David Davis MP writes for The Telegraph on the Bank of England’s operational independence


As published by the Telegraph:

I have to feel some sympathy for Rishi Sunak. He has faced some of the most testing economic challenges in modern times, yet the two most powerful institutions that he depends on have essentially failed him. The Bank of England last year was forecasting a 3 per cent or so blip in inflation, now it is forecasting a 10 per cent level that may not go away. In essence they thought the problem was going to be easily manageable, and now it is turning into a nightmare.

In March 2021 the Treasury and Office of Budget Responsibility estimated the need for public borrowing for 2021-22 at £234 billion, but the outturn was £145 billion, an error of almost £90 billion. They massively underestimated the amount of tax that would be paid. In practice the United Kingdom paid £718 billion in tax, the highest in history. The Treasury/OBR failed to forecast this because they always underestimate the buoyancy of tax when growth increases.

These two enormous errors have very sizeable consequences. Firstly the Bank’s error meant that the Chancellor was led to believe that the inflation problem for ordinary families was much less than it is turning out to be, and that delayed and reduced his response.

Secondly the massive underestimate of tax revenue meant that the Treasury was taking money from citizens when they did not need to. To put it in context, £90 billion additional tax revenue means that we are taking about £3,000 more from every household than we expected, so there was no necessity to take another £12 billion for the NHS/Social Care fund.

What is more, the Bank’s error was to a large extent self inflicted. The Bank’s QE strategy amounts to effectively printing money and buying bonds to minimise interest rates. This is a smart idea when we are trying to offset economic shocks, but it carries enormous inflationary risks at other times. John Redwood highlighted this in the Commons when he challenged the Chancellor over the many billions of cash that the Bank created from the end of 2020 through 2021.

And to those who think that the whole problem is a function of wars and shortages, look at other countries. Differences in monetary policy are a major contributory reason why countries like Switzerland and Japan manage to maintain much lower inflation rates in the face of energy and food price shocks.

So there is a real question as to whether the “independence” of the Bank of England is worth maintaining. It has been in place since the early Blair years, but that has been a largely benign inflationary environment. Today its mistakes are beginning to have large consequences, and the Chancellor will shoulder the blame for its failures.

The independence is to a significant extent illusionary anyway. The Chancellor has to approve the money creation and the underwriting of the bonds in any event, so perhaps it is time that Parliament required the Treasury to recognise and defend its role in this policy. That way we might get better decisions.

Where Parliament has an explicit responsibility is over the question of tax. Because of the shoddy forecasting, the discussion to date has been about a series of competitive illusions rather than hard facts. Treasury Ministers mutter about balancing the books. Even the strictest fiscal conservative knows that you balance the books over a full economic cycle not one year, and certainly not a year when you have not recovered from a once in a generation economic crisis. Furthermore, in doing such a calculation you have to work out the effect of tax increases on growth, and therefore upon the tax yield over the whole cycle.

High taxes damage growth, and that damages tax returns. The windfall levy is a good example of this. Firstly because of the complex offsets in it, it is very unlikely indeed to raise the £5 billion predicted. What it will do however is make companies in all industries, not just energy, worry about the attitudes to tax and profits of the British State. Over the decades British governments have used windfall taxes about five times on energy and banking companies, and that creates a real deterrent to investment. That will damage growth, and cut the long term tax base.

The truth is that we should have used the huge tax buoyancy shown by the British economy last year to cancel all the pipeline tax increases. A number of us predicted that if we did not do this the growth rate would be harmed, and that is precisely what happened last month. This is now extraordinarily dangerous.

The Governor of the Bank of England, having missed his forecast the first time around, is now predicting something that looks very like stagflation, the crippling combination of low growth and high inflation. The best protection against that economic malaise is a high intrinsic growth rate. Without that all the answers to the high inflation are horribly painful.
So what the government should not be doing now is overtaxing us and then handing us back our cash like pocket money. It should be taking every opportunity possible to cut or cancel taxes in pursuit of growth. It should certainly not be introducing any new taxes, like the currently touted online tax, until our economy is on a steady growth path with inflation under control.