DR ANA CAROLINA GARRIGA – WRITTEN EVIDENCE IBE0019 – INQUIRY ON THE BANK OF ENGAND: HOW IS INDEPENDENCE WORKING?

 

Questions addressed

Is the Bank of England’s statutory framework still defined appropriately? If not, how should it be defined?

What should be the role of secondary objectives in the remit of the Bank?

 

Summary

The BoE’s remit includes several potentially conflicting objectives. There are two sources of potential conflict: between the financial and price stability objectives, and between the price stability and support to HMG’s economic policy objectives. Comparative evidence suggests that (1) most countries – especially OECD countries – do not include so many conflicting mandates in their central bank’s statutory frameworks; instead (2) price stability tends to be stated as the primary goal of central banks. This suggests the value of defining the relationship between the BoE’s objectives, and providing the rationale for additional objectives. Clearer objectives should result in better accountability. Further research should inform potential trade-off of objectives combinations, and their effect on socioeconomic variables.

 


The statutory framework and sources of potential conflict

The BoE has a financial stability objective “to protect and enhance the stability of the financial system (section 2A) and dual monetary policy objectives: to maintain price stability, and “subject to that, to support the economic policy of Her Majesty’s Government, including its objectives for growth and employment” (section 11).

 

1. Multiple and conflicting objectives

With different hierarchy, the statutory framework lists five objectives: financial stability, price stability and, subordinately to the later, support for the government’ economic policy, specifying support for growth and employment. These objectives are not foreign to the mandate of other central banks. Figure 1 shows the percentage of central banks in the world (left side) and among OECD countries (right side) that have included those five objectives in their central bank’s remits between 1970 and 2021.

 

Figure 1. Main central banks objectives
Percentage of countries explicitly stating each of these objectives in their central bank’s statutes. Different samples

Source: Garriga (2022).

 

In comparison with central banks in the rest of the world, the objectives of the BoE are not unique, yet some of them are less frequent in other countries. By the end of 2021, in a sample including 194 countries, 95% (184 countries) had price stability, and 73% (142 countries) of central banks had financial stability as one of their objectives. Regarding secondary objectives, 41%(79), 45%(88), and 11% (21) central banks listed support for government’s policies, growth, and employment as objectives, respectively (Garriga 2022). For OECD countries, in the same year, the objectives of 94% central banks included price stability, 68% financial stability, 59% support for government’s policies, 32% growth, and 29% employment as objectives (Garriga 2022).

Although most central banks have more than one objective, the combination of these five objectives in a central bank remit is far less frequent. Only six other countries in the world have shared this configuration of objectives with the BoE: Argentina (2012-2021), Eritrea (1997-2021), Israel (2010-2021), Kenya (2007-2021), Malawi (1989-2010), and Turkey (2001-2021).

With limited instruments, and without explicit hierarchy of objectives – particularly between price and financial stability – and with independent committees involved in the decision-making process, it is possible that these multiple objectives demand contradictory uses of the same instrument. In those cases, conflict regarding the best course of action may delay actions, lead to suboptimal decision, and obscure accountability – that is, the justification of actions taken prioritising different objectives.

 

2. The relationship between the financial and price stability objectives

The order in which the financial and price stability objectives are addressed in the law (sections 2A and 11), the existence of two independent committees (Financial Stability Committee and Monetary Policy Committee) without explicit coordination or conflict resolution mechanisms, and the lack of explicit hierarchy between these two objectives suggest the parity between the financial stability and price stability objectives.

This is potentially problematic in cases in which actions towards preserving financial stability conflict with the need to achieve the inflation target, and it may hinder accountability. For example, did the central bank not meet its monetary target because of a wrong diagnostic of the macroeconomic context, poor decision-making, or because it prioritised financial stability over the monetary goal? Do “optimal” actions towards financial stability need to be moderated to preserve price stability, or should price stability be sacrificed in the shorter term to protect the financial system?

Worldwide, most central banks have had price stability as one – or the primary – objective (see Figure 2). Financial stability is also normally among central banks’ objectives (142 countries in 2021), and for most of these cases this objective is found with the price stability goal (137 countries). This is consistent with research suggesting that independent central banks are associated with lower financial instability (Klomp and de Haan 2009).

 

Figure 2. Price and financial stability objectives. Trends
Percentage of countries explicitly stating each of these objectives in their central bank’s statutes. Different samples

Source: Garriga (2022).

 

How have countries addressed the relationship between price and financial stability objectives? Several countries have opted for explicitly stating the primacy of the price stability objective over other objectives. As Figure 2 illustrates, worldwide, 56% of central banks (109 countries) have explicitly stated price stability as their primary goal. Notably, this tendency is stronger since the aftermath of the Global Financial Crisis. The figure is 65% among OECD members. This is consistent with a global norm regarding central bank independence as  increasing evidence of the linkages between the focus on price stability – and central bank independence, more generally – and inflation, inflation volatility, growth, and even political stability (Alesina and Summers 1993; Bodea and Hicks 2015; Cukierman 1992; Garriga and Rodriguez 2020, 2023; Grilli, Masciandaro, and Tabellini 1991; Keefer and Stasavage 2003).

