25
Examination of witnesses
Andreas Dombret and Edward Chancellor.
Q62 The Chair: Good afternoon. Welcome to this hearing of the Economic Affairs Committee. We have two witnesses this afternoon, Andreas Dombret and Edward Chancellor. Before we go any further, I declare that I know Andreas professionally, as well as socially, through my work as an adviser to Banco Santander. Perhaps you would both briefly introduce yourselves.
Andreas Dombret: Thank you very much for the invitation. I was born in the United States to German parents. I grew up in Germany. I have been a banker all my life. I started with Deutsche Bank, then JP Morgan, Rothschild, Bank of America Merrill Lynch, being appointed to the board of the German central bank from 2010 to 2018, where I was in charge of markets, financial stability and bank supervision. I also joined the supervisory board of the European Central Bank and the board of the Bank for International Settlements.
Edward Chancellor: I am a financial historian and financial journalist. I started out as an investment banker with Lazard Brothers and have worked as a professional investor for an institutional fund manager. I am the author of three works: Devil Take the Hindmost: A History of Financial Speculation; a long report on the credit boom, Crunch Time for Credit?, which was published in 2005; and most recently The Price of Time: The Real Story of Interest, which is a history starting five millennia ago up to more or less the current day.
The Chair: Excellent. Thank you both, again, for coming in. Andreas, I think you want to set the scene with a very short statement.
Andreas Dombret: It is not a very short statement, so I would rather hand it in.
Q63 The Chair: That is fine. Let me ask you a question, to set the scene. When you look back over the last 25 years at the track record of the Bank of England, how do you feel it has performed? I am trying to get you both to take a step back.
Andreas Dombret: It is not for me to rate the performance of the Bank of England, but since you ask me, if you compare it with the inflation goal of 2% set by the Government, I would argue that over the past 25 years the performance of the Bank of England looked very similar to the performances of the Federal Reserve and the European Central Bank. It was even close to its target at the time running into Brexit. There were three times when inflation was not close to target. The first was in combination with the global financial crisis. After that, it undershot the target or underperformed—if that is a good way of saying it in English—and eventually it outperformed and skyrocketed the target.
In a nutshell, I would argue that, with the exception of very extraordinary times, either here or outside the United Kingdom, the performance of the Bank of England in terms of inflation is very good. As in other cases, the performance in very special and unusual terms is not so good for reasons we can discuss later.
Edward Chancellor: First, clearly over the past 25 years there has been an extraordinary amount of financial turbulence. Shortly after independence we ran into the dotcom boom and bust, followed by the credit boom and global financial crisis. I would argue that the very low interest rates, which we will get on to in a second, created their own problems. Finally, we got into the Covid boom and the inflation that has followed.
As Andreas said, the Bank of England’s inflation performance is, on the whole, roughly in line with that of some of the other central banks. That might suggest that the central banks themselves are not absolutely in control of inflation, and that other factors were determining the level of inflation on a global basis rather than on an individual country basis.
In recent years, since Covid, the Bank’s performance has been relatively poor, but over the longer period it has been roughly in line. My concern, and this is not just a criticism of the Bank of England but in general, is that narrow, short-term inflation targets were mistaken. I think that Lord King agrees with that, from some of the things I have read by him. It was responsible for taking interest rates down to the lowest levels since the Bank of England was founded in 1694.
I argue that the narrow pursuit of the inflation target became a rationale for very low rates that had unintended consequences. As I point out in the book, interest serves a number of functions. It is not merely used as a lever to control inflation. Interest determines the valuation of assets. It determines the allocation of capital. As the 18th-century economist Ferdinando Galiani says, it is the “price of anxiety”, or what we would call the price of risk. It has an influence on the amount of savings. It was seen as a reward for abstinence. Again, this is a criticism not of the Bank of England particularly but of monetary policymakers in general, that they have had too narrow a view of what interest did. The interest rate should never have been taken down so low. The rationale, leaving aside the immediate aftermath of the financial crisis, was fear of deflation.
Central banks and bankers in general confuse what might be called the good deflation that comes about when traded goods prices fall, as they did in the recent era of globalisation and the Chinese export share rising, and which makes everyone better off—your iPhone or computer might fall in price—with the bad deflation, the debt deflation, that comes about after a financial crisis. By making that confusion, they have allowed too much debt to build up in the system, which makes the bad deflation more likely.
The Chair: There is a lot of meat in that, which I am sure we can get into. Can I bring you back to what we were told last week by Ed Balls and George Osborne? It was put to them that a number of central banks saw inflation as transitory in recent years. They were arguing that this was a global phenomenon among all central banks. Do you perceive it as that, Andreas Dombret? Do you see it as a global case of groupthink that all the central banks got into? If so, how come everyone got it so wrong, as your answer just implied, Mr Chancellor?
Andreas Dombret: To come back to the first question, in general there are three ways of looking at inflation. In the case of this country, it is one number given by the Government. In most other cases, the central bank itself decides on its target. It can be either a corridor or an upper limit. There are different ways of going about that. If we compare central bank with central bank, we should be very careful about what definitions we use. Although they all look alike, they are not just the same and do not have the same origin.
It is very true that there has been underestimation of inflation, and we all thought that it would be transitory or temporary. I think this has less to do with groupthink and more tglobal o do with structural input to how the models work. It was a commonly held belief that the pandemic was not fully understood. There were no models for the pandemic in the first place, and the structural input to the models caused it not to be understood correctly.
There is no groupthink among economists, though. There are many economists’ opinions. There were also economists very early on who thought that this was not temporary or transitory. Having said that, what really matters is when the central bank takes the interest rates out of the situation. Do you exit at the right time? It is very easy to go into a low interest rate environment and very difficult to get out of it. There is a tendency to be hesitant in taking it out of the low interest rate environment, and not at the right time.
Edward Chancellor: With regard to the question of groupthink and the central banks’ attitude to inflation, the other concept, aside from groupthink, is cognitive dissonance—people failing to see something that they do not already believe, particularly when they have made an error. The best way of putting it, as chairman Jay Powell of the Federal Reserve said last year, is that we are beginning to understand how little we understand about inflation.
The oldest inflation theory, which goes back to the 16th century, had apparently been discredited and was not seen as worthy of consideration. Various Keynesian models, such as the Phillips curve, have likewise been discredited. We were left with inflation expectations, which Lord King referred to as the Canute theory of inflation. That has also been discredited. It seems that central bankers around the world, not just here, did not understand inflation. Where the Bank of England has particularly discredited itself is in failing to recognise its errors and being duly contrite. Instead, it has blamed just about everyone, whether President Putin, retirees, workers or companies for the inflation that has resulted.
The Chair: There is lots I would like to pick up, but I think Lord Turnbull wants to come in.
