State of dependence
George Osborne is exerting his influence on the Bank of England. Britain’s Chancellor of the Exchequer has decided that the central bank’s new Financial Policy Committee must support government policy. That raises questions about the FPC’s ability to bust financial bubbles. But it won’t change the committee’s current dilemma: how to combat excessive risk-aversion.
Before the crisis, the British central bank obsessed about controlling inflation, while bank supervisors worried about individual lenders. Neither was able – nor willing – to tackle the huge credit bubble that eventually caused a severe recession. In response, the authorities created the FPC to take charge of “macro-prudential” policy.
Right now, financial bubbles are hardly the leading threat in the UK’s financial sector. Banks and the economy are suffering from excess caution, not exuberance. Regulators are unsure what to do. As Donald Kohn, the former Federal Reserve governor who sits on the FPC has pointed out; it’s easier to take the punch bowl away from a party that is getting out of hand than to spike the punch to get the party going. The tension is clear in the almost contradictory stance of the FPC towards bank capital and liquidity buffers. It has both urged banks to rebuild them and suggested they could be run down to counter economic weakness.
Enter the UK government. Osborne announced last week that the FPC would be given a secondary objective of supporting government policy. That has set alarm bells ringing: could the FPC act to rein in a future housing bubble if, say, the government had an explicit policy of promoting home ownership?
These fears may be overblown: the Monetary Policy Committee, which sets interest rates, is already required to support government policies, provided they do not conflict with the goal of maintaining stable prices. And Osborne is right that policies which maintained financial stability but choked off economic growth would be perverse.
However, the debate over state influence misses the FPC’s more immediate problem, its shortage of effective tools for addressing the current slump. That is a problem that no amount of ministerial meddling will solve.