a historical and legal account – Bank Underground

Michael Salib and Mesha Ghazaleh

The Bank’s monetary policy objectives are some of the most significant objectives bestowed by Parliament on any UK public authority. They are to maintain price stability and, subject to that, support the Government’s economic policy, including its objectives for growth and employment. In our paper we offer a historical and legal account of the Bank’s monetary policy objectives by looking at their origins, the parliamentary debates around their wording and their interpretation in practice. Since being introduced in 1998, our paper finds that they have proved remarkably resilient in directing the Bank’s monetary response over the past 25 years, partly due to the in-built flexibility in their wording. 

Historical resistance to statutory objectives 

For over 300 years of its existence, the Bank’s governing legislation said little about the institution’s objectives and purpose. This largely stemmed from the Bank’s unusual form of incorporation by a chartered corporation in 1694. But the obscurity of the Bank’s statutory role was long-considered an advantage. As discussed in our paper, as recently as the 1990s, Bank Governors argued that the absence of statutory objectives provided the Bank with a considerable degree of autonomy to act in the public interest which might be lost if its role was strictly prescribed in statute.

There was similar resistance from UK politicians who, despite growing international consensus on the benefits of central bank independence from the late 1980s, were wary of losing control of monetary policy by transferring responsibility to unelected technocrats. In her memoirs Margaret Thatcher recalled how she forcefully dismissed a proposal by her Chancellor Nigel Lawson to grant the Bank independence over monetary policy, with accompanying statutory objectives, noting it would be seen as ‘an abdication by the Chancellor’. 

Introduction of the monetary policy objectives

The watershed moment came with the election of the Labour government in 1997 and enactment of the Bank of England Act 1998. 

Within days of the election result, Chancellor Gordon Brown issued a seminal letter outlining a new monetary policy framework. This explained that: the Bank was to be given operational independence in the formulation of monetary policy to achieve an inflation target determined by the Government; policy decisions would be taken by majority vote by the Monetary Policy Committee, made up of both internal and external members; and there would be greater focus on the accountability and transparency of the Bank’s decision-making. The aims of the reforms were both to de-politicise, as well as de-personalise, the monetary policy decision-making process, and to ‘underline the Chancellor’s commitment to creating a low and stable rate of inflation’. 

The letter also including wording for the Bank’s monetary policy objectives for the first time, the drafting of which is largely replicated today in section 11 of the 1998 Act. 

While described as ‘a British solution to meet British needs‘, the framework was unquestionably inspired by the international experience of independent central banks across the world. Gordon Brown had originally intended the objectives to be ‘exactly the same as the Fed‘, but ultimately the wording in the 1998 Act owes more to Europe than the United States. In particular, the wording of the objectives bears a striking (and deliberate) resemblance to the objectives set for the European Central Bank (ECB) introduced by the Maastricht Treaty in 1992. The Bank’s hierarchical objectives, like the ECB’s, give clear primacy to price stability with supporting broader economic policies as a secondary objective. This is in contrast to the approach of the Federal Reserve and other ‘dual mandate’ central banks where price stability and maximising employment are put on equal footing. 

Interpreting the relationship between the objectives

Even though price stability is given clear primacy, different interpretations can legitimately be taken of the precise relationship between the primary and secondary objectives. In particular, to what extent can the Bank pursue its secondary objective to support government economic policy outside the pursuit of price stability?

A narrower interpretation is that the Bank, as it acts to maintain price stability, should have regard to government’s economic policies and should act where possible in a way which supports those policies ie the secondary objective is entirely ancillary on the primary. Our paper finds that, on balance, a broader interpretation would seem the better view ie the Bank, in conducting monetary policy, should – within important limits – consider acting to support the Government’s economic policies even in circumstances where it would have concluded that such exercise was not warranted on price stability grounds alone. In that sense, the secondary objective can be said to have independent standing or ‘a life of its own’ – albeit constrained by three key limits.

First, the support must concern matters of economic policy – as opposed to issues exclusively concerned with other areas of government policy. Second, any measures adopted by the Bank must still be said to be ‘in relation to monetary policy’ (the words that preface the objectives) and so, in practice, limited to the instruments the Bank has at its disposal to pursue monetary policy. Third, and most importantly, supporting the Government’s economic policies must not risk compromising or conflicting with the pursuit of the primary objective of price stability; and in the face of a conflict the former must give way to the latter. Given the similarity with the ECB’s objectives, it is notable that the ECB Legal Service recently considered this issue and has taken a similar view. 

Elaboration through the remit letters

The 1998 Act requires the statutory objectives to be supplemented by a ‘remit letter’, which requires the Chancellor to flesh-out the objectives – what price stability means and the Government’s economic policies – on at least an annual basis (2024 version). This has been a source of continuing democratic legitimacy and flexibility, allowing for learning and adaptation as the regime has been applied. 

These letters do not have the status of formal statutory instruments made by Ministers. The advantage of this approach is that the letters are not legalistic and are therefore more accessible in terms of public understanding. While Parliament does not formally approve the remit letters (as it might for secondary legislation), scrutiny can and does take place via Parliamentary Committees. 

When combined with the remit letter process, the statutory objectives have proved remarkably flexible and adaptable to changing circumstances: they have allowed the Bank to make trade-offs about the speed at which inflation should return to target; enabled the Bank to develop unconventional policy instruments (most notably quantitative easing); and empowered the Bank to support the Government’s economic policy which, in addition to growth and employment, now includes supporting the Government’s efforts to transition to net zero economy.

Other areas considered

Our paper also considers how the monetary policy objectives interact with other legal frameworks, in particular the prohibition of monetary financing (the financing of government deficits by central banks) and the Bank’s statutory financial stability objective (given to the Bank after the 2007–08 financial crisis). It also examines Treasury’s (never-used) ‘reserve power‘ to direct the Bank in relation to monetary policy in ‘extreme economic circumstances’; Parliament has set strict procedural safeguards on the use of this power which, if invoked, would have the dramatic effect of suspending the Bank’s monetary policy objectives. 

Conclusion

For the Bank, the monetary policy objectives were a defining moment for an institution that had long-eschewed having its mandate prescribed in law. Their success meant they served as a model for the Bank’s financial stability objective following the 2007–08 financial crisis.

While the objectives have enjoyed a sustained consensus across the political divide, they have not been without criticism. Some argue that the objectives allow for too much ambiguity in their interpretation and too much flexibility in their implementation leading to accusations of ‘mission creep’ or, conversely, that the objectives are not being pursued with the requisite vigour. Some question whether price stability should be pre-eminent or whether maximising employment should be given equal weight, resurrecting a debate from when objectives were first granted.

Against this backdrop, it is important that there is a degree of understanding of what a nation’s central bank has been mandated to achieve, not just within the political class and the central banks themselves, but also within markets and the public at large. This is truer than ever given the increasing breadth of impact of central banks on the global and national economies, as well as the wellbeing of the citizens affected by their decisions. 

As a contribution to this ongoing debate, our paper seeks to offer an in-depth historical and legal account of the Bank’s statutory monetary policy objectives, exploring the relevant statutory provisions and the debates that surrounded their drafting, as well as their application and interpretation in practice.

Michael Salib works in the Bank’s Secretary’s Department and Mesha Ghazaleh works in the Bank’s Legal Directorate, Financial Stability Division.

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