There are six Central Banks that make a real difference to the world, the Federal Reserve of the United States, the European Central Bank, the Bank of China, the Bank of Japan, the Bank of England and the Russian Central Bank. Two of these are federal banks with statutory independence, the Federal Reserve and the European Central Bank; two are wholly answerable to their Governments, the Banks of China and Russia; two are an intermediate position, with a measure of independence but a degree of influence from their local governments.
The Northern Rock (LON: NRK) panic has raised the question of the relationship between the Bank of England and the British Government, and all the other banks are interested in the outcome, since any change in the British relationship could have an influence on their own. In theory, the relationship of the Bank of England to the British Government is determined by two reforms, each introduced by a Labour Government.
The 1945 election was won by the Labour Party, then led by Clement Attlee, the Prime Minister whose Government created the Welfare State and nationalised the “commanding heights” of the British economy. In their election manifesto, the Labour Party promised to nationalise the Bank of England. The Bank had been founded as a private bank, with private shareholders, in 1694, and had remained private for the following 250 years. The Labour Party blamed the Bank of England for deflationary policies in the 1920s and 1930s, which they believed had aggravated the slump and the high unemployment of the inter-war period. The Bank Nationalisation Act gave the Government total power over the Bank of England. One could regard the British 1946 Act as the logical opposite to the founding European agreement, which created the European Central Bank on a basis of total independence.
The second reform was also introduced by a Labour Government immediately after a landslide victory. In 1997, half a century after their great victory in 1945, Labour was returned to power with another overwhelming majority. Tony Blair was the Prime Minister, but economic and financial policy was in the hands of Gordon Brown, who did not become Prime Minister until 2007. The Gordon Brown reform partly reversed the 1946 Act. The Brown Reform did increase the independence of the Bank of England by giving the Bank independence to set Bank interest rates, though real interest rates in the interbank market are not tied to this Bank rate. At the same time, the Bank ceased to be the regulator of the banking system. That responsibility was transferred to the Financial Services Authority.
A further change of definition was made in the Bank’s role as recently as last year, though it did not attract a great deal of attention at the time. The previous formulation was that the Bank was “responsible for the overall stability of the financial system as a whole”. This must have been considered as too broad a remit. The new formulation is that the Bank “contributes to the maintenance of the stability of the financial system as a whole.” This obviously puts the main responsibility on the Government as a whole, and particularly on the Prime Minster and Chancellor of the Exchequer.
In all six countries, it is very important to show who takes the final decision particularly in a financial panic. It may, of course, be a disadvantage to a government to be the taker of the final decision, since that means that the buck stops with the person who takes the decision. In Russia, I am sure it is President Putin, in China, it is the leaders of the Communist Party, in Britain it is the Prime Minister, in the United states it is the Chairman of the Fed, in Japan it is the Government, in the Eurozone it is the Board of the European Central Bank. These are not all the formal positions, but I think they represent current practice. Yet no-one seems very satisfied with the present distribution of powers. And there are changes ahead – in several countries, including Britain.
for the Daily Reckoning Australia