicon Valley Bank, it is interesting because both the Federal Reserve and the FDIC went out of their way to say, “We are not bailing out regional banks”, and the Bank of England initially said that the SVB UK situation was not systemic, or words to that effect. Then it emerged over a few days that in fact, the whole tech ecosystem, probably the most productive part of the economy, depended on this particular bank.

Now, you could ask yourself how the world ended up in that situation, but I personally think it was hard to see in advance. What was not hard to see in advance was that bank runs could happen very quickly. I also think it was not hard to see in advance that Credit Suisse was going to be in a lot of trouble. I do not know the answer, but how many conversations were going on between the Bank of England, the Swiss authorities, and the US authorities?

We did an interesting exercise, which is publicly known but has not really had much attention, where I did a role play as Chancellor with the Treasury Secretary, Mark Carney, who was then the governor, and the Chair of the Federal Reserve at the time, plus various other US regulators. We did a role play in Washington, and we left at the tail-end of an IMF meeting, when no one would notice we had gone. We went to the FDIC headquarters in Virginia and role-played for three or four hours what would happen if a large US investment bank failed—which was code for about three or four household names—and what would happen if a large British international bank failed, which was code for about two household names. We managed to assemble these very senior policy-makers in the US and the UK to run through this scenario, which, in my experience in government—apart from the odd military security role play—was the only time I did an exercise like that.

From our point of view, it was designed to establish that, in the end, the Federal Reserve would give us a dollar swap, which was not entirely clear and had not been entirely clear in a previous crisis involving Standard Chartered, in which a New York state regulator had threatened to remove the dollar licence from Standard Chartered. It was not clear whether the Federal Reserve would give us the dollar swap facility to bail out a bank that had been singled out by a US regulator, albeit not at federal level.

We ran through this big exercise, and I thought it was really healthy and interesting. I promise you that at the time, everyone was saying, “We are all very busy people; why are we being asked to do this?” But it was a really good exercise, and it built a lot of co-operation between the two teams, both in the preparation of the exercise and in carrying it out. I would be interested to know whether that kind of thing still happens and whether the UK and the US have done anything similar. Let us be honest, these problems are mostly going to involve a US leg. Is there any role-play or scenario planning, particularly at the principal level? If not, perhaps it should be encouraged.

Ed Balls: Lord King and I went through two such role-plays in 2006 and early 2007: a UK role-play in which a northern building society got into trouble with collateralized problems, which then infected a major clearing bank. We learnt some important lessons, which—

Baroness Noakes: Which did not stop the financial crisis.

Lord King of Lothbury: You had time to pass the legislation on a resolution scheme that came out of that exercise, and that would have meant the issue over Northern Rock would have been very straightforward to handle.

Ed Balls: That is true.

Lord King of Lothbury: The most interesting one on the US, when we did it, was when we had a video conference with the Chancellor, the governor and the head of the FSA. At the American end, there were so many regulators you could not see them all on the same screen.

Ed Balls: Also, if you remember, Mervyn, they would not go in the same room; the Americans all had to be in their own institutions, so we were talking to each other across the three. As I have written about, in our UK role-play the lifeboat in Christmas 2006 was ABN AMRO. Reflect upon that. Unfortunately, it turned out that it sank.

The Chair: What lessons should we learn from these role-plays, Mr Balls? Are you saying we should we be doing more of them?

George Osborne: I think we should do more of them. The Credit Suisse example is a good one. Everyone had known for some years that that institution was in trouble. Andrew Bailey himself said, “We had a plan; it is just that we did not know that the Swiss were not going to follow the plan”. Those are the hardest situations because, in the end, every jurisdiction will look after what it perceives as its immediate short-term interest.

Building a level of trust with the Swiss, the ECB and the Americans is really important; and confronting the reality that when you are dealing with the Americans, there are many different regulators. You might know who the Treasury Secretary is, but if the Treasury Secretary says, “Sorry, I cannot do anything about this regulator”, then your plan does not work.

Q58 Baroness Kramer: I do not know how much time we have got, and you have covered an awful lot of the ground, but there is a whole international aspect to this, and from what you were saying, Mr Osborne, the regulators operate within a national jurisdiction, but the markets do not, and crises do not. I wanted to know if you had any additional thoughts on whether or not we could enhance co-operation internationally to deal with this range of issues, and whether or not the FPC, for example, has the mechanisms needed to pick up on crises which originate elsewhere.

I am going to go slightly beyond my question, because 50% of finance now is outside of the banking world and is in what we politely call shadow banking, thus adding to the complexity of regulation here. Can you give us some ideas or some thoughts on where we could go to try to deal with this changing world?

George Osborne: It is a big question. Yes, international co-operation is important, and you can use a number of fora to do that, such as the G7.