Among the banks with a financial stability objective, 86 central bank statutes explicitly state that price stability is their primary goal. In 2021, only 17 central banks have financial stability as a primary objective – none of them an OECD member (see figure 2). This seems consistent with research suggesting that governance arrangements suitable for financial supervision are more likely when the supervisor is located outside the central bank’s remit (Masciandaro, Quintyn, and Taylor 2008).

Figure 3 shows the geographic distribution of the combinations of these two objectives. According to the most recent data. By the end of 2021, 70% of the central banks have both price stability and financial stability objectives. Most of them (84 countries) explicitly state that price stability is the primary objective, and 50 countries include both objectives without indication of subordination of one to the other.

 

Figure 3. Price and financial stability objectives
Countries that have either or both objectives in their central bank’s statutes

 

 

Source: Garriga (2022).

 


3. The secondary objectives of support for the government policy, growth, and employment

There is little research on the economic effects of including or not support for the government, growth, or employment among the objectives of the central bank. There have been important discussions in other OECD countries regarding the desirability of a “dual mandate” for monetary policy – understood as including the objectives of price stability and (full) employment in the remit of the central bank. Of note, in countries with a dual mandate, employment is not conditioned on the policies of the government.

These three objectives may have a normative role in the BoE law, but it is not clear to how they should be articulated in the decision-making or in the justification of those decisions in terms of accountability. It is also not clear to what extent they mirror the idea of the monetary “dual mandate” and to what extent political considerations regarding growth and employment strategies should be weighted. As stated now, these three secondary objectives, as stated, may potentially (1) obscure accountability if decisions were to be grounded on these considerations, and (2) also open the decisions to politically-motivated (instead of fundamentals-based) challenges to monetary policy from different stakeholders (Koop and Scotto di Vettimo 2022).

If the political goal was to include employment or growth considerations in the adoption and justification of decisions for example, it would be clearer to include employment or growth as objectives, instead of the less precise statement of “support the economic policy of Her Majesty’s Government, including its objectives for growth and employment.” Further research should support the macroeconomic gains of this inclusion.

 

Evaluation and recommendations

The BoE has not had significant challenges pursuing the financial stability goal that could be attributed to the inflation mandate. In contrast, the UK has experienced higher inflation rates than comparable countries – all exposed to the negative consequences of the Covid-19 crisis and energy prices shocks. This higher inflation could be attributed to a series of other factors – the consequences of Brexit, and political announcements that had negative impact on markets and the pound. Of course, inflation could have been even higher with a less independent BoE in charge of monetary policy. This suggests the importance of revisiting what should be the primary objective of the BoE.

Price stability may have been less of a pressing concern 25 years ago, during the Great Moderation. However, a clearer focus or pre-eminence of the price stability objective in case of conflictive orientation of the financial and monetary decisions should result in higher trust in monetary and reduce price instability and potential inflation volatility.  Comparative data shows that the dual objective of price and financial stability is normally complemented with the primacy of price stability as main focus of central banks. The primacy of the financial stability objective is not observed in other OECD countries – and in very few countries in the world. Research on articulation of these two objectives when financial stability is one of the goals of central banks could inform institutional revisions.

Regarding the all the objectives in the current remit, descriptive data suggests that other countries with similar central bank’s objectives configuration have been outperformed by peers. Further research should explore whether multiple and potentially conflictive objectives affect central banks’ performance.

 

Recommendations

 

References

Alesina, Alberto, and Lawrence H. Summers. 1993. “Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence.” Journal of Money, Credit, and Banking 25(2): 151–63.

Bodea, Cristina, and Raymond Hicks. 2015. “Price Stability and Central Bank Independence: Discipline, Credibility, and Democratic Institutions.” International Organization 69(01): 35–61.

Cukierman, Alex. 1992. Central Bank Strategy, Credibility and Independence: Theory and Evidence. Cambridge, MA: The MIT Press.

Garriga, Ana Carolina. 2022. “Introducing a New Dataset on Central Bank Mandates.” Paper presented at the ISA 2021 Annual Convention, Virtual Platform. Unpublished manuscript.

Garriga, Ana Carolina, and Cesar M. Rodriguez. 2020. “More Effective Than We Thought: Central Bank Independence and Inflation in Developing Countries.” Economic Modelling 85(1): 87–105.

———. 2023. “Central Bank Independence and Inflation Volatility in Developing Countries.” SSRN

Grilli, Vittorio, Donato Masciandaro, and Guido Tabellini. 1991. “Political and Monetary Institutions and Public Financial Policies in the Industrial Countries.” Economic Policy: 341–92.

Keefer, Philip, and David Stasavage. 2003. “The Limits of Delegation: Veto Players, Central Bank Independence, and the Credibility of Monetary Policy.” American Political Science Review 97(3): 407–23.

Klomp, Jeroen, and Jakob de Haan. 2009. “Central Bank Independence and Financial Instability.” Journal of Financial Stability 5(4): 321–38.

Koop, Christel, and Michele Scotto di Vettimo. 2022. “How Do the Media Scrutinise Central Banking? Evidence from the Bank of England.” European Journal of Political Economy: 102296.

Masciandaro, Donato, Marc Quintyn, and Michael W. Taylor. 2008. “Inside and Outside the Central Bank: Independence and Accountability in Financial Supervision: Trends and Determinants.” European Journal of Political Economy 24(4): 833–48.

 

 

Dr Ana Carolina Garriga
University of Essex
27 April 2023

 

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