Q64 Lord Turnbull: This is probably for Edward Chancellor. I think you may be answering a different question from the one we are trying to answer. We are trying to steer away from whether people got it wrong and made errors, although you can never fully get away from that. A different question is whether there was something about the structure, the processes and accountability that made it more likely that there would be errors.
Edward Chancellor: About forecasting inflation?
Lord Turnbull: Forecasting inflation or the interest rate response to it.
Edward Chancellor: No. I would say that it was an intellectual predisposition to misunderstand the nature of inflation and how it is formed. There are various theories. There is the money supply theory, there is the fiscal theory of inflation and so forth. Inflation is a complex phenomenon. I do not think they understood that.
To go back to the question of groupthink, the question is whether they had a diverse a group of economists. Many people pointed out that inflation was coming—I pointed out that inflation was coming. There was no credit for pointing out that inflation was coming. What was remarkable was how long it took the Bank of England and the Monetary Policy Committee to realise that inflation was there and not going away. There seemed to be almost no shifting of position.
I remember back in pre-independence days—Lord King will tell me if I get this wrong—the Monetary Policy Committee people were selected, to some extent, on their forecasting success. I seem to remember that there were rather diverse views on the Monetary Policy Committee, with a monetarist such as Tim Congdon, and a Keynesian economist, Wynne Godley. In their own different ways, in the early 1990s, they had both made decent forecasts, but they were coming from completely different perspectives. With a greater variety of perspectives and a greater variety of experience, perhaps we will not get this failure of understanding. I do not completely agree with Andreas about there not being groupthink. I think there is a narrow-mindedness and failure to understand what has been going on with inflation.
Lord Turnbull: You are highlighting a paradox, which is that, although the population of economists is highly diverse, somehow or other the people in positions at the Bank were not representative of that full range of opinions.
Edward Chancellor: It depends on the model. If everyone is using the same model, it does not matter where they come from; there is no underlying diversity of opinion. My view is that we live in an extremely complex world and a highly financialised economy, and theoretical economist models are not particularly good at describing what is going on.
The Chair: Andreas, do you want to come in on those points?
Andreas Dombret: I fully agree. It is the structural input to the models that meant that so many were wrong and late.
The Chair: To come back to my point, it seems that they were wrong in all the central banks. This is picking up on Lord Turnbull’s point. We are interested in structure and process, to be clear.
Andreas Dombret: It is the same models.
The Chair: There are the same models and the same lack of diversity of opinion and thought around the tables in not just the Bank of England but other central banks. Is that what you are saying, Mr Chancellor?
Edward Chancellor: It would seem to be the case. One has to bear in mind that the US issues a global reserve currency. The Fed is the most powerful player. The Bank of England just has a supportive role—one might almost say intellectually as well as in monetary policy.
The Chair: I want to pick up something with Andreas Dombret. I am conscious that you do not want to be overly critical of the Bank of England, so, given what you have just said about the lack of diversity of thought and about modelling, what would you suggest should be done to address those two points in terms of international experience? Is there best practice that we should be looking at, or is it a problem that all central banks should be looking at?
Andreas Dombret: In the way you craft your question, you are taking a very short period of time; even 25 years is too short to make an assessment of that magnitude. It may be that you can look over a longer period at inflation. To pick out this time, after the pandemic, plus a war following, and to make a judgment about monetary policy is a very short-term way of looking at it. I am not so sure that I would do that.
With hindsight, you can draw the graph and you will see that, over the past 25 years, you have had three deviations in abnormal times from the target, and otherwise you did not—not even in the case of Brexit. Everybody else had the same or very similar deviation. For example, right now inflation in the United Kingdom is higher than in the eurozone. What does that mean? You are looking at a very short period of time, which you cannot extrapolate into a graph. I would not recommend doing that. You have a very different situation, because of the war, in the Baltic countries, for example. How can you possibly compare that with the United Kingdom. Just to draw a one, two or three-year time period and compare it will not bring us where we want to go.
Q65 Lord King of Lothbury: Andreas, could I ask you a question closer to your home territory? If you go back to the days of the Bundesbank, pre-ECB, and then the early years of the ECB, the staff and members of the board would look at a variety of different models. They would look at what was happening in the financial system and at the money numbers, and they would construct a narrative. They would not say that, because one monetary aggregate was growing at X%, inflation had to be Y%, but they would take them all into account in forming a judgment.
As time has gone on, do you feel that the ECB has also been infected by the groupthink that has afflicted the analysis of monetary policy, primarily in academic life, but spread to central banks where all the staff come from the same graduate programmes and the same courses, and have been hooked on to the idea that you can explain inflation without any reference at all to money, the banking system or the financial sector? It is a bit odd, given that a transmission mechanism of monetary policy is via asset prices, among other things, in the financial sector. It is fixed on the idea that we cannot really understand or model the financial sector, so let us take a shortcut and assume that inflation expectations drive inflation, and inflation expectations are in turn driven by the inflation target. One of the members of the ECB board recently said that it is a bit odd that we have simulations for different paths of policy, and inflation always comes back to 2%, but it does in the models.
There are lots of diverse views among economists on many policy questions, but when it comes to monetary policy there does not seem to be a great deal of difference because they are all using the same model, which has meant that now they do not even look at the other variables in the financial sector to ask themselves what is going on.
Andreas Dombret: In what we are seeing, and what you are referring to, a lot of variables were taken into account. The ECB has the primary mandate of price stability, but, if I may say so, it also has a secondary mandate of keeping the eurozone together, which you do not have in this country so you cannot really compare. For a very long period of time the ECB was one of the few institutions in town, if not the only institution, that you could call on. It had a separate function, and it still has that. We have a very unusual situation in the eurozone. We now have one monetary policy over 20 different countries, some of them, we have very different national policies, which we try to keep in check, but they are not, especially in unusual times.
In the past, more variables were looked at. There is a fixation on a target of close to 2% or 2%. The problem I have with that, especially if you deviate by considerably undershooting or overshooting for a long period, is that your credibility with regard to price stability is questioned by the public. Then, expectations may well change over time, especially in a eurozone where you have 20 different countries closer to Ukraine or further away from Ukraine. They have very different settings.
I do not think it is too much of a groupthink; it is too much of a model fixation. In the past 10 years, there was a big fear of going into deflation. We never got there. We never went close to that, but there was a major fear among central bankers, “Are we going to have deflation?” Deflation is something we do not want to go to at all. Now, we are overshooting inflation. The models in the eurozone always point to it being back at 2% at the end of 2025. The pandemic and the war, et cetera, were not built into any of those models at all. That is why there is some similarity.
Nevertheless, some central banks were early and some were later. I remember very well how early this country was. I also remember that the Federal Reserve was earlier than the eurozone. In his acceptance speech as new president of the Bundesbank in January last year—before the war started, which was 24 February—President Joachim Nagel said, “I see inflation coming”. At that time, we were already quite above target. In some Baltic countries it was in double digits. The eurozone is an animal where the average may come to 3%, but still you have huge differences, country by country, for all major reasons.
