Breaking the Bank

The exchange of letters this week between Mark Carney and Philip Hammond made it very clear who the supplicant was. The Governor of the Bank of England informed the Chancellor of the Exchequer that he was prepared to extend his term by one year. Carney pointed out that while the personal circumstances that had made him want to limit his term to five years had not changed, this country’s circumstances had. So he would be here a little longer.

Things had seemed very different a few weeks ago, when Theresa May bemoaned the consequences of the Bank’s monetary policy in her party conference speech. ‘A change has got to come,’ she had warned. ‘And we are going to deliver it.’ The Prime Minister’s willingness to criticise the effects of the Bank’s monetary policy was seen by many as threatening its independence. Carney himself was unhappy about it, and made that clear. Former chancellors and backbench Brexiteers having a pop were unlikely to bother him, but if the Prime Minister was expressing doubts about the Bank’s approach, that was serious. If Theresa May didn’t have complete confidence in Carney, his position would be untenable.

Shortly after May’s speech, in which she blamed low interest rates for high asset prices and worsening inequality, Carney told an old friend that he was considering heading back to Canada at the first decent opportunity, 2018. He wasn’t inclined to extend his term as Governor, despite a request for him to do so. It wasn’t just May’s criticism of monetary policy that had irked him. Those who know him say he hadn’t liked the whole ‘citizen of the world, citizen of nowhere’ tone of her speech — perhaps unsurprisingly, given that he is a Harvard-educated Canadian serving as Governor of the Bank of England.

Carney’s mood had not improved when his request for a meeting with the Prime Minister was initially answered with a date several weeks hence. In the old days, No. 10 had fitted in Mr Carney rather faster than that. His meeting with May in Downing Street on Monday was the first official, face-to-face conversation they have had since she so publicly aired her concerns about monetary policy — although they had spoken on the telephone.

Hear James Forsyth and Sam Bowman discussing Theresa May's relationship with Mark Carney

Allies of Carney feared that he was a marked man due to his close relationship with the ancien régime, particularly with George Osborne. After all, Carney was very much Osborne’s personal appointment as Governor. When the Bank of England job came up, Carney was still governor of the Bank of Canada and the interview process was rather cloak-and-dagger. He was met at the airport by one of Osborne’s special advisers and taken for a meeting with the chancellor. Osborne relished appointing a ‘rock-star central banker’ who was the toast of the Davos circuit. Carney’s arrival was a personal triumph for him — which raised questions about how Carney could fit with May’s less metropolitan, more provincial, government.

But Carney had a trump card. Not to extend his term would cause market mayhem and suggest a massive rupture between the government and the Bank. Just last week, Carney told a House of Lords select committee that his decision about whether to stay or go would be determined by what was best for his family. But as Philip Hammond privately acknowledged, if Carney departed it would have been interpreted as far more than a personal decision. The media and the markets would have seen it as a populist scalp. At a time when gilt yields are rising, the last thing the UK needs is more uncertainty.

Carney’s departure would have been particularly embarrassing for No. 10, since May’s conference speech was not intended as a threat to the Old Lady of Threadneedle Street’s independence. May’s team — forged in the Home Office and lacking Treasury experience — had not realised quite how explosive commenting on Bank of England policy would be. None of this was helped by the fact that the Chancellor didn’t appear to have been shown the relevant passage. The Treasury would have explained the implications of May saying in this context that ‘a change has got to come and we are going to deliver it’. The line was a refrain of the speech, but applied to monetary policy it seemed to take on a more menacing tone. To lose the Governor of the Bank of England by mistake during a period of economic turbulence would have been a spectacular own goal by a new Prime Minister.

In May’s defence, it is odd that the whole issue of monetary policy is seen to be beyond the remit of democratic debate. Especially given that in the last few years it is monetary policy — quantitative easing and ultra-low rates — that has been doing the economic heavy lifting. George Osborne was quite explicit about this, calling himself a ‘fiscal conservative and a monetary activist’. This means that the main economic levers were being manipulated not by elected politicians, but by the independent central bank. The Chancellor and the shadow chancellor don’t clash at the dispatch box over whether their effects on savers and the housing market are or are not a good thing, because even to raise the topic is seen as a threat to the central bank’s independence.

