Britannia Radio

om The Times

March 2, 2009

Bank of England set to pump cash into economy to avoid deflation

Gary Duncan, Economics Editor

The Bank of England is set this week to begin “printing money” in a ground-breaking move that will mark its most forceful action yet to curb the slump in the economy.

The Bank’s Monetary Policy Committee is expected to act on Thursday, as soon as it is given a final green light from Alistair Darling to begin the so-called quantitative easing.

The go-ahead from the Chancellor is expected imminently, as early as tomorrow, in a letter to Mervyn King, the Bank’s Governor. The move will signal an aggressive stepping up of the Bank’s efforts to breathe life into the economy.

The radical measure will also mark a watershed in the Bank’s history since it was handed independent control of interest rates by Gordon Brown nearly 12 years ago. Until recently, that was seen unquestionably as Mr Brown’s masterstroke. On a bright morning on May 6, 1997, the man who was then Chancellor announced that he was surrendering to the Bank his power to set base rates.

RELATED LINKS

• Are we repeating Japan's mistakes?

• MPC begin to stumble on a sticky wicket

• Bank on fast-track to 'printing money'

MULTIMEDIA

• GRAPHIC: desperate remedies

It was a landmark moment. In the following decade, the country grew used to the idea that it was no longer the Treasury, but the Bank, that was at the economy’s helm. On one Thursday each month, the hand of the Old Lady of Threadneedle Street was felt on the tiller as the Bank’s decisions emerged at midday.

It was no longer the whims of a chancellor that lay behind these monthly verdicts, but the insights of a nine-strong expert panel. Five were top Bank officials, headed by the Governor — first Sir Edward George, now Mr King. The remaining four were external members, each with reputations in their own right.

Ten years later, the creation of this Monetary Policy Committee (MPC) had come to be seen as the crowning achievement of Mr Brown’s Chancellorship. It was a biting irony that this accomplishment came not from using power but from giving it up. But that did not detract from his pride.

The Bank was proud, too. By the summer of 2007, the economy had enjoyed an unprecedented winning streak of 59 straight quarters of growth. It was robust growth, too: an average annual pace of 2.9 per cent. And it came with subdued inflation, modest interest rates and rising employment. Yet hubris was about to give way to nemesis as the first tremors of the credit crunch were felt. By September 2007, global financial havoc had engulfed Northern Rock, the Bank and the Government. Boom and bust had not been banished, as Mr Brown had claimed. It was back with a vengeance.

A year on, and Britain was mired in a slump that threatens to be the worst of the postwar era. The Bank expects the economy to shrink by up to 3.7 per cent this year. Tens of billions of pounds have been thrown into bailing out stricken banks. And after a reluctant start, the MPC has slashed interest rates from 5 per cent to 1 per cent in the past five months alone.

The crisis has rocked to its foundations Mr Brown’s whole system for running the economy. His once proud construction is crumbling. Neither the Bank, nor the Treasury, nor the Financial Services Authority saw the danger coming.

Now the future of the MPC itself is in serious question. With base rates at 1 per cent, and a cut below zero impossible, the MPC’s arsenal is nearly exhausted. Yet the crisis rages on.

This week, the Bank will deploy its last resort, and begin printing money, or at least its modern equivalent. It has been forced to ask permission from Mr Darling to begin this quantitative easing. The MPC will inject billions into the economy by buying company and government bonds, their IOUs, from banks. It will create money by electronically crediting the banks’ accounts. In turn, this is intended to allow the banks scope to make billions in new loans. But the strategy raises huge questions: over whether it will work, what it means for MPC independence, and how such desperate measures became needed.

Since the MPC has had to ask the Chancellor for permission, critics believe this undercuts its autonomy. Mr Darling will set a maximum amount of money to be created. Yet it will still be the nine MPC members who decide when to act and to what extent. It is a grey area, but unquestionably the Chancellor’s hand is creeping back on to the steering wheel. An acid test will be whether the MPC can decide by itself when to stop.

Critical, too, may be how much say the four external MPC members are allowed. The decisions over how much money to create, and what assets to buy, are complex. The plans will be drawn up by the Bank’s chief economist, its markets chief, and Mr King’s two deputies. They are all the Governor’s men. But how much of the promised say will the whole nine-strong MPC have, and will they vote?

Mr King’s critics, including past and present MPC members, complain that, too often, he uses his formidable intellect to steamroller dissent.

True, there have often been as many sides to the MPC’s arguments as there are to its grand, octagonal meeting room. Yet Sushil Wadhwani, a respected former member, complains that he advocated, as far back as 2000, that the Bank should “lean against the wind” to limit an excessive boom, but was overridden. Among the present MPC, David Blanchflower has voted for rate cuts to stave off a bust in every month since October 2007, but cut a lonely figure. He is leaving the Bank in May. In a swipe at colleagues, he complained last week: “Clearly policymakers did not come to a realisation of the problems in the financial sector quickly enough.”

Mr King himself has been loath to concede any errors. He admitted last month: “I’m not pretending that everything worked. Well, clearly it didn’t.”

He, and the MPC, had better hope that this week’s last throw does work. At stake is the future of the MPC, and the fate of the economy.