Lord Turnbull: Twenty-five years ago the Treasury produced a forecast that was, in a sense, the dominant forecast. Everyone commented in relation to it that you were growing faster than the Treasury or slower than the Treasury. However, there was the sense that it was flawed, in that it was produced by the people who were also producing the policy. It was marking its own homework.
The Treasury’s policy was published thanks to Lord Rooker, and the amendment he sponsored. The Treasury withdrew from that space and created an alternative thing called the Office for Budget Responsibility, which is independent of the Treasury. In a sense, the Treasury has less ability to make the forecast look like what it wants it to look like. I think that has been an improvement.
When the Treasury withdrew from forecasting, the Bank’s forecast became very important, but it does not have an Office for Budget Responsibility keeping it honest, so to speak. There may be something called the office of evaluation, but is the Bank’s forecast still too much the product of the same people who are working on monetary policy, and hence there is a tendency for the forecast always to finish where the monetary policy people want it to finish, which is that by the end of a period you have always got back to the target? Should there be more independent challenge built into the way the Bank produces and uses its forecasts?
Edward Chancellor: That sounds reasonable. I go back to the point that it is extraordinarily difficult to forecast inflation. The markets cannot even forecast inflation accurately. I do not think it would be a particularly good idea to have a bunch of economists separate from the institution that was actually setting the rate, and then telling them more or less what they should think and suggesting what they should do. That would make the system even less accountable.
You cannot predict the outcome of complex systems accurately, but you can get a sense of their general drift or direction. Again, we can look at inflation in three or four different ways. It is not just monetary or fiscal. There is a societal aspect to inflation—a distributional conflict. These are very difficult matters to get an accurate forecast from. If you have the right people, as we go back to a variety of different models for understanding the world, and such a committee is reflecting the complexity of the problem with which it is faced, perhaps you might get a somewhat better outcome.
Andreas Dombret: Can I quickly explain how this works at the ECB and the Fed and compare it with the Bank of England?
In the ECB, the governing council meets, and the chief economist makes a suggestion. The chief economist speaks to the market. The chief economist, Philip Lane today, makes a suggestion. It is then debated and decided. The Federal Reserve has a rotation system. Some of the regional staff rotate, but in the case of both the Fed and the ECB it is all the professionals of the system.
In your system, you have the Monetary Policy Committee, where you have outsiders in the committee. I do not know of other situations—maybe there are some—where you invite outsiders into the meeting or they are sent into the committee by the Government, by the Treasury. That is a unique way of making sure that there is a debate, which you would normally not have. The groupthink among 20 governors of regional central banks, plus six directors of the ECB, must be theoretically more pronounced than in the case of your system.
Lord Verjee: My question is around groupthink, which is a really important issue. When you think about it, we come up with a policy and then we put all our eggs in that basket. There is no room for experimentation or different opinions. All our eggs go into the basket. You might think that that is a very risky policy. Mr Chancellor, you say that we should be changing things. What would you actually do to change the system and the way we operate on the Monetary Policy Committee, in particular?
Edward Chancellor: I am not a big fan of this 2% inflation target interpreted over a short period of time. As was said earlier, over the last decade or so it was the rationale for taking interest rates down to extraordinarily low levels that, to my mind, did a great deal of damage to the economy, society and the financial system. I would move to a different type of target—a broader target—that did not just consider near-term inflation pressures but looked at what else was going on in the financial system and the economy. To my mind, if you are getting a real estate boom or massive asset price inflation, it is perhaps an indication that the interest rate is too low. If you are getting a credit boom, that is another indication that the interest rate may be too low.
You need to start looking at other things apart from near-term inflation. This is a point that the former Bank for International Settlements chief economist William White wrote about in a 2005 paper, which is worth your reading, called Is Price Stability Enough? Bear in mind that the central banks were meeting their inflation targets going into the global financial crisis, more or less. We had what the Bank of England then called non-inflationary consistent expansion, or NICE, but it turned out not to be so nice. If we had been looking at the real estate boom, the leverage in the financial system and the dependence on the liquidity of banks such as Northern Rock, we would perhaps have had a better understanding of the fragility of the financial system.
The groupthink, or, as I say, cognitive dissonance, is the narrow focus. To my mind, you need a broader focus and to select an interest rate-setting committee that reflects that broader idea. To go back to what I was saying earlier, it would not perhaps be a bad idea to select some people on that committee who had a recent, decent forecasting record.
Lord Verjee: Andreas, you seem to feel that we should be giving a much longer time and we cannot look at what we should be doing in the future at the moment. Would you suggest any changes to what we do today?
Andreas Dombret: I find it difficult from my point of view, as a foreigner, to suggest changes. Let me turn it around. I would find it very difficult to change the 2% target in the middle of the race. There is a target. If we are now saying, with an inflation rate of 10%, that 3% or 4% is better, it will undermine the credibility of the system. Maybe you can debate that at a different point of the cycle but right now, in the middle of the race, I would not recommend changing the target.
Edward Chancellor: I would suggest that we have de facto already given up on the inflation target rather than de jure. You have heard about the extreme response of the central banks, not just here but around the world, to the threat of deflation. As I argue, deflation was a threat to make people’s spending power actually go further.
We now have relatively high inflation, and we have not seen such a response. Clearly, the response to inflation is asymmetric. I do not know if we are going to get into it or not, but you can quite understand why. The large amount of government debt—particularly via QE having a shorter average maturity—the inflated levels of house prices and risk-taking in the financial system in general would mean that, if the central banks were aggressively to pursue their inflation target now, they would bring down the City of London, as they almost did in September when the gilts market crashed.
Q66 Lord Londesborough: I want to pick up your thoughts on QE, its impact on inflation and particularly on the Bank’s reputation. Since 2009, the Bank has deployed QE in multiple waves, to a cumulative total of nearly £900 billion post pandemic. It has resulted in the Bank’s balance sheet representing more than a third of our national GDP. Just last week the Bank revealed that QT, selling off the QE portfolio, will cost the Treasury a net £100 billion, which is actually a £220 billion swing from the prior net surplus of about £120 billion, which never seemed to get very much publicity.
I have two questions. How do you think the Bank’s deployment of QE has impacted on its credibility, specifically in relation to its primary task of controlling inflation? Secondly, has QE, particularly its scale and repeated use, served to compromise the Bank’s independence? To quote a headline from the FT investor survey of 2021, QE was “a thinly veiled scheme to finance the Government’s deficit”. What are your views?
