Inside the Bank of England

Memoirs of Christopher Dow, Chief Economist 1973-84

C. Dow, G. Hacche

• Publisher: Palgrave Macmillan
• Year: 2012
• ISBN:
  9781137032317
• Topic: Economics
• Subtopic: Macroeconomics
• Index: Economics

A personal memoir from Christopher Dow, an influential British economist and a key player in the banking establishments of the post-war era. Contains insights and revelations into the issues and protagonists shaping British economic policy in the late 20th Century.

1

The Crisis Year 1976: Events to the Autumn, with a Brief Retrospect Back to 1973

I am starting these memoirs on holiday in France, in August 1976. During the last four or five months I have felt I ought to make a record of events, of what it felt like and why people acted as they did; but have not found time to do so. If I do not start now then impressions will be lost.

Events in several months this year may prove to have unusual interest and importance, of a sort not expected, nor according to the textbooks. Pressure on sterling involves pressure on the government. Left-wing governments are particularly likely to be faced with this; and events this year illustrate how these pressures can impinge and how a government is brought to change its policies. In this process, the Central Bank is bound to be involved; and the tensions of this year bring out important questions concerning the relation of the Bank of England to the government. A record of this sort should seek to be impersonal, yet much of its interest derives from the motivation of the people involved.

Since I am writing up, from this vantage point in time, the events of several distinct phases, I shall in this instalment follow not a strict chronological sequence, but one more structured. To my mind 1976 has been different from earlier years, and much less agreeable; and I need to start by saying something of the preceding three years.

My first three years at the Bank

I joined the Bank in February 1973; Gordon Richardson became Governor in July of that year. All my other senior colleagues had been at the Bank a long while: Jasper Hollom, the Deputy Governor, and John Page, the Chief Cashier, all their working lives; and John Fforde, domestic finance Director, and Kit McMahon, Director of external finance, while relative newcomers on this time scale, had both been at the Bank for a number of years. It is said in the Bank that no Governor can succeed in changing things against the opposition of his senior staff, and particularly that of the Chief Cashier; and many stories are told to this effect. I think the fact that both the Governor and I were new gave us fellow feeling.

I was surprised at the absence of economic expertise which I found in the Bank. I do not wish to go far into this question here, hence cannot be fair; suffice to say, I felt early on the need for new blood and a new structure for the economic services of the Bank (which has taken me years and is still to complete). The Governor, looking at the Bank as a whole, felt a more general insufficiency of ability, and strongly supported my own leanings. He came to the Bank having rebuilt Schroders on the basis of talent carefully recruited; he once said, if there was one thing he could contribute to the Bank (implying, I think, that he felt inexperienced in economic policy), it was choosing people.

The role of economists in the Bank of England has, I think, still to be resolved – probably because, 30 years after the Bank of England Act, it has still to be resolved what sort of central bank the Bank will be. Not only by geography but also, in many subtle and personal ways, in spirit, the Bank has remained part of the City. It is fair to say that the City’s business activities are very different from governmental operations; it has opinions on public policy but not, in fact, special expertise on it. On large matters of this sort, and perhaps on smaller matters also, the City feels rather than thinks; and its instincts are highly conservative. The Bank is thus on one of the frontiers between Reason and Emotion – the right-hand one, for there is also a frontier on the left. For its relations with the government, it matters a great deal which side of the frontier the Bank is on, as also for the Bank’s economists. On one side lies congenial territory, in which they can contribute happily; on the other, hostile land, in which they can fight only rearguard actions.

The two aspects of economic policy on which the Bank has direct responsibility are monetary policy and exchange rate policy. The first creates a concern with the manner of financing the public sector deficit, and, by an extension which I would say is less legitimate, the size of the deficit to be financed. The second involves an interest in the manner of financing the balance of payments and the size of the deficit or surplus. There were problems in these areas, and in fact very large deficits, both domestic and external.

