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Mervyn King has failed- it is time for some democracy at the Bank of England

Mervyn King has failed- it is time for some democracy at the Bank of England Mindful Money

Yesterday evening the Governor of the Bank of England gave a lecture for BBC Radio’s The Today Programme. Of course there is already an obvious weakness here as it should be Mervyn King receiving a lecture for his (lack of) performance! This has been followed up by an interview on The Today Programme this morning. Governor King has repeated his usual trick of discussing matters in a broad sweep in an attempt to make himself look intelligent, magisterial and dignified. He invariably avoids detail as it is often inconvenient. You know the sort of thing, inflation which is invariably above target becomes on its way down to it. Even the casual observer has started to spot that it has supposedly been on its way down to its official target for quite some time now!

Judging Mervyn King with his own words

If we go back in Doctor Who’s TARDIS to January 2005 then we see Mervyn King defining his job thus.

The trick is to see the wood for the trees. If there is a major crisis, there’ll be a wood

On his own count and criteria therefore he has failed. We have had the major crisis but Mervyn King did not see “the wood” as he ineffectually strolled around the trees. And we can be sure that Mervyn King has not changed his criteria because he has repeated them today.

That means focusing on the wood not the trees

The trouble of course is that he has just reminded everyone that he failed to do so as the biggest financial crisis of his lifetime hit. So he failed his own test.

What did he actually say?

Again we saw a familiar tactic which I note someone has already called the mea without the culpa! This is for a sort of hang-wringing apology that the more times you read it the more it looks like a non-apology. I have emphasized his attempted get-out clause.

With the benefit of hindsight, we should have shouted from the rooftops that a system had been built in which banks were too important to fail, that banks had grown too quickly and borrowed too much, and that so-called ‘light-touch’ regulation hadn’t prevented any of this.

My response to this is to consider the basic functions of a central bank. They are to defend the currency and protect and support the banking system. If we put aside for one moment Mervyn King’s active debasement of the currency we see that he failed in his role with regards to the banking system. If he was a football manager he would have been sacked and if his boss was Roman Abramovich this would have happened some time ago!

The Pre Credit Crunch Era

If we look back to the middle of the last decade we can see that there were warning signs that were flashing amber. Let me give you two main ones. UK house prices (and of course ones in Ireland, Spain the US and Australia) were in the middle of an extraordinary rise or boom. Also the size of UK bank balance sheets was undertaking an extraordinary surge from being roughly the size of the UK economy to a new animal many times larger than it. What could possibly go wrong?

And yet in a rather desperate attempt at misrepresentation Mervyn King tells us this.

Whether in this country, the United States or Europe, there was no unsustainable boom like that seen in the 1980s; this was a bust without a boom.

Really? Odd then that he talks of something several times that looks rather like a boom to me.

The most obvious symptom was that banks were lending too much

By the end of 2006, some banks had borrowed as much as £50 for every pound provided by their own shareholders

This cheap funding fuelled lending. Banks got bigger.

Can anybody see signs of a boom there? And in a rather inconvenient truth if there was no boom the increase in bank lending looks even more dangerous and should have been responded to by the relevant central bank. At this point may guilty roads are pointing not at Rome but at Mervyn King.

Let us remind ourselves of another role of a central bank

A former chairman of the US Federal Reserve William McChesney Martin, Jr. defined his role thus.

to take away the punch bowl just as the party gets going

Rather succinctly put wasn’t it? And perhaps it is no great surprise that he has been the longest serving Chairman of the US Federal Reserve (1951-70). If we look at the apparent bank and housing boom we can see that Mervyn King failed to take away the punchbowl. And if you read the quotations above you can see that he knew the party had not only got going it was in fact in full swing. Yet Mervyn King failed to act.

Why? He did nothing about us adopting an inferior inflation target

Back in 2002 the then Chancellor of the Exchequer proposed a change in the UK’s inflation target from the Retail Price Index to the Consumer Price Index and this was implemented in 2003. I was not blogging back then (did bloggers exist?) but was fuming at the stupidity. The UK has a level of owner-occupation of its houses which is internationally high so switching to an inflation index which ignores this was a mistake. The CPI has no measure for house price inflation (they are often just about to include one…) as well as oddities like ignoring Council tax. I have never heard a member of the Monetary Policy Committee acknowledge this mistake.

