bain_y_howells__monetary_economics__policy_and_its_theoretical_basis

THE EVOLUTION OF MONETARY POLICY IN THE UK 345
been a source of recurrent criticism of ECB operating procedures (see Section
13.7). Evidence from financial markets suggests that both the introduction of
inflation targeting (and most of these arrangements) in 1992 and again the
switch to central bank instrument independence in 1997 had positive effects
on credibility and openness (see Section 12.5).
The rate of inflation, which had been running at over nine per cent in 1990,
fell to two per cent in 1993 and remained in the two-three per cent range until
1997 when the Bank of England was given formal independence. The observation
that countries with an independent central bank tended to have better
inflation records than those without had been made for some years. We examined
the arguments behind this alleged superiority in Section 8.5. But we
might note here that one of the reasons advanced was the increase in ‘credibility’
that we met earlier when UK monetary policy was linked to the £:DM
exchange rate. In this case, an unelected and independent central bank is less
likely to be subject to political pressure if and when it has to make unpopular
interest rate decisions. It should be remembered also that by 1997 it was clear
that some form of European monetary union would be inevitable in the near
future and plans were already underway for the creation of a European Central
Bank modelled on the Bundesbank. If the UK were to join at some point in
the future, then the Bank of England would need to have the independence
from government that other national central banks in the European System of
Central Banks would have. Changes were also made to the way in which the
Bank of England imposed interest rate changes through its money market
operations to bring them into line with European practice. This involved the
greater use of gilt repurchase agreements (strictly reverse repos) and less
reliance on the outright purchase of treasury and other eligible bills. (See
Sections 4.2 and 12.2).
At the same time, it was decided to relieve the Bank of England of two
functions which it had carried out for centuries, the management of government
debt and supervision of the banking system. In both cases, the intention
was to increase the Bank’s sense of independence and to increase its freedom
to set interest rates as required by the inflation trend with as few distractions
as possible. The responsibility for debt management passed to a newly created
‘debt management office’ or DMO, an agency of the Treasury, in 1998.
This was a recognition of the occasions, referred to above, where the Bank
had sometimes felt it necessary either to resist changes in interest rates in
order to stabilise bond prices or to adjust them to counter trends in bond prices
(the episodes of ‘leaning into the wind’). From now on, the state of the gilts
market would be ultimately a Treasury responsibility. Similar thinking played
a small part in the decision to transfer banking supervision to the Financial