When Louise Haigh – then a lowly backbencher – wrote a policy prospectus for the leftwing Renewal journal back in May, it contained a little-noticed nugget: a rethink of the Bank of England’s mandate.
Haigh, who quit as transport secretary in 2024 after it emerged she had been convicted of fraud over a missing work phone, is back in frontline politics as a linchpin of Andy Burnham’s operation. Economists are now asking whether the Bank, and the mandate it gets from the chancellor to solely target stable prices, will be in the new administration’s sights.
Haigh wrote at the time: “As we approach the 30th anniversary of Gordon Brown giving the Bank operational independence to set interest rates, the time is right to re-examine the mandate and see whether better coordination and a greater focus on economic growth should also be included.”
Brown’s surprise decision to make the Bank independent – announced in the early days of Tony Blair’s first term in 1997 – formed part of his efforts to bolster Labour’s economic credibility.
The Bank’s monetary policy committee (MPC), made up of five senior Bank figures and four external members, sets interest rates to achieve “price stability” – defined as an inflation target set by the chancellor – these days this is 2%.
This “remit” is reaffirmed each year in a letter from the chancellor to the Bank’s governor, currently Andrew Bailey.
It already includes an acceptance of the fact that sometimes inflation must be allowed to miss the target, when choking it off with rapid rate rises could cause “undesirable volatility in output”.
Bailey used this argument himself last month, when explaining why the MPC had not yet raised borrowing costs in the face of the Middle East war, which has driven up energy prices. But some experts still fret about the risks that rates are set too high, jeopardising growth by driving up the cost of borrowing for consumers and businesses.
Economists call the impact of events like Donald Trump’s war on Iran, where inflation goes up because of a shortage – in this case of oil and gas – rather than a surge in demand, “supply-side shocks”. This challenge of dealing with these shocks has become an increasingly pressing one in recent years, as the UK economy has been hit by Covid, Russia’s invasion of Ukraine and now the Iran conflict.
With extreme weather events becoming more common due to the climate emergency, food price shocks are also expected to become more prevalent.
The independent MPC member Swati Dhingra argued in a recent speech that leaving the Bank alone to fight these inflation shocks meant higher rates – which not only slows the economy, but raises the cost of borrowing to fund the massive investment needed to shift the economy to net zero emissions.
Against this backdrop, a growing number of experts have been arguing that monetary policy – interest rates, in other words – cannot be the only line of defence against inflation.
As Theo Harris of the left-leaning New Economics Foundation thinktank put it: “The framework as it stands, in this new era of frequent shocks, is creating a doom loop of economic self-harm.
“Supply-side shocks lead the Bank to raise rates – or keep them high – which throws people into unemployment and strangles investment across the economy, making us less resilient to the next shock coming round the corner.”
Solutions laid out by economists include better coordination of monetary and fiscal policy. A recent Fabian Society paper called for a new Treasury-Bank coordinating committee, to discuss the trade-offs.
One of its authors, Jo Michell, the professor of economics at the University of the West of England, said: “The lines are blurred and I think we all really need to grow up and accept that. We’ve got to think of an institutional framework which is viable, isn’t too much of a big jump, doesn’t unsettle the markets – but does allow some form of coordination: some kind of discussion about how these things interact.”
Indeed, the strict division of labour – with the Bank handling inflation and the chancellor sticking to tax-and-spend – which many economists always argued was an artificial one, has begun to break down.
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Rachel Reeves’s budget last year included a package of measures explicitly aimed at bringing down inflation, to allow the Bank to cut rates (a hope dashed by the war).
Burnham confirmed in his leadership speech on Friday that he intended to take action to cut the cost of essentials. Working more closely with the Bank could be part of that picture.
Another longstanding suggestion is to give the Bank a “dual mandate” that includes growth as well as inflation – akin to the US Federal Reserve’s duty to weigh the impact of its decisions against unemployment.
A more radical proposal, from climate economists at the London School of Economics Grantham Institute, is to allow for what they call “adaptive inflation targeting”, where the MPC would be temporarily allowed to aim at a higher inflation rate during climate-related shocks.
Perhaps the scheme most likely to be embraced by Team Burnham, however, may be to urge – or instruct – the Bank to re-examine its approach to quantitative tightening (QT): the gradual sale of the £875bn of bonds it accumulated during the emergency policy of quantitative easing, from the global financial crisis onwards.
Critics, who range from leftwing economists to Reform’s Richard Tice, argue that QT costs the Treasury twice over: first, the government indemnifies the Bank against the losses it makes on selling these bonds, adding £6bn to the budget deficit in the current fiscal year, according to the Office for Budget Responsibility. Second, it arguably drives up the cost of borrowing, by increasing the volume of bonds being sold into the UK market.
Bailey has defended the Bank’s approach, but it contrasts with that of other central banks including the Fed and the European Central Bank. The MPC is next due to reconsider the programme in the autumn; a new chancellor could intervene.
Burnham and his neighbour at No 11 – tipped to be the current home secretary, Shabana Mahmood, – would no doubt be cautious about compromising Bank independence, seen as a positive legacy of the New Labour years, or rattling financial markets.
But taking a fresh look at the Bank’s role would send a strong signal that where economic policy is concerned, a Burnham government is prepared to do things differently.
