King’s faux pas made in first half of central bank tenure


On Twitter it can be hard to find someone with a good word to say about Sir Mervyn King, the recently retired governor of the Bank of England. He has stolen from savers to prop up the spendthrift, they claim. He wrecked retirements by manipulating gilt yields, played fast and loose with the pound, allowed banks to run amok and he has given up on inflation.

Sir Mervyn mounted a valedictory defence of his tenure before the treasury select committee in the week before his departure. Perhaps, in his recent appearance on BBC’s Desert Island Discs, he might have stuck with Edith Piaf’s Je ne Regrette rien, which was on a 2004 list of his favourite tracks, but strangely missing nine years later.

My take on his 10 years in the top job is that while he perhaps should have some regrets, it is unlikely that we’d have been better off with someone else in charge.

The King era fell into two distinct halves, and it’s the period since the banking crisis – 2007 onwards – that has been the most controversial. In March 2009, the Bank of England cut its base rate to 0.5 per cent, the lowest rate in its 300-year history and still the prevailing rate today.

It also announced a plan to create £200 billion of new money to buy gilts, with the intention of holding down long-term borrowing rates and encouraging economic activity.

Quantitative easing
Two further extensions to this quantitative easing (QE) programme came after, starting in October 2011 and July 2012, taking the total to £375 billion.

Inflation dipped in 2009 but was above 3 per cent for the whole of 2010 and above 4 per cent in 2011.

Sir Mervyn’s critics contend that this rise in prices at a time of low interest rates and restrained wage increases squeezed real incomes, especially of those in retirement.

Many also believe that QE had only limited benefit on the real economy, since much of the newly minted money was retained within the financial system to shore up balance sheets.

The treasury select committee is in the process of compiling a report on the effectiveness of QE.

I suspect it will conclude that the first instalment was effective in unfreezing the financial system but subsequent injections achieved rather less. That was certainly the tone of much of the evidence submitted to the committee earlier this year.

QE certainly lowered gilt yields; the Bank of England’s own study of its distributional impact estimated that the first £200 billion of gilt purchases lowered average yields by 100 basis points. That has been painful for those looking to buy an annuity or go into drawdown.

But QE was only one factor – there was also a global stampede for “haven” assets such as gilts. Yields on German, Scandinavian and Swiss government bonds fell sharply too, even though there was no QE in those countries. And if the Bank of England had not bought all those gilts, someone else would have done so.

Did QE stoke inflation and thus exacerbate the squeeze on real incomes? Yes, directly and indirectly. Ultra-loose monetary policy has weakened sterling; over the past five years, it’s down 32 per cent against the dollar and 11 per cent against the euro.

This has made imports more expensive. But again, other factors were at work too – VAT rose, and commodity prices remained high. If QE stoked inflation, then surely there would be an inflation problem in the US and China, where the authorities have also pumped huge amounts of money into the economies? There is not much evidence of this.

The first half of the King era was far less controversial by comparison. But I would argue that if there were big policy mistakes, they were made here. During the go-go years, the Bank of England made very little effort to prick the absurd bubble in UK house prices or the boom in reckless bank lending that drove it.

True, the Bank of England did not formally regulate banks – that responsibility passed to the Financial Services Authority in 1997. But it did have a mandate to maintain financial stability that it could have used more effectively.

Instead, it preferred to target consumer price inflation. There is barely a central bank in the world whose mandate extends to controlling asset price inflation or bursting bubbles.

Greenspan’s wisdom
Whether they should was a question posed by Alan Greenspan, then chairman of the Federal Reserve, in a now famous 1996 speech: “How do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions?”

His answer was that we don’t – and the Bank of England seems to have agreed, leaving markets to look after themselves.

Lately, Sir Mervyn has been more forthright, criticising the “Help to Buy” scheme and castigating banks for public lobbying.

His successor, who has arguably presided over a substantial real estate bubble in his native Canada, would do well to adopt Sir Mervyn’s new-found scepticism. – (Copyright The Financial Times Limited 2013)

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