Leah Downey is a junior research fellow at St. John’s College, Cambridge University and a visiting academic at the Sheffield Political Economy Research Institute.
When British Chancellor Kwasi Kwarteng announced his “mini-budget” to parliament on September 23, declaring his aim to achieve an economic growth rate of 2.5 percent, Prime Minster Liz Truss and her chancellor were asking the country to believe the only thing standing between the economy and growth was excessive taxation on the rich and a bit too much regulation on investment and production — no one believed them.
What’s more, what they offered to markets and Britons was a plan explicitly at odds with the Bank of England’s (BoE) policy position. Prior to the mini-budget, the BoE’s primary concern was inflation. Thus, the central bank had raised interest rates and was planning to initiate a round of “quantitative tightening” to slow the economy, take money out the system and thereby calm inflation — quite the opposite of the government’s efforts to spur growth by cutting taxes for the rich and stimulating spending.
Two economic policy arms of the British government are now working against each other.
What should we make of this? And does it matter that one of them is the elected government, while the other is an unelected, independent body of policymaking experts? Nowhere else do unelected independent bodies explicitly work against the stated intentions of the elected government — not in military affairs, education or immigration. So, why is this the case in economic policy?
To answer these questions, it’s important to keep two things separate: First, the basic question of what the best policy is for the U.K. to adopt, right here and right now. And on this front, other than the prime minister and the chancellor, pretty much no one thinks the mini-budget they proposed is the best strategy — even its two most stalwart supporters have since changed their minds about the package.
Second, and more fundamentally, what the relationship between the BoE and the elected legislature should be. What should the balance of power between independent elected experts and elected officials be when determining if, when, how and for whom to create money in our economy?
To this end, for the past three decades, countries around the world have made central banks independent in order to place the balance of power firmly with independent experts, attempting to strictly separate questions of monetary and fiscal policy. Under this regime, bankers are supposed to decide if, when and how to create new money to secure price stability, while the legislature is supposed to decide matters of distribution, taxation, public investment, borrowing and so on.
While it was convenient for both politicians and central bankers to believe this strict separation was possible, it’s never really been plausible. This first became obvious to everyone after the financial crisis, and the past week has made it clearer than ever: What the central bank does influences what the government can do, and what the government does influences what the central bank must do.
Currently, while the Truss government is insisting its efforts will fight recession and deliver economic growth, the BoE is working hard to slow the U.K. economy, which some economists say will necessarily lead to higher unemployment and likely recession.
Clearly, we cannot simultaneously avoid recession and spark growth and fight inflation by causing a recession. But who will win this battle? Who should win? And who is offering the better policy?
In a democracy, the general consensus is that elected officials should steer public policy because the people voted for them. They should be the ones to establish the fundamentals of the economy through fiscal policy, labor policy, environmental policy, immigration policy and so on. Meanwhile, it’s the job of the central bank to make sure the economy does the best it can given those politically determined fundamentals.
In other words, there seem to be good democratic reasons to think the elected branches of government should be in the driver’s seat.
Perhaps, then, there’s something to be said for the government’s stubbornness — the belief that elected representatives shouldn’t cower to the whims of financial markets, as politics can change the fundamentals of the economy. The problem is that the Truss government’s view of what will spark growth, of how to change the fundamentals of an economy, is about as wrong and lacking in evidence as possible.
In their view, growth will be generated by more investment from private financial markets, but in reality, and in light of the mini-budget, the very same investors the government hopes to court through tax cuts are so uninterested in investing in our economy that the BoE has had to step in and buy government bonds to prevent market collapse.
Truss and Kwarteng’s investors have essentially said, “no thanks.”
Nevertheless, the Truss government has — largely — held its course, presumably hoping these same investors will change their minds. And this stubbornness might be warranted if the government were defending a plan that could credibly deliver growth over the medium term without the good graces of private finance — a budget that borrowed to secure major investment in physical, social and environmental public infrastructure, for example. But instead, Truss’s government has set out a plan that requires the good graces of private finance, something it clearly doesn’t have.
Presumably, both the elected government and expert policymakers at the BoE are trying to do what they think is right for the economy. The central bank is trying to fight inflation the only way it knows how given existing economic fundamentals. The government, meanwhile, is trying to spark economic growth by changing those fundamentals.
One could take issue with the policy approaches of both. Some think that the BoE should be fighting inflation in a more targeted way, without resorting to damaging interest rate hikes. And nearly everyone thinks Truss’s government has the wrong approach to stimulating enduring economic growth.
What we mustn’t do, however, is let our opinions of whose policy is right obscure the more fundamental matter of how the elected government and the independent central bank should coordinate their economic policy strategies. Who should be in charge?
This matters because it’s about how our democracy works.
If we give up on the elected government now, on account of Truss and Kwarteng’s policy failures, and we ask the BoE to steer macroeconomic policy, we’ll be limiting the capacity of our democratically elected officials going forward. Imagine a new government with a large mandate to address climate change — would we want them to be similarly limited by the BoE?
Getting our democracy to work better requires separating democratic considerations, like who should be steering the economic ship, from policy opinions, like where they should be steering it to. Those who fail to do this, end up throwing out the democratic baby with the bad policy bathwater.
