The Bank of England is being modernised, but don’t assume that things will work better. Gone are the days when its staff had a cosy relationship with City traders and held 'fireside chats'. Gone too is the 'raise of the governor's eyebrows' as a means of making the bank's policy wishes clear.
But while there is validity in the charge that past relations between the City and the Old Lady of Threadneedle Street were too clubby, the move away from 'constructive ambiguity' to 'clearly communicated' policy – in the words of deputy-governor Minouche Shafik – is not sufficient to ensure that the bank gets it right on financial markets going forward.
Let’s remember first of all why the Bank of England and other central banks such as the Federal Reserve and European Central Bank (ECB) failed to prevent the financial crisis. First of all they had the wrong philosophy; second they had the wrong tools.
The mainstream philosophy of central banks in the decades up to the financial crisis was that markets were self correcting and the right policy was to be as hands off as possible. Look into the research produced by central banks prior to the crisis and it’s clear that most had recognised that risk was being mispriced and there was too much leverage. The ECB’s former president, Jean-Claude Trichet, was particularly vocal on the subject.
But the philosophy was that those outliers who had really got their calculations wrong would go to the wall and the market as a whole would fall back into line. No one really anticipated the threat of a financial sector meltdown.
In the Bank of England’s case it was limited in what it could do about it anyway as the role of regulating the banks had been hived off into the independent Financial Services Authority.
Fast-forward to 2015 and the new philosophy is that macro prudential measures need to be taken to prevent risks building up in the total system – such things as altering the permissible loan-to-value ratios for mortgages to slow down the housing market. Also, both prudential and conduct oversight are now back under the Bank of England’s control.
So the new Bank of England has both the will to act as well as the means. But it also needs to be sure it has the right information and not all of this can come from economists’ spreadsheets. Some of it has to come from market information and even market gossip.
At the moment, the Bank of England is looking hard at how it did things previously. The latest episode is the news that the findings of an independent inquiry the bank commissioned into liquidity auctions during the financial crisis of 2007 and 2008 have been passed to the Serious Fraud Office, as reported in the press on March 5. It is not clear whether this concerns any Bank of England employees or relates more to the activities of bankers with the commercial banks.
But certainly the Bank of England, as both the guardian of the UK currency and financial stability, needs to be above and beyond reproach in all its dealings. However, it still needs to have its ear to the ground.
The problem with more formalised communications systems is that the freedom to speak out and the receptivity to listen can both be lost. The next time is bound to be different – without a good listening post and the right channels the world’s central banks may have the right philosophy and the right tools but miss the message.
Brian Caplen is the editor of The Banker.
