Financial market liberalisation cannot be undertaken on only one side of the balance sheet. If there is freedom to lend, then there must be freedom to lose money on lending.
The Bank of England was nationalised in 1946. Over the 50 years that followed it became the Department of Monetary Affairs. Like other government departments it looked backward to please its political masters and forward to please its clients. Like a department, the Bank was responsible for the implementation of government policy towards its sector and for the representation of the interests of the sector within government. As with other government departments, the danger was to emphasise one function at the expense of the other: for the tax collector to be seen as a hostile force, for the Foreign Office or agriculture departments to be seen as lobbyists for foreigners or farmers.
An independent agency with a public role, as the Bank of England became in 1997, also has responsibilities both to government and to its client sector. But both aspects of the role change. A regulatory agency faces the danger of undue receptiveness to political pressure in looking backward. There is the danger of regulatory capture – in looking forward, the agency becomes the creature of those it regulates.
Policy formulation requires the balancing of competing interests. That responsibility cannot be combined with the representation of any particular interest, so the latter function must fall away. Most people in the City of London understood this consequence. An independent central bank, while in a sense more powerful, nevertheless has a more narrowly defined, more technical role. The corollary is that the City should present its own concerns directly to the Treasury. Over the past decade, such representations have probably been made rather too well for public rather than private good.
Britain has probably been more successful than any other major country in clarifying the elements of traditional central banking. There is an administrative responsibility for debt management, a policy responsibility for interest rates and credit, and a supervisory role for responsible and prudential conduct. Logically these divide between a Debt Management Office, a monetary policy committee and a Financial Services Authority. While there are loose ends to be tidied, the shape of the regime is clear and both the US and Europe could usefully look for lessons.
The implication of this change in regime is that the banking and financial services industries are now in the same position as any other industry lobbying for selective favours. All industries face dislocation from time to time, as a consequence of their own mistakes or new competition, and look for subsidy and protection to give relief. These requests normally receive a dusty answer, and should.
The primary consideration in framing interest rate policy is the control of inflation. Even if crises in debt markets have substantial implications for the wider economy – and it is not yet apparent they do – that does not make a case for central bank intervention. Unless the issue directly bears on the inflation target, the correct response is that such representations should be addressed to the political authorities. Special help for financial services is a matter for politicians to determine and – with difficulty – to defend.
This is the logical consequence of relinquishing the notion that government could, or should, engage in fine-tuning of the business cycle and that commercial banks and their lending policies are, under the aegis of the central bank, agents in the implementation of that process. Financial market liberalisation cannot be undertaken on only one side of the balance sheet. If there is freedom to lend, then there must be freedom to lose money on lending; if there is freedom to construct complex financial instruments no one ought to want, then no obligation to provide a market when people realise they do not want these complex financial instruments after all. There should be no central banker’s put. The price of demonstrating that may be nerve-racking, but there is much more good than harm in the long-term consequences.