For various reasons most such problems appeared manageable if uncomfortable till this year. Perhaps that was because both the exchange rate and the rate of domestic monetary expansion continued to be roughly what appeared to Bank and Treasury appropriate, without there being need to pull hard on the levers. Perhaps it was because the main points of anxiety lay elsewhere: the price and even availability of oil; the miners’ strike at the end of 1973 and the three-day week; the elections of 1974 and the precariousness of the new Labour Government’s hold on power; the galloping course of inflation and what this seemed to involve for relations between the government and the unions. Or perhaps the reason was that it requires a full-blown exchange crisis to bring tensions to a head, or (what may be as critical a factor) to give the Bank much pull over policy.

The philosophy of monetary policy in the middle of 1973 was still that set out in the Bank’s 1971 Consultation Document, ‘Competition and Credit Control’. Under it, credit ceilings had been abolished; the banks were supposed to compete; and the volume of money was to be limited by interest rates. Along with this had gone a rapid and unexpected increase in the volume of money, a trend still in full vigour in 1973, and (so some words of his successor made me think) a great shame and mortification to Leslie O’Brien in his last months as Governor. I always understood that the policy had owed much to the ideas of Charles Goodhart; and had been stoutly fought for by John Fforde. Their defence of the subsequent results was partly that the increases in interest rates needed to make the policy work – I do not know how strongly they had been advocated – were constantly refused by the government; and indeed it is true that the Heath Government (or rather Mr Heath himself, for under his administration the Chancellor referred every decision to him), was very nervous of any rise, because of its effect on house purchasers. It was also argued in defence of the policy that the apparent monetary expansion was in large part due to ‘re-intermediation’: the re-routing of flows of funds so that they became deposits with and loans by the banks, instead of following other channels as previously (though must not such a re-routing almost always happen when the rate of monetary expansion changes much?). These are difficult questions to argue conclusively; but it seems to me that the simple view had at least as much truth in it as the sophisticated defence against it. For it is also true that a large monetary expansion can have an important effect on asset values and property prices, both of which of course rose spectacularly at this time. To say how far this was due to the inadequately controlled activities of the banks, and how far to those of the so-called ‘fringe banks’, which then were not subject to any great degree of official control at all, would require further investigation. However this may be, the continuing rapid expansion of the money stock certainly appeared inappropriate to many commentators; and by the autumn of 1973 had become an increasing political embarrassment, which Gordon Richardson, as newly appointed Governor, felt uncomfortable to countenance for long.

The result was the imposition of a new form of monetary control, applied not on the assets side but to the liabilities side of banks’ balance sheets, and then only on interest-bearing deposits; hence soon known as ‘IBELs control’ (IBELs meaning interest-bearing eligible liabilities).¹ A given rate of increase for such deposits was laid down, and rates of increase above this rate were subject to heavy and progressive penalization (in the form of deposits with the Bank without interest). Thus the scheme (which owed much to French example) had a certain elegance, in that infringement was penalized rather than flatly prohibited, and thus perhaps preserving still a possibility of competition between the banks, a cause to which the Bank remained attached.

Though the IBELs scheme was devised in the Bank, its adoption was forced by events and by higher authority, on a reluctant Bank establishment. Action was somewhat slow in coming; I remember Ken Berrill – always quicker to appreciate the political necessities than points of possible theoretical doubt – saying, with his usual frank brutality, ‘if the Bank does not propose a line, it will be bloody well told what to do, and serve it right’. But this was not a true case of Treasury/Bank conflict; nor did this first period of IBEL control last long enough ever to have a chance of becoming one. The demand for bank credit slowed down of its own accord, no doubt because of the gathering recession; and the control was removed within 15 months or so of its inception. From its authors’ point of view, the scheme had always been open to the purist objection that it made things look different without changing anything important; i.e., that it could achieve monetary restraint merely by disintermediation. I am not sure of this myself. The same can be said in degree of all monetary restraint; and anyhow availability effects count for something. But this objection has remained alive as a counter-argument to any later thoughts of reviving IBELs control; and to it has been added another, namely that such control is bound to discourage private access to bank credit, to the advantage of public borrowing. Strangely enough, this argument has only subsequently become important and has only done so by reason of the emergence with altogether new force of various strands of opinion hostile to public borrowing and public expenditure – an evolution well worth remark and analysis.