Edward Chancellor: I agree with what the FT appears to have said. Quantitative easing obviously enabled the Government to increase their debt and run a massive deficit. We saw the largest fiscal deficit in peacetime, as far as I understand. During the coronavirus period the Bank was paying only 10 basis points on the debt. As an earlier committee of the House of Lords wrote, it made government debt a dangerous addiction. It makes it very difficult for the Bank of England to get out of the bind it is currently in. It pays interest on reserves, so any movement in short-term interest rates feeds very much more quickly into the cost of government financing. That creates a risk of what it calls fiscal dominance. It would seem extremely unlikely that the Bank of England is going to make an interest rate decision without considering its fiscal impact.
My feeling is that the Bank will never really be able to go through so-called quantitative tightening, and therefore the losses on the bonds will not be realised, because it will have to hold them until maturity. That, in turn, creates other problems. I think it has got itself into a bind and allowed the Government to spend far too much money and run up too much deficit, and then, in effect, impeded the freedom to use monetary policy to control inflation. That goes back to the point that the groupthink pursuit of a near-term inflation target has left the Bank in a position where it is that much harder to control inflation with this massive securities portfolio.
Andreas Dombret: I would also start by talking about fiscal dominance. There are several economies now in a situation where they are close to what this term describes. Clearly, if you do quantitative easing to that extent, you have an effect on the borrowing possibilities of the Government, but with an overall debt ratio of 85% in the UK at present I do not see that fiscal dominance is something this country should be overly concerned about, especially if you compare it with other economies. That does not mean that there are no effects, but it is not something that I am really worried about. It is not an overarching concern to me. That is why I do not think that the independence or the credibility of the Bank of England are at all harmed.
There is no total independence of a central bank in the first place. There needs to be very good communication with the Government about all of this, including all the side-effects. I am not sure to what extent that is happening. I assume that it is because there is no total independence. The central bank does not live in a vacuum, as we all agree.
To sum it up, fiscal dominance is not an overarching concern for this country, if I look at it from the outside. I do not think that the debt markets are worried to the extent that your question may have implied.
Lord Londesborough: Talking of the side-effects, Edward, in your written evidence you have particular concerns about such areas as productivity and distribution of wealth. Do you want to elaborate on that?
Edward Chancellor: As I said earlier, the rate of interest has different types of effects. One function of interest is on the allocation of capital—what we call the payback period. Again, this is not exclusive to the United Kingdom, but the very low interest rates have led to the accumulation of so-called zombie companies, which crowd out sectors that have low levels of investment, low levels of business, new entries and low productivity. It is a question of the horse and the cart. The central bank has said that low productivity was dovish for interest rates. In other words, when it saw low productivity, it was an argument for bringing interest rates down. But if you see low productivity as a function of low interest rates, you will reach a different conclusion.
The question of inequality is important, I think, and has been overlooked. Interest will always be a question of distribution. Who receives the interest? Who pays the interest? If you go back to the earliest writings on the history of interest or usury, the view has been that high interest has always been exploitative. That is fairly true of a rural economy and is still true today. However, in a financialised modern capitalist society, I think that low interest rates are abusive to the general public in a variety of different ways.
First, if you inflate asset prices, you benefit those who already own asset prices, and you make it that much harder, particularly with housing, for people to get on to the housing ladder. We have had endless discussion in this country about the so-called housing crisis. People often talk about it in terms of needing to build new houses, but it is actually the valuation. If you talk to your children or grandchildren, it is not that they do not have a roof over their head, it is that they cannot afford the roof over their head because the prices of houses are too high. There have been detrimental effects, particularly intergenerational, from very low interest rates.
Very low interest rates benefited investors, bankers and private equity people who could borrow at extremely low interest rates to buy assets that were rising in price. I do not think they were of much use to the general public. I think a lot of the discontent that one finds with the so-called capitalist system today, particularly among the younger generation, is a sort of disaffection induced in large measure by the unintended and, what is more, unobserved consequences of the ultra-low interest rate period.
The Chair: I know you want to come in, Andreas, but I want to bring in Lord Layard on some of these points.
Q67 Lord Layard: I would like to follow that up with a question on the relationship between fiscal and monetary policy. Obviously, the underlying theory behind the arrangements we have, central bank independence and so on, is that the Government do their fiscal thing periodically and then the control of inflation is done by the Bank on a monthly basis, or however frequently, through actions that it takes to affect the level of employment. That is the model we all have in mind for how the thing is meant to work.
The lever, or the instrument, that the Bank has had, in people’s minds, is the interest rate, but that did not work when you hit the lower bound. That is how QE came in, to try to preserve the model and have the ultimate responsibility for the level of employment and inflation remaining with the central bank. You could say that, when you have hit the lower bound, the more sensible approach, which would avoid some of the problems you have been talking about, would be a more expansionary fiscal policy rather than a more expansionary monetary policy. That would go against the fundamental theory on which the system is based.
Could you both say something about how important you think it is to stick to that fundamental theory, or do you think that we should be talking much more about explicit co-ordination of monetary and fiscal policy? In that context, does Britain have a bit of an advantage, in the sense that it is easier to arrange that sort of thing here than in the eurozone or in the United States?
Andreas Dombret: Coming back to the previous question, on quantitative tightening and the eurozone, the only way the ECB could actually tighten was by introducing a transmission policy instrument as a backstop for countries that were not able to do so. There is some truth to that question.
On the interplay and interrelatedness—if that is a good English word—between fiscal policy and monetary policy, I personally think that, as I said before, there is no total independence of the central bank and that there needs to be a lot of communication. There need to be clear responsibilities.
One of the biggest goods the central bank has is the trust of the people, the trust of the Government and the trust of the markets. The way I look at it—the old model—is that in the central bank you have the responsibility for monetary policy, of course on the basis of the 2% target set by the Government. In the Government, you form the basis of the Budget and all the other very important things such as pension policies. You have to have a way of co-ordinating that among them. Each and every side has to understand what the other side wants, and in their choices has to take the other choices into account, back and forth. If monetary policy does not remain with the central bank, you strip the central bank of the potential for keeping that trust, especially in more problematic situations. We have seen some recent cases of distress, and in many cases it was the central bank that was able to calm the markets.
Edward Chancellor: I do not really like the concept of the zero lower bound for monetary policy or the idea of interest just being a lever for controlling inflation. I do not think the bank rate should ever fall to zero. Walter Bagehot, the 19th-century financial journalist, said, “John Bull can stand many things, but he cannot stand two per cent”. What Bagehot was saying was that the moment interest rates came down to 2%, John Bull—the epitome of common sense—would go and do some rather stupid things and invest in railways to Watchet and canals to Kamchatka, or buy into bonds of countries in South America that were never going to pay their debt. I do not like the concept of taking rates down to the so-called zero lower bound.
