The Bank of England
The Bank of England on London’s Threadneedle Street Robert Evans - Alamy Stock Photo

Ahead of the upcoming general election in July, the nation will be scrutinising the economic strategies of both the Conservatives and the Labour Party. Presently, the economic outlook is improving, with the 12-month CPI inflation falling to 3.2% in March and 2.3% in April.

Given the bleak poll ratings for the Conservatives, the government is keen to present the falling inflation as a result of their effective economic policies. The Prime Minister stated that the latest inflation figures are "proof that the plan is working and that the difficult decisions we have taken are paying off." Furthermore, Britain can expect "brighter days" in the future, "but only if we stick to the plan to improve economic security and opportunity for everyone," Sunak claimed.

However, discussions about inflation must not only focus on the Government and the Treasury but also consider the role of the Bank of England (BoE) in monetary policy decisions.

Situated on Threadneedle Street in the heart of the City of London, the BoE is one of Britain's most crucial policymaking institutions. Unlike the Treasury's economic policy, the BoE's decisions are not dictated by the government of the day. This has been the case since 1997 when New Labour Chancellor Gordon Brown made the central bank independent of the Government to add long-term credibility to UK monetary policy.

While the BoE's independence is intended to depoliticise monetary policy and benefit the UK's long-term economic prospects, decisions made by the Bank's Monetary Policy Committee (MPC) are still subject to criticism and controversy. One sceptic and critic of the BoE is Dr Roger Gewolb, founder of the Campaign for Fair Finance and co-founder of Dr Gewolb is a financial commentator motivated to help UK consumers burdened by debt.

Dr Gewolb has objected to the BoE MPC's decisions to raise and hold the Bank Rate at the current figure of 5.25%. In an interview earlier this year, Dr Gewolb argued that the UK economy desperately needs lower interest rates and that the rate hikes implemented by the MPC have worsened inflation and constrained the economy. According to him, even a decrease in the interest rate by a quarter of a percentage point would benefit the UK economy. However, to fully benefit, interest rate decreases should be incrementally sustained.

Following its last meeting, only two members of the BoE's MPC voted to lower interest rates to 5%. The remaining seven voted to keep the rate at 5.25%. The Bank Rate has been at 5.25% since August 2023, when the MPC voted to raise interest rates from 5% to 5.25%. This decision followed 13 previous increases, making it the 14th successive hike in the Bank Rate. The BoE claims they have raised interest rates to slow price rises and bring inflation back to the target rate of 2 per cent.

Cost-Push vs Demand-Pull Inflation

Dr Gewolb's explanation is based on an analysis of different types of inflation. According to him, the UK currently faces cost-push inflation. Cost-push inflation occurs when suppliers experience an increase in production costs, which they pass onto consumers through price increases. For example, if the cost of energy increases due to supply shocks, businesses raise prices for consumers to cover higher production costs. Additionally, if energy is consumed directly by consumers, the price will be higher.

In contrast, demand-pull inflation is caused when demand increases relative to supply, pushing up prices. For example, if there is an increase in the money supply that translates into consumer spending, aggregate demand for goods and services will increase relative to aggregate supply, creating upward pressure on prices. In other words, when the supply of goods and services cannot keep pace with increased demand, prices naturally rise.

The BoE acknowledges the reality of cost-push inflation in the UK, citing Russia's decision to invade Ukraine and its impact on gas prices, as well as the decrease in the number of people available to hire after the pandemic. If the labour supply decreases, hiring costs increase, leading businesses to raise prices to cover these costs.

However, Dr Gewolb argues that cost-push inflation always falls by itself as energy and food markets adapt and fluctuate over time. "The food cycle moves and prices fall, the energy cycle moves and prices fall," he explained. Therefore, interest rate hikes are not needed to address this kind of inflation. With time, changes in production costs resolve themselves, and inflation eases. "In 2009, we had similar cost-push inflation," Dr Gewolb noted. At that time, "the BoE left interest rates at 0.5 per cent for three years until the cost-push ran itself out."

Moreover, Dr Gewolb expressed frustration at the notion that raising interest rates addresses cost-push inflation. "They (the BoE) keep talking as if raising rates is actually combating our inflation," he explained. In his view, attributing recent falling inflation to the BoE's interest rate decisions is mistaken because Britain's cost-push inflation is not driven by consumer spending, which increases demand and creates demand-pull inflation.

Furthermore, according to Dr Gewolb, not only do interest rates not address cost-push inflation, but they also make it worse. The BoE's 14 successive interest rate rises have "prolonged, enlarged, and inflamed" inflation. He elaborated that raising interest rates in response to cost-push inflation forces businesses to increase prices further as the cost of borrowing money rises. Therefore, base rate increases simply cause more inflation, akin to "dumping oil on a raging forest fire." Additionally, they have suffocated consumers, with negative impacts felt in the mortgage, rental, and property markets, preventing young people from getting on the property ladder altogether.