I do not remember much critical comment on public spending under the Heath administration. I often, however, heard it said – particularly by the economic advisers in various government departments who ought to have been in a position to know – that the disintegration of central control over spending really started then, notably as a result of panic measures to increase public spending resorted to in the recession of 1971 – a panic which over-rode the usual restraints. Equally important must have been the major acceleration of inflation in 1973 and 1974, which made it very difficult to discern what part of excess expenditure was real, and what merely reflected higher prices – what was inevitable or justifiable, and what was to be fought. The acceleration of inflation can also be laid at the door of Mr Heath. Relatively rarely can there have been a miscalculation so massive and harmful as the cost of living indexation in ‘Stage III’ of his incomes policy – a promise which was expected to cost nothing, but which in fact must have added 10–15 per cent to the price level by the middle of 1974. This episode is indeed as striking an example of the ease with which the price level may be forced upward as the purely political wage settlement in France that followed (and was the price paid to bring to a close) the ‘Events’ of 1968. Surely monetarists should recognize the power of incomes policy to do harm, even if they deny its power to do good; and if so, why should one not believe that trade unions will also take advantage of the economic system’s easy acceptance of an upward jump in the price level?

There were no doubt other reasons for the failure to control public spending. The control of spending, as a result of the routines initiated some years earlier by the Plowden report, tended to become a gentlemanly exercise in foresight in the medium term: the sergeant major’s bark was muted. (I think, perhaps unfairly, that this reflected the personality of that nice, intelligent, gentle man, Douglas Henley, who was the second secretary of the Treasury in charge of public expenditure until succeeded by Leo Pliatsky – certainly a man with more bark.) Also, of course, the political pressures to increase spending are even greater under a Socialist than a Conservative government. Criticism of public spending is also more likely to come from Conservatives than the other side – and to be less restrained when a Labour, not a Conservative, government is in power. Failure, anyhow, there was.

The swell of opinion against public spending subsequently got entwined with a parallel virulence against public borrowing. But at the beginning it seemed to me (in 1974) that this latter line of argument was an academic matter almost entirely. Both strands were, I think, of great importance.

In the orthodox Keynesian tradition the government’s financial stance ought to aim to counteract the excess or deficiency of demand produced by the private sector. The size of the public deficit (and of public borrowing) emerges as a by-product of the pursuit of that aim; it is thus not an objective of policy in itself. The whole of post-war policy has been based on this principle of functional public finance.

The view which, for a time, emerged in Cambridge in the early 1970s does not in principle challenge this view but in practice goes around it. Perhaps the kernel of the ‘New Cambridge’ doctrine was the following sequence of propositions: that the private sector of the economy always generates the same excess of saving over investment (or alternatively that this excess varies regularly with the economic cycle); hence that the surplus or deficit of the public sector is in some sense the mirror image of the third component of the economy, namely the balance of payments on current account; that to correct any balance of payments imbalance, the public sector deficit or surplus must therefore be adjusted; and finally – since fine-tuning is too difficult, that the surplus or deficit of the public accounts should always be held to what is in some sense its ‘normal value’.

Economists, like theologians, are trained to detect misstatements and, equally important, misleading half-statements of the truth; but they are very far from infallible. The practical conclusion of New Cambridge is to reverse Keynesian orthodoxy. It emerged, I suppose, from the conjunction of three heads put together in Cambridge; those of Nicky Kaldor, Wynne Godley and Robert Neild, of whom I would suppose that the two first were predominant. If I and others like me are right, they are exceptionally wrong-headed.

How can such intelligent, indeed brilliant, men be brought to think like this?

If one pushes rational distrust of reason too far it becomes irrationalism. Wynne – once the government’s chief forecaster – now denies the possibility of forecasting, and consequently, the kind of policy that tries to keep the economy on keel by reacting to forecasts. If you do not act empirically, you have to act on some Rule, or rule of thumb; and, in practice, these always seem to be arbitrary. The result is to open the way to irrationalism – in this case the irrationalism of the Right (‘We always thought deficit finance too clever by half’). This seems to me like slipping from the statement that all men are sinful in the sight of God, to the statement that they are worthless.

There is another strand in both Nicky’s and Wynne’s thinking: that foreign trade is not greatly sensitive to price changes, so that the correction of the present external deficit will require import controls – for which there has long been pressure from Wedgwood Benn and the Tribunites. New Cambridge can thus also be said to have gone along with the irrationalism of the Left: to be fair this should also be mentioned!