As for fiscal policy, you could say that there has apparently been a lack of co-ordination between the fiscal and the monetary, but it is not as if we have not ended up with doubling our debt to GDP level over the last 15 years or so. The lack of co-ordination between the monetary policymakers and the politicians means that the central bankers, not just in Britain but everywhere, tend to blame the politicians for not dealing with the problems of inequality, or whatever they are, that to my mind, follow from the monetary policy to a large extent. Bear in mind that all the things we talk about are complex factors influenced by many things aside from the interest rate policy that we are talking about now.
Q68 Baroness Kramer: I will take us back a little bit. Please forgive me if I am putting the wrong words in your mouth, Mr Chancellor, but if I am right I think you were positing that monetary policy has a particular structural weakness because of the way that it is set up currently in the Bank of England, so that it does not necessarily take into account the factors in the broader context that should be shaping decision-making. Forgive me if that is wrong, but that is what I took away from what you were saying.
The Bank of England is responsible not just for monetary policy but for financial stability. At present those are in two separate committees, with no overlap among the external members. Is there a structural way in which that second responsibility could play into generating broader thinking in the monetary policy context? For example, we heard a suggestion last week that sometimes external members could, on a regular basis, be present at meetings of the opposite committee, or whatever else, in order to cross-fertilise the thought process that is taking place. Or should we see them as two separate activities, to sit apart?
Edward Chancellor: I am glad you raise the issue of financial regulation. I mentioned earlier how one aspect of interest is the price of anxiety, or the price of risk.
Baroness Kramer: I was rather taken with that phrase.
Edward Chancellor: It is Ferdinando Galiani, in Della Moneta.
What I argue is that after the global financial crisis we had a great swathe of financial regulation. There were thousands and thousands of pages in Dodd-Frank and the updating of the Basel regulations, and so forth. Jeremy Stein, a Harvard economist who was briefly a Fed governor, said that monetary policy gets into all the cracks, and a very low interest rate will drive risk-taking behaviour in ways that the regulators themselves do not understand. That is why I do not think it is useful just to have the financial regulators coming in and looking over the shoulder of the people setting the interest rates. That presumes that the people with the remit for financial stability or regulation understand what they are doing.
What is remarkable is the crash in the gilts market and the fact that UK pension funds, apparently levered seven times with footings of over £1 trillion, almost brought down the City of London without the regulators picking it up. If the regulators did not pick that up, I do not see why they would have been particularly useful in overseeing the interest rate-setting policy. I think it is a necessary condition for financial stability to have a rate of interest that does not induce fragile financial structures. That has not been the case over the last 10 years, in this country, in Europe, or in the United States.
Baroness Kramer: Mr Dombret, would you keep the two activities separate? Is it appropriate that a central bank has both responsibilities? Do they sit in separate boxes?
Andreas Dombret: There are two areas of concern. They are interrelated, but they are different. My English is not so good, but if you throw the economy under the bus that is not really what you should be doing. The same is true the other way around: if you put financial stability at the forefront, you may not get to monetary policy issues. You need to consider both, but there is a primary mandate, which is price stability.
In the eurozone, we have learned the hard way that the system is bigger than the sum of the parts of each individual issue. If you add up the risk for each and every bank in the eurozone, the system is bigger than the addition of all the single risks for all those banks. You need to have a view on financial stability. It is imperative.
Where are we today? Do not quote me on the years, but on financial stability we are probably where we were on monetary policy 20 or 25 years ago. We do not have the instruments yet. We are not that advanced, so there are still huge differences between the two areas.
With regard to the overlap, there is partial overlap in the committees at the Bank of England already, but the overlap is exclusively for the Bank of England representatives; it is not for the outsiders. I do not have a particular opinion, but if you accept the argument that it is good to have Bank of England representatives in both committees, why should you not also have it for outsiders? I do not know why that would not be possible. I do not know how the voting structure works, but those two different areas need to look at each other and learn from each other.
The example of the gilt market would have been exactly my example too. I have seen papers showing that all the information about the market was there. How can it be that, if all the information was there, it was not put into a financial stability viewpoint? That was obviously not considered in the right way. It is not lack of information; it is putting the pieces together that is really important.
The instruments you have in monetary policy and bank supervision are much more granular and much clearer than in financial stability. I look at financial stability as more of an interplay, not between monetary policy and financial stability but between bank supervision, microprudential policy and macroprudential policy. I see a major link there, because you can learn from the transmission in the single banks; you can learn a lot for the system, and the other way around. It is not only monetary policy and financial stability.
Baroness Kramer: From a structural perspective, is there a good example of how that has been better resolved than it might be in the Bank of England, or is it inevitable that it will be a very imperfect relationship?
Andreas Dombret: It is not inevitable. The Bundesbank, which is no longer setting interest rates, just put both microprudential and macroprudential policy under one person, whereas in the ECB they are as far away as it can possibly be. You have the SSM—the single supervisory mechanism—responsible for microprudential supervision and the financial stability is within the ECB itself. It is very far away, although they share services and research. The research can basically be used for both. We are not yet so advanced in financial stability that it is given the important role that it should have, and that must change over time.
Lord Davies of Brixton: I am not clear whether you thought that the system was working or not working. Do you think the Financial Stability Oversight Council—the US approach—is better? How would you compare the two?
Andreas Dombret: I held the FATF meeting on the Financial Stability Oversight Council when I was in office. I do not know how many agencies the US system has; it is a big number. They did not talk to each other and they were very competitive with each other—they still are, actually. They needed something like the FSOC. Janet Yellen now chairs it, but it was an almost impossible system. When I did my review, long ago, the commissioners of the agencies were shouting at each other in the meeting while I was there to write a report on them. It was quite unusual. You do not have that here, and we do not have it in the eurozone either. That was very unusual and not comparable to this situation.
Lord Davies of Brixton: You would not describe it as creative tension.
Andreas Dombret: We have had four bank problems over the last two months. Three of them were in the US. What did that committee do to prevent those three bank failures? Not much. The FDIC has a major role, but how the very independent agencies in the US talk to each other is a major issue.
There is another model, the ESRB—the European Systemic Risk Board—of which I was a member in my time. It is more of a hybrid model. I think that the FSOC makes a whole lot of sense for the United States of America, but it is not a model that you would normally transfer here. The European Systemic Risk Board is a hybrid model where you have more of a debate in the council—which, by the way, issued early warnings on interest rate risk last year. That is something I would like to point to. If you are looking for a model, that may be closer to what makes sense here. The committee does not protect you from bank failures or the threat of a financial stability issue, but it is a very important platform. I am a fan of the United States, but agencies need to talk to each other in a civilised way.
Edward Chancellor: The question was whether you can separate financial supervision or regulation from monetary policy. I would argue that you cannot.
