| Forrest Capie, Cambridge University Press, 2010, 890
pages, £95 |
| The period which Forrest Capie’s new history of the
Bank of England describes, from the 1950s to 1979, the first year of the
Thatcher administration, was a turbulent one. It began in the long
aftermath of the Second World War and the associated overhang of
government debt, and was marked by the return of current account
convertibility, the Radcliffe Report, the devaluation of sterling, the
breakdown of the international monetary system, the end of credit
controls, a banking crisis, rampant and uncontrolled inflation, two
unsettling encounters with the IMF, and a seemingly endless sequence of
sterling crises, among other things. |
| Professor Capie has produced a coherent and
comprehensible account of what happened. The book is easy to read and,
even for someone who was (like me) slightly involved in some of the
events described, contains interesting new information. This new history
will be an essential source of information on British monetary history. |
| During the 1950s, when the narrative begins, the
annual rate of inflation averaged 4.3% and never exceeded 9.2%. In the
1970s, when the narrative ends, it averaged 12.6% and reached 24.2% in
1975. These facts pose an obvious question about the performance of the
Bank of England. Was it really as bad as the bald numbers suggest?
Professor Capie’s answer is, essentially, yes it was, though he
expresses it in the nicest possible way: “In a paraphrase of the Book of
Common Prayer: the Old Lady left undone those things she ought to have
done and did those things she ought not to have done.” |
| There can be no dispute that inflation was a major
and destructive economic problem, particularly in the 1970s, that it was
worse in the UK than in most other countries, and that the monetary
authorities failed to deal with it. Anyone wishing to defend the Bank of
England against Professor Capie’s charge would have to assert that the
Bank did the best it could, but was unable to prevail. |
| There are some grounds for such a defence. The Bank
of England was in no sense independent or autonomous in those days. It
was only in 1976 that the Treasury macroeconomic model finally
acknowledged that there was no long-run trade off between inflation and
unemployment (at about the time that Prime Minister James Callaghan made
the same point in a famous speech). |
| Could the Bank have mounted a full-scale
intellectual challenge to the Keynesian orthodoxy? Needless to say, it
did not, for a number of reasons. First, such a challenge would have
required whole-hearted commitment from the Governor of the Bank; but
none of the Governors during the period were trained economists with the
requisite views. If one of them had been such a person, it is a fair bet
that his successor, chosen by the government, would have been quite
different. It should be acknowledged that the IMF enforced necessary
changes in British official thinking about monetary policy in the late
1960s. It was not until the Richardson era (1973-83) that the Bank saw
any need for a serious dialogue with other critics. |
| Second, while the then-dominant Keynesian school
really had no explanation for inflation (other than bad luck), and no
cure (other than ineffective incomes policies), the opposing monetarist
position had its weaknesses, too. How should money be defined, exactly?
What about the awkward fact that, after Competition and Credit Control
(1971), the demand for money, on any definition, turned out to be
unstable? When the Bank did begin to express a view on monetary policy
strategy, Gordon Richardson was careful to make it clear that he was
embracing ‘practical’ monetarism (borrowing Paul Volcker’s phrase), and
not an ideology. His caution made him, and the Bank, deeply unpopular
with the newly-elected Thatcher administration, but it was
well-justified, as was demonstrated in 1980-81 by the coincidence of
rapid growth in broad money and deep recession in the economy. |
| Nevertheless it is clear from Professor Capie’s book
that, throughout the period, opinion in the Bank was generally concerned
that there was something wrong with government policies, especially
fiscal policy. So the Bank’s strategy could be described as ‘collaborate
and complain’. The Bank collaborated by doing its best to smooth the
government’s path in financial markets, for example by organising
seemingly-endless programmes of external support for sterling. It could
hardly do otherwise. At the same time, it complained that not enough was
being done to eliminate the need for such expedients. |
| This was not a particularly glorious strategy, and
the Bank did not always pursue it as effectively as it might have done.
The Bank gradually supplemented ‘collaborate and complain’ by
accumulating sufficient economic expertise to enable it to take a
leading role in designing monetary policy as the inadequacy of naïve
Keynesianism became more and more apparent during the 1970s. This meant
that when governments realised that they would have to pay a price to
overcome inflation, and that the price was worth paying, the
intellectual groundwork necessary for a new strategy had been done. This
is surely the Bank’s main monetary policy achievement of the 1970s. It
enabled the Bank to help manage a successful anti-inflationary monetary
policy in the early to mid-1980s. |
| Professor Capie also thinks that the Bank was too
timid in its market operations, for example being too ready to support
the gilt-edged market by making purchases when prices were falling. He
is probably right. However, the main thing that the Old Lady did that
Professor Capie thinks she ought not to have done is the Lifeboat
operation, and associated bank rescues, after the secondary banking
crisis in the 1970s. Professor Capie thinks that it was a bad idea,
though well-executed, and that “the same result might have been achieved
at much lower cost and without the danger of generating moral hazard.”
Such judgments are notoriously hard to make, particularly in the heat of
the moment. In this case, Gordon Richardson clearly thought that the
crisis threatened to have systemic consequences and that the operation
was justified in order to contain them, and in the light of the
prevailing financial and economic chaos of the time, it seems to me
likely that he was right. |
| All history, and any review of history books,
including this one, is written with the benefit of hindsight. The recent
financial crisis exposed a gulf between thinking about monetary policy
and thinking about bank supervision, which has been always perceived by
its practitioners as a mainly micro-economic activity. Communication
between supervisors and those responsible for monetary policy in the
Bank of England was, in my recollection, not close. One reason is that
it was hampered by the confidentiality provisions of the Banking Act,
and probably also by the fact that the supervisors were preoccupied
above all with the institutions for which they were regarded as
responsible. The latter was not entirely surprising, since if any bank
got into difficulties which became public knowledge, the public reaction
was (and still largely is) invariably to put all the blame on the
supervisors. More fundamentally, the objectives of supervision were
never, to my mind, adequately defined or codified, so that it was
impossible to relate them to the other functions of the Bank. |
| Professor Capie illuminates all these issues with an
impressive exposition, both of the facts and of the debates that
preceded important decisions. Recent events have been a reminder of the
importance of understanding economic history as well as economic theory,
and anyone interested either in the history of the period or in current
monetary policy is recommended to read his book. |
Bill Allen
Formerly Deputy Director of the Bank of England in each of its three
main areas: Monetary Stability; Markets; and Financial Stability. |
A longer version of this review is available at:
http://blog.enlightenmenteconomics.com/blog/_archives/2010/10/31/4668778.html
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