The three independent reviews of the Bank of England’s performance before and during the financial crisis must have been sobering for the court, its governing body. In polite but pointed language the reviews, published on November 2, confirmed that the BoE was ill prepared to recognise or deal with the crisis in its early days. The BoE’s forecasting was also found to be subject to groupthink. The reviews provided many detailed recommendations but also made it clear that a full-scale cultural change is needed to address the root causes of the problems. This will be a high priority for the next governor.
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It will not be easy. From the four years I spent on the Monetary Policy Committee and the subsequent four years on the court, these criticisms ring true. The hierarchy was strong and self-perpetuating. Junior staff rarely spoke up in meetings where senior people were present. When, as an MPC member, I asked for a detailed briefing on a research note prepared by a bright young economist, their boss always came along and did most of the talking. There were few women in middle management, let alone at the top.
The central bank’s culture will not be changed by the imminent addition of a chief operating officer to its top-heavy hierarchy. There needs to be a flatter structure and a replacement of long-serving middle and senior managers with new people from outside the bank. This will be difficult in such a sheltered and self-financing public sector organisation. It will take time and may get stalled unless the court supports the new governor and keeps up the pressure.
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In addition to implementing the reviews’ technical recommendations, there are three looming issues that the new governor will need to address: the exit strategy from quantitative easing, fixing the forecasting model and avoiding conflict among the departments.
Deciding and implementing an exit strategy for QE will be the most important challenge for the MPC over the next year or two. The US Federal Reserve faces a similar problem. “Nobody – in fact, no central bank anywhere on the planet – has the experience of successfully navigating a return home from the place in which we now find ourselves,” says Richard Fisher, president of the Federal Reserve Bank of Dallas. With interest rates near zero and huge holdings of government debt on central bank balance sheets, it will be a long road back to functioning financial markets and positive real interest rates.
The first, seemingly small, decision about the exit strategy for QE will arise in March next year when the initial tranche of gilts bought during QE1 begins to mature. Only £7.7bn of redemptions are due in 2013, but the MPC’s decision on whether to reinvest the proceeds will be an important signal to the market.
The second looming issue is how to fix the bank’s forecasting model to improve its performance and give better guidance to the MPC and the markets. The review by David Stockton found that the MPC’s forecasts have been worse recently than before the crisis and marginally worse than those of outside forecasters. The bank’s model has little financial market detail, yet credit constraints and household deleveraging are major factors affecting Britain’s recovery. And now that QE has become the dominant policy instrument, a model that lacks detailed financial channels to analyse how QE actually works is a major problem.
The next governor must find a way to avoid policy conflict among the MPC, the Financial Policy Committee and the micro-prudential functions of the Prudential Regulation Authority which will supervise individual banks. Having them all report up through the BoE’s hierarchy to a single person is no guarantee of policy coherence. Having different outside members on the MPC and FPC puts additional onus on the bank governor and his deputies to ensure that everyone has the same access to information and analysis. This too will require a culture change in an organisation whose tradition is for secrecy rather than openness and where outsiders can be kept in check through a strategy of divide and conquer.
The BoE has a proud tradition, but its reputation has suffered from the crisis and its ways of working constrain its effectiveness. The new governor and court face a formidable task. At this critical time, the sooner they begin the better.
The writer is a former member of the court of directors of the Bank of England and of the Monetary Policy Committee