What links the crash in the gilts market and the pension problems to the regional banking crisis in the United States is what we call duration risk, or the risk of exposure to rising interest rates. Pension funds were levering up 50-year UK linkers that had negative yields and they lost 85% of their value. The regional banks were just buying short-dated Treasuries, but with enough leverage that was enough to wipe out their capital and bring them down. In both instances the regulators did not pick that up. In the case of Signature Bank in New York, Barney Frank, who framed the financial regulations after the financial crisis, was actually on the board. That is the clearest demonstration that financial regulations on their own—macro, micro, call them what you will—will not achieve the job.
Some of you may be aware of the economist Hyman Minsky; a financial instability hypothesis was his fame. Minsky argued is that after every crisis the regulators will build a new set of regulations to protect against the last crisis, and the clever people in the financial world—what we call the regulatory arbitragers—will find their way round these financial Maginot lines to create the next crisis. I think that is inevitable. Looking back to Babylonian history, one finds that regulatory arbitrage appears to have been taking place to get round Hammurabi’s law. There is no way that one will stop that, even with the greatest thicket of regulation you could possibly imagine.
Q69 Lord King of Lothbury: We have had a very interesting discussion about what a central bank should do to achieve broad economic and financial stability, and the role of monetary policy in that. We could discuss that for hours and it would be fascinating.
I want to move now to something rather different. In addition to this debate, which I agree is the most important and central one for monetary policy, central banks themselves have now been given quite a number of other responsibilities which, as such, have nothing to do with monetary and financial stability—whether it is climate change, looking at the employment opportunities in the US for those who are disadvantaged, or looking at diversity, there is a whole series of things.
In the remit given to the Bank of England, whether as to monetary policy or the remit for the Financial Policy Committee, there has been a noticeable expansion of that—literally, in the number of words, as well as in the number of objectives. Do you think that there is a risk in that? Do you think that it is appropriate for central banks to be given those responsibilities? What is your reaction to what has happened, and has having these other things to look at taken the eye of central banks off the ball?
Andreas Dombret: I believe that climate change is the biggest risk for this planet, and that means that it must play a major role in financial stability issues. Baroness Kramer just asked about financial stability and monetary policy. It is very clear that if this is a very major risk, despite the fact that it is somewhat outside, it has to have an effect on financial stability. It also has an effect on bank supervision. If banks lend very long term, and things change because the climate is changing, over time the risks also change. There is a reason for climate change, as a remit, to be discussed in financial stability and even at the PRA.
I find it very difficult, though, to see the role of climate change in the monetary policy side of things. We talked about interrelation with financial stability, but leave that aside. I find it difficult, for example, that when you purchase securities the central banks should make a decision as to whether they are green and whether the banks should sponsor green financing or be negative on brown financing. Who is making those decisions? Is it the mandate of the central bank now?
Furthermore, if we now have, let us say, climate change as a remit, are we going to have gender or equality? What are the next challenges being put forward to the central bank? If we look at new challenges such as climate change, it makes it even more difficult for a central bank—whether the Bank of England or any other central bank—to pursue its price stability mandate. I am very conservative with regard to monetary policy but a lot less conservative with regard to financial stability. I see a big role, for example, for climate change in the microprudential.
Lord King of Lothbury: Even though the remit in different countries seems to focus exclusively on climate change and does not mention things like the risks of a pandemic, cybersecurity or other things that we have actually seen realised in the last few years.
Andreas Dombret: That is another point I should have made. This is my view on things.
Edward Chancellor: I go back to what I was saying. If the central bankers as regulators are not particularly good at spotting risk in the financial system, what confidence does one have in them identifying risks some decades hence?
What happened in the last decade of the period of quantitative easing was that, so to speak, the central bankers were the only game in town. They were expanding their balance sheets. In Japan, they tried to affect corporate governance. In Europe, they affected the allocation of credit. There was an actual tendency of central bankers to extend their remit. That is probably over. Now that inflation is out and they are losing money on their securities portfolios, the age of quantitative easing is over and the age of central bankers thinking, “What shall we do now?”—in other words, “What new powers shall we confer upon ourselves?”—is probably past.
When I wrote my book, I expressed a concern about what I called “central banker capitalism”, as if they were going to take over the whole system. On reflection, I think that risk has somewhat abated.
Baroness Noakes: I have a brief supplementary to the points raised by Lord King. The remit in the UK has been expanding, both in secondary objectives and various “have regards”. Can you identify whether there was good practice in central banking around the world that would indicate what should be done in the UK? As I say, we have been growing our remits. I wonder what you would describe as good practice.
Andreas Dombret: Coming from the eurozone, I would argue, as I said earlier, that price stability is the primary mandate, but the overarching goal of keeping the eurozone together, given its structure, is the super-main goal rather than price stability in itself. That leads to a lot of political influence on the central bank by many national Governments for their own advantage and does not really help solve the primary goal of price stability.
I am a bit critical of secondary and tertiary goals if there is one really important goal, especially now, as you rightly said. Of course, the financial system needs to be as safe as possible. Of course, the financial institutions where monetary policy is transmitted need to be safe. That does not mean that each and every bank needs to be saved.
My short answer to your question is that I like your structure in this country in the Bank of England, and I still believe that is the best way, within your mandate, to achieve what you are supposed to achieve.
Baroness Noakes: Mr Chancellor?
Edward Chancellor: I have nothing to add to that.
Q70 The Chair: Can I ask Mr Chancellor and Mr Dombret about the remit? Maybe Edward would like to talk about it from the UK perspective and Andreas from the EU perspective. How much parliamentary scrutiny do you think there is of the remits, and how much should there be?
Edward Chancellor: Perhaps you know better than me, but I have not had a sense that the mandate has been scrutinised. Going back to our groupthink, a wave of central banks switched to the 2% inflation target. The Reserve Bank of New Zealand was the first to do it, Britain was sort of mid-wave, and the Fed caught on after the global financial crisis. That was deemed a technocratic solution and everyone’s best practice, with not enough observation, to my mind, of whether it was right.
In the 1920s, there was a movement for price stability, as it was called, which was roughly the equivalent of inflation targeting today, and all the great economists were in favour of it: Keynes, Ralph Hawtrey at the Treasury, Gustav Cassel, and, most of all, Irving Fisher in the States, who was, I think, head of the price stability league or some such association. The young Austrian economist, Friedrich Hayek, was starting his PhD studies at New York University, and his first papers were on the potential problems that adopting a price stability target would have at a time of productivity booms when prices would naturally be falling. What is curious, to my mind, is that that early critique of the price stability that the Federal Reserve actually followed in the 1920s has been completely ignored in the roughly 100 years that have followed.
It is convenient for politicians to give central bankers an inflation target, and then when they make a mess of things to not be considered responsible in any way, but I do not think that is good enough. Our politicians should be in charge of considering how the mandate is interpreted and what policies it engages in. There needs to be much greater scrutiny.