Baroness Kramer: Can they move fast enough?

George Osborne: They can if they need to. What these situations most recently have proved is that things can move incredibly quickly if they need to, and authorities can move incredibly quickly. However, whatever rules you have established in advance, such as, “We are going to bail-in these creditors”, can all be thrown out of the window in a crisis, if the truth be told. The US had told everyone their deposits were not insured and then, sure enough, insured their deposits. That is going to have quite a lot of implications for the US banking system and, indeed, where people store their money in the world.

You have to be tolerant of the fact that, however much you try to prescribe it in advance, each crisis is unique, and in a crisis national authorities will do what they regard as being in their supreme national interest at that moment. You need always to have that in mind, be realistic about that, and build relationships both internally within your own system and externally with other regulators and governments in order to best prepare yourself for that situation.

Ed Balls: It is always really important to use crises well. When I started, soon after the Bank of England independence, around the time of the Thai/Indonesian crisis and then LTCM, it was actually the UK that first proposed that there should be a financial stability forum and that the IMF should report on financial risk at the meeting of the IMFC. There was huge opposition to that, mainly from our American colleagues, who just did not want there to be any collective discussion of these regulatory or financial risk issues. The US has moved a long way over 25 years, though we often discover that it is not as far as we thought and there are setbacks.

The question we need to be asking at the moment, to the Bank and the Treasury, is: what is happening now within those international fora to try to make sure that the next time we have one of these crises is better than this one? This one was better than the last one, so we are moving forward, but always imperfectly. The truth is that, actually, the Bank of England came out well from the last couple of weeks, but for the Swiss financial system and for the US, it has been a knock.

Baroness Kramer: You talked about the rescue of Silicon Valley Bank UK, which Baroness Noakes has been very vocal on as well, but we may have holed ring-fencing below the water line, or at the very least given a huge competitive advantage to HSBC, so it is not 100% perfection.

George Osborne: If you have money in a crisis, you are always in a good position.

Baroness Kramer: Yes, you have everybody over a barrel.

Lord Verjee: My original question has been covered, but I would like to just go back to my point about accountability and what Lord Griffiths said about groupthink. In a world that is so much more dynamic, that moves so much faster, as a man or a woman in the street, it seems to me that we have been thrashed; the system has been thrashed six nil, seven nil. We are in a really bad situation and yet we are sitting here and saying, “Well, nothing needs to change”.

George Osborne: I would be a bit more optimistic. I would say we went through a financial crisis which had all the hallmarks of what happened in the 1920s and 1930s and, shocking as it was, it did not lead to the mass unemployment that we had seen in previous generations. We went through a pandemic and, for the first time in world history, we could actually pay people to stay at home rather than having to force them to work and infect everyone. We could feed their families and manage that crisis. We have just had a war in eastern Europe which has not spilled into a wider conflagration across Europe, and we have been able to support families through the winter, despite it involving one of our major energy suppliers.

I would say there are lots of things that have gone wrong, but broadly speaking, these western systems have handled very unusual crises. We have not had spectacular economic growth, nor have the opportunities been what we would all wish them to be, but nor have we had mass unemployment. We have not done badly, given some extraordinary situations. I am trying to think of a better way to express it, but the systems have not done too badly.

Ed Balls: Following on from that, we had an interesting discussion in the autumn about what was called Treasury orthodoxy. An interesting question is, what is this Treasury orthodoxy?

There have been many periods in history when there was an orthodoxy of view, but the reality is that in the last 24 or 25 years, Treasury orthodoxy has supported Chancellors who wanted to cut the top rate of tax or to increase it; to increase tax credits or to reduce them; to reduce capital gains tax or to increase it. There have been lots of different, important economic and distributional decisions—to have regional development agencies or to back elected mayors—but the consensus in the last 25 years is to have an independent central bank, clear fiscal rules and independent forecasting, as has emerged through the NAO role we had and then the OBR, and proper respect of Budget processes.

What happened in the autumn was an attempt to rip up, in the name of challenging Treasury orthodoxy, that cross-party consensus about the right way to make economic policy. It was a catastrophe and ended up restoring the sensible way to make modern economic policy in an open economy like ours. That is a very positive thing, and that actually happened with public support.

You are completely right that, in order to see off populist political pressures it is also important that people feel that inflation comes down, their energy bills are supported, the economy grows, and all those things. If we do not sort those wider things out, then our politics will continue to be challenged. But you cannot lay all those wider economic and political objectives at the door of the Bank of England, for precisely the reason Lord King says: it would add too many secondary objectives to the institution you are examining in this inquiry. The institution in this inquiry has been strengthened by a populist attempt to rip up the system, and actually the system has emerged stronger as a result.

The Chair: Lord Davies, did you want to quickly come in?