Yet the move to ultra-low interest rates is the biggest economic change in Britain since the crash. Taxes, benefits, government spending — none of these have altered life as dramatically as rock-bottom rates have. Savers are no longer rewarded; annuities have lost their purpose. Lower borrowing rates mean sky-high asset prices and a distorted housing market. The Bank of England itself has released a study showing that quantitative easing has made the richest richer, and the poorest poorer.

It is a safe bet that in the next few years we will hear much more debate about central banking policy. It would be bizarre if we did not. The only question is whether it will be led from inside — or outside — Parliament.

But it was still a mistake for May to say what she said in her conference speech, for one simple reason: if a Prime Minister criticises anything, it implies that she will change it. She is not going to, though, because no one has come up with a practical alternative. Even if she were to replace Carney (whether with Andrew Bailey, chief executive of the Financial Conduct Authority — the candidate favoured by insiders — or, less likely, Paul Tucker, the former deputy governor of the Bank), such a personnel change would be unlikely to lead to a dramatically different policy. Low rates are now global.

Of course, there is also the nuclear option: ending the Bank of England’s independence. After all, it has only been independent since 1998 — so it is hardly some hallowed part of the constitution. One could argue that just as the financial crisis exposed the flaws in New Labour’s financial regulation regime, the current economic situation is revealing the drawbacks to central bank independence. But given that the British government needs to be able to borrow tens of billions of pounds every year, and that the country is preparing for the biggest change to its trading arrangements in 40 years, the Prime Minister would be courageous (in the Yes, Minister sense) to end Bank of England independence any time soon.

This is also no time to install an academic central banker, loftily detached from the markets. Carney’s experience as a commercial banker undoubtedly helped him steady the markets straight after the Brexit vote. He misjudged the tone of some of his interventions in the referendum, but he behaved more responsibly than the politicians did on 24 June, coming out early on with a clear plan for how to handle the situation. Some considered his early August interventions, including cutting interest rates, premature. But combined with the fall in the value of the pound, they have given the economy an adrenalin shot. The Bank of England has also been clear — in private — about the risk of staying in the single market without a say in the setting of its rules: you can’t run the City of London by copying and pasting.

What is more, if Carney were to quit before Britain left the EU, it would send a bad signal, suggesting that Britain was pulling up the drawbridge rather than looking outwards. Carney’s appointment was symbolic of the extreme openness of Britain: economically, socially and politically — precisely the quality needed to make a success of Brexit. There are not many countries where the central bank governor could be a foreigner without it causing any upset.

There are lessons to be learnt from the Carney imbroglio by the May government. First, her camp needs to accept that in the economic circumstances they can’t allow a gap to open up between No. 10, the Treasury and the Bank. May and Hammond are never going to have as close a relationship as Cameron and Osborne, but in their attempt to replace the chumocracy with a more formal approach, they mustn’t overcorrect. The Prime Minister needs to think more about how Britain is perceived by the rest of the world, which is still trying to figure out what to make of Brexit. Moves that suggest a turning inward — such as demanding that companies state the number of foreign workers they employ — should be avoided.

Instead, May should emphasise her laudable aim that Britain become a global leader in free trade. The government would do well to set up a new Rhodes scholar-style scheme to encourage exceptional students from Europe and the wider world to do postgraduate studies in Britain. The fact that the Prime Minister of Australia was a Rhodes scholar at Oxford hasn’t hurt trade talks between the two countries; Britain will need more of these connections in the decades ahead.

Carney’s decision to leave in 2019 means that the government will have to appoint a new central bank governor before the next general election. This governor will be one of the most important in the Bank of England’s history, helping to steer the economy through its first post-EU years. The search should be international in scope. It may well be that someone like Raghuram Rajan, previously of the International Monetary Fund and also a former governor of the Reserve Bank of India, is the best candidate for the job.

If Mrs May is worried about the social effects of monetary policy, then she could factor this into the mandate for the next Bank of England governor, rather than heckle from the party conference stage. This standoff between Downing Street and the Bank has been resolved with relative ease. But any repeat could be far more damaging.