The Chair: Andreas, from a European perspective, is there some best practice that we can adopt from the European Union?
Andreas Dombret: I come from the most independent central bank I can possibly imagine. In preparing for today’s session, I read through the three remit letters. They are very unusual. I have never seen anything like them where I come from. I found them very detailed, very directing, and not leaving the central bank with the possibility of crafting its own policy. I was astonished by how detailed those remit letters were. I am not used to that sort of thing.
The Chair: Given how detailed they were, would you expect there to be quite a high degree of parliamentary scrutiny of them?
Andreas Dombret: I will give you one example. The Bundesbank has microprudential supervision under its roof, but the legal act is done at BaFin, which is something the FSA used to do in the past. When the Government suggested that the Bundesbank might take the FSA into the Bundesbank, it said, “We would rather not do this, because then we are subject to a lot of political influence and that is not something we would like to do”. It tried to be as independent as possible.
It is also about time. My mandate was an eight-year mandate, and it was renewable, but only as another eight-year mandate, to keep me as independent as possible from any political term. The terms of politicians are shorter and they may change over time, whereas my mandate would be independent of the term of any Government. The entire idea was to be as independent as possible, but, again, it can only work with the consent of the Government and the people. In Germany, for what it matters, the Bundesbank still has, I think, the highest approval rating among the public of all public institutions, together with the Supreme Court. That is what the independence is based on.
Baroness Kramer: I want to explore that a bit. The remit letters come from the Treasury. They do not go through a parliamentary process, as far as I know. To the extent that there is a political voice, do you have any recommendation about whether it is one that engages with the much broader parliamentary process rather than the narrow government process? I do not know whether or not the Bundesbank has some way of interacting with the German Parliament.
Andreas Dombret: It depends on which part of the policies of a central bank you are referring to. I cannot imagine a remit for monetary policy. On the other hand, if a bank fails and public money is needed to resurrect the bank, there may be problems in putting up that money. Of course, the Parliament needs to be involved to see how the people’s money was spent and whether it was effective or not. That is logic. It depends on which part of the central bank you are talking about. There were big bank failures in Germany, for example. Public money—German money, not European money—was there to support those cases, and then, of course, a parliamentary sub-committee looked exactly at how the money was spent, how the decisions were made and where the mistakes were made, and then you go after that. I see a logical point for that.
Q71 Lord Rooker: Having listened to you both for an hour and a half, I have to say that I have worked out what your answer is to the question I am going to ask. Edward, you raised the issue of inequality, which is not raised very often in our hearings. Your short, eight-paragraph submission to the committee is pretty devastating. Do you have any confidence that the Bank of England and maybe the other regulatory frameworks can identify emerging systemic risks?
Your basic conclusion, which you offer to talk to us about, is that the independence of the Bank seems to have worsened the monetary, financial and economic situation, but nobody is taking any responsibility for it, either at the Bank, because it is not admitting to any mistakes, which was what you said very early on, or indeed at Westminster. Is the Bank of England actually listening to anybody about possible risks that it ought to be concerned about?
Edward Chancellor: I started writing the book on the history of interest in the middle of the last decade, and I did not see the central bank, whether the Bank of England or the other central banks, showing any awareness of the risks that were building up in the system. By the time I handed the book to the publishers at the beginning of last year, I said, “You can market this as the first book of the next crisis”, because a crisis is unavoidable given the build-up of duration risk and overvaluation that has occurred. That, I think, is a point that has not been understood in the Bank of England.
It is a strange world of monetary economics where people ignore their models, ignore the financial system and assume equilibrium and so forth. That is a problem of the Bank of England. Now, one can hardly open a newspaper without someone launching an attack on the Bank of England, so one is beginning to feel slightly sorry for it. It is in a state of denial, I would say, about the errors it has made, and it would be better not to be in that state of denial. As for the politicians, as I said earlier, they seem to be just keeping their heads low and saying, “It’s nothing to do with me”, which is slightly against the remit of “Take back control”. If you are going to take back control, you might as well take some purview of what is happening in the financial system and some responsibility for it.
Lord Rooker: If anybody wanted to take back control, what would be the immediate changes that you would recommend?
Edward Chancellor: Are you going to talk about central bank digital currencies?
The Chair: We will come on to that in a bit. Do you want to address any points other than that?
Edward Chancellor: That has a potential solution, which one could discuss later.
Andreas Dombret: Systemic risk identification has two elements. First, they are the structures we know well. We have the numbers. We look at the processes. We see the deviations. We analyse. We try to calm things when they get out of hand. We know all the screws we need to turn, and that is most of that. The second element is the structures we do not know so well, coming back to the examples that were mentioned, such as the pandemic or the war in Ukraine. There, we are reactive at best. That is the financial stability question asked earlier. That is the interesting part, and there nobody has the solution; it depends on whether you have mechanisms and committees to debate it and to come up, on the run, with some good ideas.
We can confidently say that the central banks know all the parts of the system, but they do not fully understand how each and every part works with each and every part in the system all the time. That is where the challenge is. Clearly, inflation creates massive inequality, and we know that, but we have only recently started thinking about it. Inflation, especially high inflation, always hits the most vulnerable parts of the workforce most. What I am trying to say is that we differentiate the parts of the structures we know very well from the parts of the system we do not know very well, and that is why financial stability plays such an important role, in my opinion.
Q72 Lord King of Lothbury: I have a brief question for Edward. As you know, I have a lot of sympathy with the points you have been making about the consequences of very low interest rates and the concerns about another financial crisis, particularly given the scale of debt. What is less obvious to me is that this is the consequence of the independence of the Bank of England as opposed to a particular intellectual view about how monetary policy operates. After all, in the pre-independence era, the 1970s and the 1980s were hardly examples of either monetary or financial stability.
I think someone like Paul Volcker would defend to the last the idea that central banks should be concerned about price stability. You can talk about how long you might want to define that over, rather than doing it over a very short period. He would have been concerned about some of the issues that you have mentioned, but he would regard them as something that only independence of the central bank would be able to achieve because it was insulated from political pressures.
Edward Chancellor: That is fair comment. It may be just that the Bank of England ran into a run of bad luck since independence, and the independence itself is not the cause of that. Bear in mind, as we have been saying consistently, that central banks in other countries have had similar problems and similar inflation records, so one does not want to make too much of that.
You might have an independent central bank, but the question is whether we have identified the right mandate, whether the mandate is being imposed in the way one would approve, and whether the people charged with realising that policy understand the economic and financial system in a way that one approves. Those are the areas where there are grounds for oversight or discussion. My problem is that the mandate has been written in stone and then buried and not considered sufficiently. You have probably come round, from what I have read of your stuff, to quite a similar conclusion.
Lord King of Lothbury: I am not a witness today. I am not in the witness box, or the dock, I hope.