The Competence Of The BoE

Dr Gewolb's criticism of the BoE extends beyond opposing the interest rate rises decided by the MPC. He expressed strong criticism of Andrew Bailey, both for his competence and that of his colleagues on the MPC. Moreover, he argued that the BoE suffers from "groupthink at its absolute worst." According to Dr Gewolb, "Bailey and his thick-skinned colleagues just won't listen to anybody."

Andrew Bailey studied History at Queens College, Cambridge. Although he later earned a PhD in economic history at Cambridge, Bailey has been criticised for his intellectual capacity to lead the BoE. Dr Gewolb referred to a conversation with Alex Brummer, City Editor at the Daily Mail and former Assistant Editor at the Guardian. Brummer stated that Bailey is "not an economist" and, given his previous record at the Financial Conduct Authority (FCA), did not have "the intellectual wherewithal to lead on this particular subject." Moreover, according to Brummer, Bailey was "slow to act" at the FCA, particularly in response to "the problem in the Woodford investment empire."

Dr Gewolb also criticised Ben Bernanke. In July last year, the BoE announced that Bernanke would head a review into the BoE's forecasting capabilities. Bernanke, former chairman of the Board of Governors of the US Federal Reserve from 2006 to 2014, was criticised by Dr Gewolb for failing to spot the 2008 financial crisis. According to Dr Gewolb, bringing in Bernanke was a mistake as he is "a man exactly like himself with a similar track record." Dr Gewolb suggested that Andy Haldane, the former BoE Chief Economist of 30 years, would have been a better choice, as Haldane also opposes the BoE's decisions to raise interest rates.

Bernanke's review, published on 12 April this year, articulated some concerning criticisms of the BoE. According to the report, "the most serious problems" pertain to "the Bank's forecasting infrastructure." The report recommended replacing or revamping COMPASS, the BoE's "baseline economic model," which has "significant shortcomings." Additionally, the report suggested updating and modernising the BoE's software, making "model maintenance and development" an ongoing priority, and revamping the forecasting framework to pay greater attention to supply-side factors such as productivity, labour supply, job-worker matching efficiency, supply-chain disruptions, and trade policy.

The Politics Of The BoE

If monetary policy is being so mismanaged, why hasn't the BoE faced more public scrutiny for its decisions and the institutional workings behind them?

According to Dr Gewolb, "Gordon Brown gave the BoE unfettered independent powers in 1997." As a result, "no one can touch them." Dr Gewolb also criticised the government for its failure to act, stating that the current Chancellor and Prime Minister are "too weak to do anything."

For example, a report published in November last year by the House of Lords Economic Affairs Committee expressed key criticisms of the BoE regarding monetary policy. Dr Gewolb agreed "with every word" of the House of Lords report, which aimed to review the framework of "operational independence" that has defined the BoE since 1997. The summary claimed that the failure of the UK economy to meet its 2% inflation target in recent years "reflects errors in the conduct of monetary policy." Dr Gewolb noted that "you would think the Chancellor of the Exchequer would take a report like that in his hands and do something."

More specifically, the House of Lords report highlighted key limitations of the BoE. Firstly, there is concern over the effect of "repeated use" of quantitative easing (QE) on the BoE's balance sheet and the operational independence of the BoE. The report explained that the use of QE is potentially not always independent of government politics, meaning the BoE is not truly independent.

Secondly, there is concern that the expansion of the BoE's remit to address issues such as climate change is "jeopardising" its ability to prioritise its primary objectives.

Thirdly, the report articulated concerns that the BoE's modelling and forecasting systems are not robust enough, echoing Bernanke's review. The report suggested that "a concerted effort" must be made to "foster a diversity of views and strengthen a culture that encourages challenge." Attention must be paid to the hiring and appointing practices of the MPC.

Fourthly, the report articulated the concern that a democratic deficit has emerged, meaning that BoE officials have not been adequately held to account as the Bank's remit has grown.

To sum up, I asked Dr Gewolb about Labour's role in all of this as the main opposition party. Dr Gewolb was no less critical of Labour than of the current Conservative government or the BoE. He expressed his view that if Labour is elected, the narrative on interest rates and inflation will not change.

Labour's Shadow Chancellor Rachel Reeves stated in her Mais Lecture that "the Bank's Monetary Policy Committee must continue to have complete independence in the pursuit of its primary objective of price stability." She also stated Labour's support for the BoE's 2% inflation target. Moreover, there appears to be nothing in Labour's agenda indicating a willingness to address any of the criticisms of the BoE made by the likes of Dr Gewolb.

In conclusion, as Britain heads to the polls, the BoE's role in shaping economic policy remains a critical issue. While the current government lauds the falling inflation as a success of its policies, critics like Dr Gewolb argue that the BoE's approach to interest rates has been misguided and detrimental. The forthcoming election will determine whether there will be any significant shift in the economic narrative or if the status quo will persist. The scrutiny of the BoE's decisions and its independence will undoubtedly continue to be a focal point of debate in the economic landscape of the UK.