MPC proves itself for third year running

There was no birthday cake and no celebration yesterday when the Bank of England marked the end of its third full year of setting interest rates. Instead it was business as usual, with a simple statement announcing that borrowing costs had been left at 6% for the fourth consecutive month.

Operational independence for the Bank was Labour's first big decision following its victory in May 1997, coming just five days after the election. Gordon Brown set interest rates himself only once before coming up with a system under which the government would set an inflation target and charge the Bank's nine-strong monetary policy committee to hit it.

Some of the concerns expressed about the MPC when it was set up remain. There are some who argue that it is undemocratic to leave the main tool of economic policy in the hands of technocrats; others who say that independent banks inevitably err on the side of deflationary policies; still others who say that it is asking for trouble to have different hands on the monetary and fiscal policy levers.

All that said, however, the Bank's record in conducting monetary policy over the past three years has been good.

The economy is in its ninth year of growth, unemployment - measured by the claimant count, admittedly - is the lowest in the G7 at 3.9% and inflation - on a harmonised basis - is the lowest in the European Union. The government's target measure of inflation - which excludes mortgage interest payments - has remained close to its 2.5% target, and has been slightly below it for the past year.

No bed of roses

Not everything in the garden is rosy. While the economy has continued to expand, growth has been slower under Labour than it was under the Conservatives, and exporters have been rightly alarmed at the difficulties they have been caused by the strong pound.

But the fact remains that the gyrations of the economy have been much less pronounced in the most recent cycle than they were during the booms and busts of the 1970s, 1980s and early 1990s.

This may be the result of changing economic circumstances, with globalisation helping to keep the lid on inflation. It may be that the MPC has just been lucky, and has yet to be tested in a real recession. However, it is also the case that the government's decision to make the inflation target symmetrical - with an undershoot considered to be as serious as an overshoot - was a crucial factor in ensuring the MPC worked effectively.

The outside members of the committee have been well chosen, and have acted with sensitivity and no little skill. DeAnne Julius and Sushil Wadhwani have both made their presence felt on the committee, challenging the orthodox view.

The MPC began by increasing interest rates at each of its first three meetings. It believed that there had been a build-up of inflationary pressure in the run-up to the election and that this was likely to be exacerbated by the windfall gains for consumers from the demutualisation of building societies and insurance companies in the summer of 1997. The tightening continued into 1998, when the MPC made its one real blunder by pushing rates to 7.5% in June on the back of unreliable figures which appeared to show an acceleration in wage inflation.

With the global economy weakening rapidly, the Bank was guilty of overkill - and this became apparent when the Russian crisis blew up two months later.

The MPC then reacted swiftly and decisively, cutting rates seven times between September 1998 and June 1999. The easing of policy meant that although the economy was perilously close to recession in the winter of 1998/9 it did not actually tip over the edge, and by the summer of last year growth had recovered so quickly that the Bank felt the need once more for a touch on the brakes. As a result, rates were raised four times between September and February, but since then they have been left on hold at 6%, exactly where they were on election day in 1997.

Hyperactive

Only once - between November 1997 and June 1998 - has the MPC left rates unchanged for longer than in the most recent four-month period. The fact that it has moved rates 17 times in three years - double the eight changes in the three years leading up to May 1997 - has drawn accusations that the Bank has adopted a hyperactive stance, and is trying to do the impossible by fine-tuning the economy with minuscule base-rate variations.

Most of the moves have been justified either by the state of domestic and global economic conditions or by the remit laid down by the government, which means that the MPC has a single target - inflation - and a single policy instrument for hitting it - interest rates.

The argument that the government should change the remit to take into account the exchange rate is likely to fall on deaf ears. A more likely fate is that the MPC's reward for its success will be its abolition when Britain joins the euro.

There may not be many more birthdays to come.