Care is needed here as the version of RPI which was targeted excluded mortgage costs but at least there was a version with them! And it measures housing costs in an eccentric way but using mortgage interest-rates and house depreciation for example but at least it has them. Can anybody see how a measure of house prices might have helped us in a house price boom?

Going forwards my contention is that our inflation target needs to include asset prices. Now let us think of the reform that has happened on Mervyn King’s watch. Ah yes zero!

Remember the current system could hardly have failed much more…..

Speaking of inflation

The day-to-day tasks of controlling inflation and curbing the excesses of the financial system will fall to the Bank of England

We now know that the latter did not happen so let us take a look at the former controlling inflation. Let us recall that the official inflation target is 2%, how is that going?

2.9%,3.5%, 3%,3.4%,3.7% 3.4%,3.2%,3.1%,3.1%,3.1%,3.2%,3.3%,3.7%,4%,4.4%,4%,4.5%,4.5%,4.2%,4.4%,4.5%,5.2%,5%,4.8%,4.2%,3.6%,3.4%,3.5%

If we look at this period we might think we have found Mervyn’s “boom”, well in inflation anyway! But the scale of the failure here is evident when we look at the state of the UK economy. Since the credit crunch began we have lost some 4% of our economic output which we have not regained and we have just officially moved back into recession.

No wonder Mervyn mentioned inflation very little as it is another failure on his watch.

But surely Quantitative Easing will save us?

Governor Mervyn King failed to mention that the latest tranche of UK Quantitative Easing ended yesterday as it reached its £325 billion target. Perhaps he wanted to avoid awkward questions like what is it good for? After all he has over 30 different explanations to remember now many of which are contradictory.

Let me offer a critique of some of them. Here is one from the Bank of England website

it lowers longer-term borrowing costs

This may of course been inconvenient if as likely a member of one of the million mortgages that saw their interest-rates rise at the beginning of the month happened to be there and chose to point this out.

Still it will raise inflation according to the Bank of England to stop it falling below target. At this point you might like to peruse again the actual inflation numbers which outside the fantasies of the Bank of England show no sign at all of doing so. And it has had this consequence which has ruined the whole programme. I explained the situation on January 18th.

A Fundamental Problem: falling real wages

Here is the “rub” as Shakespeare put it. QE has contributed to a fall in real wages and via this route has in fact contributed to a contraction in the economy in a perversion of its supposed role.

As it gave a boost to inflation this contributed to inflation going above target rather than the supposed intention of to target. If we look at the period from August to October this year inflation in the UK was approximately 5%, however the Office for National Statistics has reported this for the same period today.

Total pay (including bonuses) rose by 1.9 per cent on a year earlier, down 0.2 on the three months to October 2011

So there you have it, real wages have fallen at an approximate annualised rate of 3% per annum over this period and continue an existing trend. So there you have it. Whatever stimulus QE might provide in theory it has been offset and quite possibly more than offset by the fall in real wages.

If we look at econometrics we see that consumption is heavily influenced by the level of real wages (bad in this instance) but much more weakly influenced by a rise in asset prices (of the sort QE has provided). Or as a piece of Bank of England research put it last year.

the split between inflation and activity has certainly not been everything we would wish

So another failure.

Mervyn King’s view of his role in the credit crunch

With a hat-tip to Shaggy.

It wasn’t me, It wasn’t me, It wasn’t me


There is a way out of this record of failure and it can be combined with an increase in democracy.

I have a policy recommendation and it does indicate quite a change. As the role of the Monetary Policy Committee has changed and expanded more than could have been forecast when it was introduced back in 1997 there now needs to be new checks and balances on its power. My suggestion for a change is that MPC members should stand for election as they are currently much more powerful than many of our elected representatives.

If the powers that be want the Bank of England to get a grip on events then as Carly Rae Jepsen puts it.

But here’s my number,
So call me, maybe?

This article was written by Shaun Richards and originally published on Mindful Money under the title: Mervyn King has failed and as he will not be sacked it is time for some democracy at the Bank of England

Tags: central bank , central banks , democracy , Mervyn King , Sir Mervyn King , UK , UK banking sector , UK banks , UK economy , UK financial system
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