Q73 Lord Turnbull: It seems that we have a rather impoverished accountability system for the bank. It is almost entirely about setting up a model and a target; interest rates go up if it is above the target, and the converse. What there seems to be no accountability for is what we have talked a lot about, which is the model itself, and why no one is talking about the alternatives of how you bring in assets and asset inflation, and who is saying, “Why do you have that model?” The answer may be that you do not ask the Bank that; maybe you ask the Chancellor of the Exchequer that. I do not see any sign that anyone is running any kind of debate, apart from you, that this model is flawed or inadequate. It is a strange feature.
We talk about the average rate of inflation in the last 10 years being about 2%, but, actually, it is probably not 2% in any particular year. We had about eight years when it was low and two years when it was very high. Average it and you get to the target. The answer is that, for an inflation target, the system is not working as well even on its purest basis. The more important question is: when we do we start asking ourselves questions about inflation targeting, which we have told ourselves has been a jolly good thing, and lots of witnesses have told us that, and when do we start asking questions about whether there is some other model that we should be working with?
Edward Chancellor: It depends on what you mean by a model.
Lord Turnbull: Sorry, I do not mean an economic model; I mean a mindset or a framework for how policy is determined.
Edward Chancellor: If one is dealing with complex problems as simple models with unrealistic assumptions, I am not going to do a very good job, in my view. We have been living through what Jim Grant, the American financial journalist, calls the PhD standard, as opposed to the gold standard, in which, not quite exclusively, the leading central bankers and the teams informing central bankers adopt the same model. There was no room for the economics of Hyman Minsky at the highest levels of monetary policy-making.
To go back to what I was saying earlier, my view would be to have a more diverse intellectual group of economists, not ones who necessarily look to the world in the same way, and perhaps bring in more people who are not economists. Everything I have been saying to you is more or less common understanding in the investment world. I used to work for an investment firm, and my boss said when he employed economist PhDs it took him two years to un-brainwash them in order that they could understand how markets actually worked, so a lot of my criticisms are actually not unorthodox. They are the orthodoxy of the more thoughtful people in the investment world who have looked aghast at what has been happening over the years. I do not know who should form the committees, but, as I said, diverse committees, perhaps not solely composed of economists with models built on unrealistic assumptions, might be a place to start.
Andreas Dombret: In some of my speeches, I have referred to the Minsky moment. It is a concept that was considered when I was in office. Let me remind the committee that the UK is in a situation where the target comes from the Government. It is not a self-picked target or a self-argued target; it is a government target. Furthermore, where does the 2% come from? Although many central banks have a target of 2%, or close to 2% or about 2% or up to 2%, there is an illusion of money behind the 2%, and there is enough distance from deflation that people feel that they are growing. There is not a lot of intellectual input in a 2% inflation target.
Lastly, let me repeat what I said earlier. I warn against changing a target in the middle of a race. I do not think that is beneficial to the credibility of a central bank or of a Government setting the target.
The Chair: I have a quick question before I turn to Baroness Kramer for her last question. Edward, you just mentioned diversity of views. Is there a central bank you have in mind that has an approach to appointments in the key aspects of its operation that you think has got that right?
Edward Chancellor: No.
The Chair: Right. Andreas?
Andreas Dombret: No. I do not think it is that wrong either, so I am not so worried.
The Chair: That was quick. Very good. Thanks very much.
Q74 Baroness Kramer: I feel as if I am opening up a can of worms. We could go on for the next two hours. Let me keep the question brief. What is the impact of central bank digital currencies on the Bank’s independence and role? I will leave you to answer that as broadly as possible knowing it is the last question and that we are running low on time.
Edward Chancellor: First, we do not know what central bank digital currencies will look like and how they will be rolled out.
Baroness Kramer: There is wholesale or retail.
Edward Chancellor: I am not evading your question. Lord Rooker asked me if there was some solution to the problem. It is conceivable that a central bank digital currency could be a solution to the problem. One of the many risks of central bank digital currencies is that they would suck deposits out of the banking system.
My friend the German economist, Thomas Mayer, who used to be at Deutsche Bank, suggested that central bank digital currencies should replace bank deposits in the banking system, and that in effect when you did that it was a revival of the Chicago plan and would render the banking system safer. You would not have deposit flights. You would not have the creation of credit mixed up with the creation of money; it would be the separation of money and credit that Irving Fisher called for in the 1930s.
There would be a number of other benefits. Your money supply, your central bank digital currency, could continue to grow at a certain rate, in which case you would in principle at least deal with the problems of inflation and deflation, so we would not need to give the central bankers a mandate on that matter. What I like most about it is that once you have the supply of money, in effect, growing at a fixed rate but not created by the commercial banks or by the central banks, you get a rate of interest set in the market that is closer to what one might call the natural rate or the genuine market rate of interest. Interest rates under that system would never go to the zero lower bound, but they would be much more stable over the long run. I do not know what the central bank digital currency rollouts are going to be, but there is, as I say, a possibility that they could solve some of our problems.
Another particular benefit is that, in the process of switching, the central bank digital currency would be backed by all the bonds at the central bank, so you would never have to have quantitative tightening, and, in effect, it would reduce the interest-bearing debt of the Government. It could solve a lot of problems. It is almost too good a solution. We are, strangely enough, half way there already, but whether we actually go ahead with it or not we will see.
Andreas Dombret: I talked a lot about the independence and credibility of central banks. CBDCs may make central bank independence and credibility even more important. Should CBDCs become more widespread? That is not clear yet, but it very much looks like it. Many central banks are studying CBDCs. Should they become more widespread, the business of money will become even more competitive, and investors will have even more possibilities and opportunities to place their money in different ways. If markets decide on a particular currency, monetary stability becomes even more of an issue.
Right now, as was mentioned earlier, the US dollar has about 60% of global reserves, the euro has about 20%, and the yuan, the renminbi, has about 1%—I am not quite sure—so it is not at all illogical that the People’s Bank of China is the first advocating and testing CBDCs, making a test case. It is also no big surprise that the European Central Bank could well be second. Its position is that, while the United States of America is studying the implications of a CBDC at MIT and other universities very carefully, it sits back and watches what others are doing. It is very clear to me that depending on where you are in the order of reserve currencies—you have to answer yourselves where you think the United Kingdom is—it is important for the sovereignty of a country at least not to dismiss it without having studied it. That is my take.
If you were to ask me who should decide on a central bank digital currency, at the end of the day, I think a Government would have to do that, in clear consultation with a central bank, but it is not something a central bank can do by itself. It is too big an issue. There has to be very good communication. My take is that if you are not the United States of America you should look at a CBDC without making a final decision, and for sure not as the central bank itself.
The Chair: Thank you very much. We have covered an enormous waterfront. We have gone from Washington to Babylon and back. Thank you both very much indeed.
