Financial crisis: Bank of England 'did not understand problem'
- guardian.co.uk, Monday 22 December 2008 08.26 GMT
The Bank of England underestimated the severity of the current financial crisis, according to its deputy governor who has admitted that interest rates are only a "blunt instrument" with which to control the economy.
Sir John Gieve told the BBC's Panorama programme, to be screened tonight, that new tools are needed to complement rates. He also admitted that the Bank knew "crazy borrowing" was taking place and the price of houses and other assets was rising unsustainably, but did not fully understand the problem.
"We didn't think it was going to be anything like as severe as it's turned out to be," says Gieve, who is in charge of financial stability at the Bank. "Why didn't we see that it was so serious? I think that's because we, perhaps, we hadn't kept pace with the extent of globalisation. So the upswing here didn't involve the big increases in earnings and consumption and activity which we saw in previous booms. We saw the credit, we saw the house prices, but we did see a fairly stable pattern of earnings, prices and output."
Explaining why the Bank did not raise interest rates to curb the lending and house price boom, Gieve says: "If we'd used interest rates to try and address this asset-price credit growth, we would have been holding down the level of activity elsewhere in the economy, in manufacturing, in other services, holding down the level of employment at a time when consumer price inflation and earnings were stable and reasonably low. And people would have said, you know, 'this is a wilful reduction in the prosperity of the country'."
The Bank cannot just rely on interest rates to control the economy, he argues. "One of the main lessons from this is that we need to develop some new instruments which sit somewhere between interest rates, which affect the whole economy and activity, and individual supervision and regulation of individual banks," Gieve says.
"Maybe we need to develop something which bridges that gap and directly addresses the financial cycle and prevents the financial cycle and the credit cycle getting out of hand ... I think we need to complement interest rates, which are a blunt instrument - you set one interest rate for the whole economy - with something which is more financial-sector specific."
"This is a major storm we haven't seen the like of for 100 years," he adds. "It would be very surprising if we weren't learning lessons from it and we are."
Gieve also casts doubt on whether the Treasury will get all of the money back that it has poured into the banking sector, pointing to a "level of defaults" in the books of nationalised lenders Northern Rock and Bradford & Bingley, which are now held by the taxpayer.
Speaking on the same programme, John Varley, the chief executive of Barclays, predicts that consumers and businesses will struggle to access credit for the next one to two years.
Sir John Gieve told the BBC's Panorama programme, to be screened tonight, that new tools are needed to complement rates. He also admitted that the Bank knew "crazy borrowing" was taking place and the price of houses and other assets was rising unsustainably, but did not fully understand the problem.
"We didn't think it was going to be anything like as severe as it's turned out to be," says Gieve, who is in charge of financial stability at the Bank. "Why didn't we see that it was so serious? I think that's because we, perhaps, we hadn't kept pace with the extent of globalisation. So the upswing here didn't involve the big increases in earnings and consumption and activity which we saw in previous booms. We saw the credit, we saw the house prices, but we did see a fairly stable pattern of earnings, prices and output."
Explaining why the Bank did not raise interest rates to curb the lending and house price boom, Gieve says: "If we'd used interest rates to try and address this asset-price credit growth, we would have been holding down the level of activity elsewhere in the economy, in manufacturing, in other services, holding down the level of employment at a time when consumer price inflation and earnings were stable and reasonably low. And people would have said, you know, 'this is a wilful reduction in the prosperity of the country'."
The Bank cannot just rely on interest rates to control the economy, he argues. "One of the main lessons from this is that we need to develop some new instruments which sit somewhere between interest rates, which affect the whole economy and activity, and individual supervision and regulation of individual banks," Gieve says.
"Maybe we need to develop something which bridges that gap and directly addresses the financial cycle and prevents the financial cycle and the credit cycle getting out of hand ... I think we need to complement interest rates, which are a blunt instrument - you set one interest rate for the whole economy - with something which is more financial-sector specific."
"This is a major storm we haven't seen the like of for 100 years," he adds. "It would be very surprising if we weren't learning lessons from it and we are."
Gieve also casts doubt on whether the Treasury will get all of the money back that it has poured into the banking sector, pointing to a "level of defaults" in the books of nationalised lenders Northern Rock and Bradford & Bingley, which are now held by the taxpayer.
Speaking on the same programme, John Varley, the chief executive of Barclays, predicts that consumers and businesses will struggle to access credit for the next one to two years.
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Majority of economists is talking about free market, about free pricing, but when it comes to the most important price on the market, the price of money, they suddenly turn their heads and completely accept the idea of setting interest rates administratively. And then are they surprised. Maybe reading some books of Austrian school economists would help. But I am sure they have read some of them. But the power to "control" the economy is sooo - obsessive...
ReplyDeleteTake care
Lorne