Lord Davies of Brixton: My question has just been answered.

Ed Balls: Positively or negatively?

Lord Davies of Brixton: That is a good question.

Q59 Lord Griffiths of Fforestfach: I would like to ask one question about the Court of the Bank of England; my sense is that the Court has actually gone down in status. I was once a member of it, joining in 1982 alongside 11 non-executives, including Adrian Cadbury, John Baring, and David Scholey. Eddie George brought monetary policy to the agenda for the first time since 1957 and the bank rate scandal. We met once a week on a Thursday from 12 until 1 pm, followed by lunch. There was a very close relationship between the senior executives at the Bank and outsiders; they obviously talked a lot all the time and there was a lot of advice given and so on.

My sense today is that the experience of people who are on the Court has really declined and, as a result, it plays a different function. I just wonder whether it would be much more helpful to the governor and the deputy governors if there were more senior people there—more people who are running big companies and had more experience than we have at present. I would very much like to know what your view on that would be.

George Osborne: I did look at reform of the Court on a couple of occasions. Proposals were put to me that we should create a more modern board structure, but I thought, “I am not going to be the Chancellor who tears up the Court after 300 years. That is a depressing thing to do.”

I am probably speaking beyond my knowledge here, but I wonder, if the financial system and the private sector were different in the area you are talking about, whether you would have British-based institutions where these individuals would be prepared once a week, as you say, to come and give the governor the benefit of their views. I wonder whether you would be able to assemble such a group in the modern financial services system today.

I also think, in some ways, the Bank of England's intelligence and connection with the financial system has been more formalised through the PRA than was the case then. The Court performs the function it does at the moment of, I guess, being a bit of a sounding board and a connection with the City, and then performing the corporate functions of running a large institution. Remember that the Bank of England is subject to all the pressures that any modern institution is around workplace rights and equality and all that, so the Court is trying to do that job. I do not know if it is the right institution to be the sounding board that it clearly was when you were on it.

Q60 Lord King of Lothbury: You have both spoken eloquently about the importance of central bank independence, and George, when you said about people who put proposals to you about the Court, I could not help thinking instinctively that the motives of those putting them forward were to try to get more Treasury control over the budget.

Clearly a key part of the independence of an institution is having its own budget. In the days when we were both involved in all this, the Bank had a five-year settlement. The Treasury was quite tough, and we had to justify what that five-year settlement was, but it could not be changed quickly in the light of a particular problem that had come up, where challenging financial independence could be seen as part of a bargaining threat to influence policy.

I just wondered if either of you have a feel about the merits which have resulted from giving that away? Essentially, it is now an annual settlement. You have the Audit Commission auditing the Bank now. Certainly, when it came to speak to us about it, it was utterly incapable of auditing any complex financial operation, which was really what the Bank was involved in. Do you think that where we are, where we have got to, is potentially a threat to independence, because we have lost that longer term financial settlement for the institution?

George Osborne: I honestly do not remember the settlement for the Bank of England being an issue that I spent a lot of time on. The general complaint in the Treasury was that Bank of England officials were paid a lot more than Treasury officials. Quite often, people migrated from the Treasury to the Bank for pay and rations issues.

I instinctively agree with you that you would want to secure a long-term budget and to try to make it, if not independent of the Government of the day, then with some security from being regularly changed. I would do the same with the OBR: make it a bit more distinct from and separate it out from the Treasury, and try to replicate some of the structures of the Bank of England. I take your word in describing that there is a potential threat, but we have heard today that it has £1 trillion on its balance sheet, so it can still afford to stock the wine cellar.

Lord King of Lothbury: Profits all go to the Treasury.

Q61 The Chair: May I ask a final question, on deed of indemnity? Do you see any reason why that cannot be published? We asked the Governor of the Bank of England, and he said it could be. The Government, in a written answer in December, seemed to say that publishing it would likely expose sensitive information, so we are getting very different views from the Treasury.

George Osborne: I personally would not know why they could not publish it, but that does not mean they should. They should perhaps elaborate on why they do not want to.

Ed Balls: I have not been involved in Bank finances for a long time. George, when I was shadow Chancellor, I spent rather more time on the finances of the Crown household than Bank finances.

George Osborne: That was very interesting.

Ed Balls: But if I was ever concerned about these issues, I would have asked our extremely tough and public service-minded non-executive Chair of Court, Baroness Noakes, for her view, because I knew that she would know the right answer. If I was in the committee, that is what I would probably do this time.

The Chair: Thank you. Praise indeed. We have covered a great deal of ground and you have both raised some very interesting points which we may come back to if you feel able and willing to flesh them out in writing. We are very keen to offer up some practical thoughts on improvements that might be made, so getting views from you on those points is incredibly valuable. Thank you both very much.