Monetary Policy Committee

What is the Monetary Policy Committee?

The Bank of England's Monetary Policy Committee (MPC) is a specialised economic advisory panel responsible for setting the short-term base interest rate.

There are nine MPC members: the Bank's Governor, the two Deputy Governors, the Chief Economist, the Executive Director for Market Operations and four external members appointed by the Chancellor of the Exchequer. Each member has expertise in the field of economics and monetary policy.

The MPC convenes on a monthly basis to consider a broad range of economic data before publicly announcing its revised decisions on interest rates. Decisions are taken on the basis of a majority vote. The MPC also publishes a quarterly inflation report detailing prospects for the inflation rate in relation to the budget target. A Treasury representative attends meetings to ensure that the MPC is fully briefed on fiscal policy.

Background

In 1997, the new Labour Government gave the Bank of England the power to set interest rates. This followed a period of high interest rates in the early 1990s, peaking at 15 per cent. It was felt that Ministerial control over interest rates was not conducive to long-term economic stability, as multiple political factors had long clouded economic judgments about what monetary policy should be used for.

At the same time, the Treasury set a new inflation target, and it would be the Bank's duty to use its power to adhere to that target.

This new power was formalised by the Bank of England Act 1998, which also created the MPC on a statutory basis, requiring the Bank to "maintain price stability, and, subject to that, to support the economic policy of HM Government including its objectives for growth and employment."

The Chancellor restates the inflation target each year. It remained at 2.5 per cent, based on the RPIX measure of inflation, from 1997 until December 2003, when it was changed to 2.0 per cent, based on the new Harmonised Consumer Price Index measure of inflation.

If the actual rate of inflation misses the target by more than one per cent, the Bank must provide an explanation. Another 1997 change was the introduction of a symmetrical inflation target, which the Bank must seek to neither exceed nor fall below.

The decision to vest power in the Bank of England's Monetary Policy Committee was a major reform, as centrally held control of such monetary policy was historically vested in the elected body and was traditionally a major feature of Governmental power.

To temper any concerns about the transfer of this power, the Government retained ultimate sovereignty over the setting of the rate and granted only operational control over the attainment of a centrally determined inflation target.

Despite its relative youth, the MPC has been subject to intense scrutiny from within parliament and beyond, with the Treasury Select Committee alone having produced six reports by 2002. New appointees are also interviewed in public by the Treasury Committee.

The interest rate level has a significant impact on the functioning of the economy as a whole, influencing exchange rates, inflation, market rates, asset prices and the expectations and confidence of the market.

Controversies

There is broad consensus that the MPC has been a success, exemplified by the strong economy. However, concerns have been raised about the composition and appointment of the MPC, the publication of MPC minutes, forecasts issued by the MPC, and a variety of technical issues.

The creation of an independent Bank of England and the separation of monetary and fiscal policy control caused a great deal of controversy when the plans were first announced.

Opponents claimed that it would lead to a poorly co-ordinated economic policy and could potentially lead to conflict in fiscal and monetary policy aims, resulting in particular from an over-emphasis in setting rates to meet inflation targets at the expense of other factors such as the exchange rate.

In response, the Government highlighted the role the Treasury plays in keeping the MPC informed of fiscal management policy and stressed the Treasury's ultimate veto if it feels rates should be set at a different level.

There was controversy in 2001 when the Chancellor announced that the UK would operate under a new inflation rate calculation, replacing the RPIX with the CPI. Critics claimed the new calculation, introduced principally to harmonise European standards, distorted inflationary targets and performance and therefore hampered any attempts to properly assess the performance of the MPC.

In recent years, there have been complaints about the willingness of lenders and banks to respond to cuts in the Bank's base rates, resulting in the benefits of reductions not being passed on to borrowers. However, in November 2008 when the global economic crisis led to an unprecedented 1.5 percentage points cut in the base rate, banks such as HBOS, Lloyd's TSB and Abbey all passed on the full 1.5% cut to borrowers with standard variable rate (SVR) mortgages. But banks were said to have warned the Chancellor that following this unexpectedly high reduction, any further cuts would not be passed on in full.

Statistics

The Bank of England’s Monetary Policy Committee today voted to maintain the official Bank Rate paid on commercial bank reserves at 0.5%. The Committee also voted to continue with its programme of asset purchases totalling £275 billion financed by the issuance of central bank reserves.
The Committee expects the announced programme to take another three months to complete. The scale of the programme will be kept under review.

Source: Bank of England – November 2011

Quotes

"Four years into the crisis it is surely time to accept that the underlying problem is one of solvency not liquidity– solvency of banks and solvency of countries. Of course, the provision of additional liquidity support to countries or institutions in trouble can buy valuable time. But that time will prove valuable only if it is used to tackle the underlying problem."

Mervyn King, Governor of the Bank of England; from a speech to the Institute of Directors, Liverpool - October 2011