hould be prepared for changes at the Bank of England when the new governor, Canadian Mark Carney, takes over in the middle of next year. George Osborne has chosen to go outside the UK economic policy establishment in his choice of a successor to Sir Mervyn King. And that suggests that he is looking for a fresh perspective on the critical issues facing the Bank of England over the next five years.
There will be three big challenges in the new governor’s in-tray. The first is how to chart an exit from the monetary policies put in place to fight the financial crisis – extremely low interest rates and large injections of quantitative easing. These policies have had the benefit of stabilising the economy and supporting a return to growth. But they have had a number of unfortunate side-effects.
Inflation has run persistently above the government’s 2 per cent target – averaging about 3.5 per cent over the past five years. Returns to savers have been undermined by a prolonged period of very low interest rates. And the Bank of England has accumulated a substantial holding of the national debt – around a third of the total.
It is unlikely that we will build a sustainable recovery on the basis of these extreme policy settings. So the new governor needs to plan an exit strategy to a more normal world in which inflation is under control, interest rates offer a better return to savers and the Bank’s holdings of government bonds are returned to the private sector.
The second challenge facing the new governor is in reorganising the Bank of England to manage its greatly increased range of responsibilities. When I joined the Monetary Policy Committee (MPC) in 2006, the main responsibility of the Bank was monetary policy – keeping the economy on a steady course with stable prices. And it had the benefit of operating in the benign economic environment that prevailed before the financial crisis.
The Bank of England which Mark Carney will inherit will be operating in a more uncertain and volatile world. And it will have not one, but three very big and challenging responsibilities: monetary policy; financial stability; and financial regulation – all of which contain difficult problems for the Bank to grapple with. Dealing with these problems will require not only the skills of a capable governor, but also a strong team of deputy governors and supporting senior managers.
In my view, this means that the Bank’s deputy governors will need to take on more responsibility in their particular areas. And the new governor will therefore need to adopt a more supervisory role in the running of the Bank, delegating more to his deputies and supporting management team. Carney may not agree with this model and may have other ideas. But whatever he decides, he will need to put in place a management structure which reflects its expanded range of roles and responsibilities.
Third, the new governor faces the challenge of rebuilding confidence among the general public in the financial system, which has clearly been dented by the experience of the financial crisis. In doing this, regulatory changes – including the “ring-fencing” of investment banking activities – will be important. But that won’t be enough. The new governor must also work closely with banks and other institutions to ensure that big financial risks are better identified and managed. It was a failure to do that which contributed greatly to the banking problems we experienced from 2007 – and the financial crisis which then followed.
In meeting these challenges, Carney will hopefully have one great advantage. As someone who is already an experienced international central banker, he will bring a wealth of international experience to his new role. In the highly-globalised economy we now inhabit, that will be crucially important.
As a member of the MPC during the financial crisis and in its aftermath, I felt that the international influences on our economy – such as changes in energy and commodity prices, changes in the value of the pound, and the growing importance of the Asia-Pacific region to the world economy – were not always properly recognised within the Bank of England. Carney’s appointment may help to bring an international perspective that addresses this issue. I wish him well in his new appointment.
Andrew Sentance is senior economic adviser at PwC and a former member of the Bank of England’s MPC.