Though he looks detached and unworldly, Wynne in his way has a liking for publicity, and various characteristics that ensure that he gets it. He always feels he is right, and right in a good cause: this makes him simple, persuasive and with the ring of conviction in what he says or writes. He quite likes, too, to be shocking or controversial. When he had attacked Treasury control of spending (in 1975), his phrases were not designed to be most acceptable to his former colleagues. Nor were they: he probably never thought how much they were resented. Wynne has continued to propagate his views. Kaldor was incorporated into the Treasury from 1974, and could argue only inside – as he did, indefatigably, and, so I have always been told, to the great disruption of public business. There is a story told of Nicky just after the war, that when he called on Pigou in his base in the Lake District at tea-time, without knowing as he did it, or realizing afterwards, he ate Pigou’s week’s butter ration. He is like that; never seeing any damage he does, and with the kindest feelings to everyone.

Mr Heath (who had appointed Gordon Richardson as Governor in the middle of 1973) got defeated in February 1974, having fought and lost an election on the issue of whether or not the miners should get a wage increase that exceeded the government’s norm. I do not remember to have seen a good analysis of this affair. When such an event occurs, and brings something new so quickly, one has no time or interest for the status quo ante. Heath was pushed from behind by the Conservative right wing; they were no supporters of incomes policy, but I suppose felt it intolerable to knuckle under to trade unions – ‘let us see who is master’. There was evident hesitation, which lasted a week or more. This cannot have helped. There was already a strong defeatist belief that the miners could not be defeated. It was believed at the time, though erroneously, that output was being seriously disrupted;² and industrialists must have become progressively less keen to see confrontation through. Heath turned aside from the path towards a compromise offered by the TUC (Trades Union Congress). They offered to treat the miners’ award as an exception, not to be followed by others. It is true that this self-denial might well, afterwards, have been widely flouted; but, at the time, refusal to compromise looked obstinate. So, out of a great mixture of wrongheadedness and rightness, Heath lost.

Hence Harold Wilson again became Prime Minister; and, six weeks before budget time, Denis Healey Chancellor of the Exchequer. Shortly before this, Douglas Allen had taken William Armstrong’s place as head of the Civil Service; and Douglas Wass, relatively young, became Permanent Secretary of the Treasury, overstepping Derek Mitchell, and perhaps some other claimants. It must have been shortly after the election that Lord Rothschild retired as head of the Cabinet Office ‘Think Tank’, the Central Policy Review Staff (CPRS). Kenneth Berrill had become Economic Adviser the previous year – an appointment which was criticized, though I thought it a good one.³ Partly because he did not relish working with Denis Healey – who had a rough way, they all say, with his civil servants – Ken Berrill took Rothschild’s place when it was offered him. Wass then brought back Bryan Hopkin, whom he had always admired, although two years before Bryan had been allowed to leave the Treasury early and take up a professorship at Cardiff. At the time of his reinstatement he was approaching the normal Civil Service retiring age of 60. Wass, though himself a mathematician, had been Kaldor’s pupil at Cambridge and had continued to keep in contact with him, as had the new Chancellor. So Kaldor too was brought back: Healey seemed to love a plenitude of advisers; Douglas Wass liked open argument; and Bryan Hopkin was too decent to object to an arrangement bound to be awkward and troublesome, especially to him.

It seems to me that the new Treasury team must have started work on the March 1974 Budget – which had of course to be prepared in a great hurry – already convinced that the borrowing requirement mattered. The main meas...

Table of contents

• Cover
• Title
• Copyright
• Contents
• Figures and Table
• Foreword
• Editors’ Introduction
• 1 The Crisis Year 1976: Events to the Autumn, With a Brief Retrospect Back to 1973
• 2 Autumn 1976 to Summer 1977
• 3 Autumn 1977 to Summer 1978
• 4 Autumn 1978 to Summer 1979
• 5 Autumn 1979 to Summer 1980
• 6 Autumn 1980 to Summer 1981
• 7 Autumn 1981 to Summer 1982
• 8 Autumn 1982 to Summer 1983
• 9 Conclusion: Summer 1984
• Notes
• Notes on Names
• Calendar of Main Developments
• Index